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Ten Principles of Economics - Part 11

Ten Principles of Economics - Part 11. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 5 ELASTICITY AND ITS APPLICATION 105 responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price. The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce. For example beachfront land has an inelastic supply because it is almost impossible to produce more of it. By contrast manufactured goods such as books cars and televisions have elastic supplies because the firms that produce them can run their factories longer in response to a higher price. In most markets a key determinant of the price elasticity of supply is the time period being considered. Supply is usually more elastic in the long run than in the short run. Over short periods of time firms cannot easily change the size of their factories to make more or less of a good. Thus in the short run the quantity supplied is not very responsive to the price. By contrast over longer periods firms can build new factories or close old ones. In addition new firms can enter a market and old firms can shut down. Thus in the long run the quantity supplied can respond substantially to the price. COMPUTING THE PRICE ELASTICITY OF SUPPLY Now that we have some idea about what the price elasticity of supply is let s be more precise. Economists compute the price elasticity of supply as the percentage change in the quantity supplied divided by the percentage change in the price. That is Percentage change in quantity supplied Price elasticity of supply ---------------- ------ ---- -------. Percentage change in price For example suppose that an increase in the price of milk from 2.85 to 3.15 a gallon raises the amount that dairy farmers produce from 9 000 to 11 000 gallons per month. Using the midpoint method we calculate the percentage change in price as Percentage change in price 3.15 - 2.85 3.00 X 100 10 percent. Similarly we calculate the percentage change in quantity .