In this situation, the average quantity of coffee supplied is (100,000 + 120,000) / 2 = 110,000 kilograms, and the average price of coffee is ($8 + $10) / 2 = $9 per pound. So, the percentage change in quantity is (120,000 - 100,000) / 110,000 = 18.18% and the percentage change in price is (10 - 8) / 9 = 22.22%. Thus, the elasticity of supply is 18.18 / 22.22 = 0.82.
Factors that influence the elasticity of supply are: (1) the available substitutes for resources (inputs) used to produce the good and (2) the time that has elapsed since the price change.
Available resource substitutions. When a good or service can onlv be produced using unique or rare inputs, the elasticity of supply will be low. Thai is, the short-run supply curve mav be nearly vertical for these goods. On the other hand, consider agricultural goods such as sugar and rice. 1 lie.se tioods can be urown using the same land (resources!, and the opporuinirv cost of substituting one lor the other is nearly constant. As such, both of these products have highly elastic (nearly horizontal) supply curves.
Supply decision time frame. 1 hree lime-dependent supply curves must be considered v\hen evaluating how the length of time following a price change affects the elasticity of supply: (1) momentary supply, (2) short-term supply, and (3) long-term supply.
1. Momentary supply refers to the change in the quantity of a good supplied immediately following the price change. When producers cannot change the output of a good immediately, the momentary supply curve is vertical or nearly vertical, and the good is highly inelastic. Grapes and oranges are examples of goods for which the quantity produced cannot be immediately changed in response to price changes. On the other hand, goods such as electricity have nearly perfectly elastic momentary supply curves. No matter what the demand for clectricitv, the amount provided can be changed without a significant change in price.
2. Short-term supply refers to the shape a supply curve takes on as the sequence of long-term adjustments are made to the production process. For example, manufacturing firms will adjust the amount of labor they use in response to a price change. The resulting increase or decrease in the cost of this input changes the shape of the supply curve. As time passes, additional adjustments may be made, such as technological innovations and training new workers, which will further change the shape of the supply curve, making it more elastic the longer the adjustment period.
3. Long-term supply refers to the shape of the supply curve after all of the possible ways of adjusting supply have been employed. This is usually a lengthy process. It may involve building new factories or distribution systems, and training workers to operate them. Typically, long-term supplv is more elastic than short-term supply, which is more elastic than momentary supply.
LOS 13.b: Calculate elasticities on a straight-line demand curve, differentiate among elastic, inelastic, and unit elastic demand, and describe the relation between price elasticity of demand and total revenue.
Price elasticity of demand is different at different points along a linear demand curve. Consider the demand curve presented in Figure 3.
Figure 3: Price Elasticity Along a Linear Demand Curve
• At point (a), in a higher price range, the price elasticity of demand is greater than at point (c) in a lower price range.
• Price elasticity in the $6 to $7 range is [(20 - 30) / 25] / [(7 - 6) / 6.5] = -2.6.
• Price elasticity in the $1 to $2 range is [(70 - 80) / 75] / [(2 - 1) / 1.5] = -0.2.
• The elasticity at point (b) is -1; a 1% increase in price leads to a 1% decrease in quantity demanded. This is the point of greatest total revenue (P x Q) which equals 4.50 x 45 = $202.50.
• At prices less than $4.50 (inelastic range) total revenue will increase when price is increased. The percentage decrease in quantity demanded will be less than the percentage increase in price.
• At prices above $4.50 (elastic range) a price increase will decrease total revenue since the percentage decrease in quantity demanded will be greater than the percentage increase in price.
Thus, we can use a total revenue test to estimate elasticity of demand. If an increase (decrease) in price increases (decreases) total revenue, then demand is inelastic. If total revenue moves inversely to price (decreases with a price increase or increases with a price decrease), then demand is elastic at the current price.
Professor's Note: It is important that you notice that price elasticity of demand changes as you move along the demand curve. Elasticity is not simply the slope of the demand curve!
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