Supply

Elasticities of supply also differ from the long run to the short run. For most products, long-run supply is much more price elastic than short-run supply

7 This includes imports, which were capturing a growing share of the U.S. market Domestic auto sales fell by even more.

FIGURE 2.15a Primary Copper: Short-Run and Long-Run Supply Curves. Like most goods, supply is more elastic in the long run. If price increases, firms would like to produce more but are limited by capacity constraints in the short run. In the longer run, they can add to capacity and produce more.

FIGURE 2.15b Secondary Copper: Short-Run and Long-Run Supply Curves. If price increases, there is a greater incentive to convert scrap copper into new supply, so initially secondary supply (i.e., supply from scrap) increases sharply. But later, as the stock of scrap falls, secondary supply contracts. Secondary supply is therefore less elastic in the long run than in the short run.

FIGURE 2.15a Primary Copper: Short-Run and Long-Run Supply Curves. Like most goods, supply is more elastic in the long run. If price increases, firms would like to produce more but are limited by capacity constraints in the short run. In the longer run, they can add to capacity and produce more.

FIGURE 2.15b Secondary Copper: Short-Run and Long-Run Supply Curves. If price increases, there is a greater incentive to convert scrap copper into new supply, so initially secondary supply (i.e., supply from scrap) increases sharply. But later, as the stock of scrap falls, secondary supply contracts. Secondary supply is therefore less elastic in the long run than in the short run.

because firms face capacity constraints in the short run and need time to expand their capacity by building new production facilities and hiring workers to staff them. This is not to say that supply will not increase in the short run if price goes up sharply. Even in the short run, firms can increase output, by using their existing facilities more hours per week, paying workers to work overtime, and hiring some new workers immediately. But firms will be able to expand output much more given the time to expand their facilities and hire a larger permanent work force.

For some goods and services, short-run supply is completely inelastic. Rental housing in most cities is an example. In the very short run, because there is only a fixed number of rental units, an increase in demand only pushes rents up. In the longer run, and without rent controls, higher rents provide an incentive to renovate existing buildings and construct new ones, so that the quantity supplied increases.

For most goods, however, firms can find ways to increase output even in the short run, if the price incentive is strong enough. The problem is that be-

table 2.3 Supply of Copper

Price Elasticity of:

Short-run Long-run

Primary supply Secondary supply

Total supply

0.25

1.50

cause of the constraints that firms face, it is costly to increase supply rapidly, so that it may require a large price increase to elicit a small short-run increase in supply. We discuss these characteristics of supply in more detail in Chapter 8, but for now it should be clear why for many goods, short-run and long-run supply curves resemble those in Figure 2.15a. (The figure refers to the supply of primary [newly mined] copper, but it could also apply to many other goods.)

For some goods, supply is more elastic in the short run than in the long run. Such goods are durable and can be recycled as part of supply if price goes up. An example is the secondary supply of metals (i.e., the supply from scrap metal, which is often melted down and refabricated). When the price of copper goes up, it increases the incentive to convert scrap copper into new supply, so that initially secondary supply increases sharply. But eventually the stock of good-quality scrap will fall, making the melting, purifying, and refabricating more costly, so that secondary supply will contract. Thus the long-run price elasticity of secondary supply is smaller than the short-run elasticity.

Figures 2.15a and 2.15b show short-run and long-run supply curves for primary (production from the mining and smelting of ore) and secondary copper production. Table 2.3 shows estimates of the elasticities for each component of supply, and then for total supply, based on a weighted average of the component elasticities.8 Because secondary supply is only about 20 percent of total supply, the price elasticity of total supply is larger in the long run than in the short run.

EXAMPLE 2-5 THE WEATHER IN BRAZIL AND THE PRICE OF COFFEE IN NEW YORK

Subfreezing weather occasionally destroys or damages many of Brazil's coffee trees. Because Brazil produces much of the world's coffee, the result is a decrease, in the supply of coffee and a sharp run-up in its price. A dramatic example of this occurred in July 1975, when a frost destroyed most of

8 These estimates were obtained by aggregating the regional estimates reported in Franklin M. Fisher, Paul H. Cootner, and Martin N. Baily, "An Econometric Model of the World Copper Industry," Bell Journal of Economics 3 (Autumn 1972): 568-609.

(a)

Price

\ .

S' s //

p2

/

Po

77

(

1

Q2 Qq Quantity (b)

FIGURES 2.16a, b, and c Supply anrfDemand for Coffee. (a) A freeze in Brazil causes the supply curve to shift to the left. In the short run, supply is completely inelastic; only a fixed number of coffee beans can be harvested. Demand is -also relatively inelastic; consumers change their habits only slowly. As a result, the initial effect of the freeze is a sharp increase in price, from Po to Pi. (b) In the intermediate run, supply and demand are both more elastic, so price falls part way back,to P2. (c) In the long run, supply is extremely elastic; new coffee trees will have had time to mature, so the effect of the freeze will have disappeared. Price returns toPo.

Brazil's 1976-1977 coffee crop. (Remember that it is winter in Brazil when it is summer in the northern hemisphere.) The spot price of a pound of cof fee in New York went from 68 cents in 1975 to $1.23 in 1976, and then to $2.70 in 1977.

The run-up in price following a freeze is usually short-lived, however Within a year price begins to fall, and within three or four years it returns to its prefreeze level. For example, in 1978 the price of coffee in New York fell to

$1.48 per pound, and by 1983 it had fallen in real (inflation-adjusted) terms to within a few cents of its prefreeze 1975 price.9

Coffee prices behave this way because both demand and supply (especially supply) are much more elastic in the long run than in the short run. Figures 2.16a, 2.16b, and 2.16c show this. Note that in the very short run (within one or two months after a freeze), supply is completely inelastic; there are simply a fixed number of coffee beans, some of which have been damaged by the frost. Demand is also relatively inelastic. As a result of the frost, the supply curve shifts to the left, and price increases sharply, from Po to Pi.

In the intermediate run, say, one year after the freeze, both supply and demand are more elastic, supply because existing trees can be harvested more intensively (with some decrease in quality), and demand because consumers have had time to change their buying habits. The intermediate-run supply curve also shifts to the left, but price has come down from Pi to Pi The quantity supplied has also increased somewhat from the short run, from Qi to Q2. In the long run, price returns to its normal level; coffee growers have had time to replace the trees damaged by the freeze. The long-run supply curve, then, simply reflects the cost of producing coffee, including the costs of land, of planting and caring for the trees, and of a competitive rate of profit.

Was this article helpful?

0 0
Trash Cash Machine

Trash Cash Machine

How recyclable trash can save the world and bank us huge profits! Get All The Support And Guidance You Need To Be A Success At Recycling! This Book Is One Of The Most Valuable Resources In The World When It Comes To How To Make Profits With Trash!

Get My Free Ebook


Post a comment