What are the determinants of the price elasticity of supply?

… a core concept in Economic Analysis and Atlas102

Click for MRU video

Concept description

The elasticity of supply is a measure of how responsive the quantity supplied is to a change in price:

Elasticity of supply = the percentage change in quantity supplied divided by the percentage change in price

If the absolute value of the elasticity of supply is <1,  the supply curve is inelastic; if it is >1 the supply curve is inelastic; if it is =1, the supply curve is unit elastic.

Alex Tabarrok elaborates in his MRU video (link above right, reference below). He notes that, although elasticity is not exactly the same a the slope of the line, they are related and presents the following simple rule: If two linear supply curves run through a common point, then at any given quantity, the curve that is flatter is more elastic.

Determinants of the elasticity of supply

Tabarrok lists the following determinants:

1. Change in per-unit costs with increased production (the fundamental determinant)
   1. If increased production requires much higher costs, then the supply curve will be inelastic
   2. If production can increased with constant costs then the supply curve will be elastic
2. Time horizon
   1. Immediately following a price increase, producers can expand output only using their current capacity, making supply inelastic
   2. Over time, however, producers can expand their capacity, making supply elastic
3. Share of the market for inputs
   1. Supply is elastic when the industry is a small demander in its input markets because supply can be expanded without causing a big increase in the demand for the industry’s inputs
   2. Supply is inelastic when the industry is a big demander in its input markets
4. Geographic scope
   1. The narrower the scope of the market of a good, the more elastic its supply
   2. The wider the scope of the market of a good, the less elastic its supply

This can be summarized in the following table:

Elasticity and the slave redemption program in Sudan

Click for MRU video

Tyler Cowen (reference below, video on right) uses these principles to analyze the effectiveness of the 1990s humanitarian initiative to buy the freedom of slaves in Sudan. As indicated in the diagram to the right, the evidence from the change in the market redemption price over time suggests that the longer term supply curve (flatter blue line) is rather elastic and that the humanitarian program was actually leading to the enslavement of more people, at least until their freedom was purchased through the program.

The program is analyzed in more detail in the first 8 minutes of a second Tabarrok video (reference below; diagram and video directly below. Tabarrok calculates that the program may have led to a net of 400 slaves freed, but at the cost of the at least temporary enslavement of 1,200 people.

Click for MRU video, minutes 0:00 to 8:00

Gun buyback programs

Tabarrok is even more definitive about the futility of municipal guy buyback programs, given the highly elastic supply of guns in a local market, as seen on the diagram below.

Click for MRU video, minute 8:00 to end

Practice questions

See http://www.mruniversity.com/node/186778, http://www.mruniversity.com/node/186779, and http://www.mruniversity.com/node/186780, accessed 28 April 2016.

1. Which of the two goods is more likely to be elastically supplied?
   1. Supply of apples over the next growing season
   2. Supply of apples over the next decade
2. Which of the two goods is more likely to be elastically supplied?
   1. Supply of construction workers in Binghamton, NY
   2. Supply of construction workers in New York State
3. Which of the two goods is more likely to be elastically supplied?
   1. Supply of breakfast cereal
   2. Supply of food
4. Which of the two goods is more likely to be elastically supplied?
   1. Supply of gold
   2. Supply of computers
5. If a new process for manufacturing diamonds is created, will the supply curve for diamonds become more elastic or more inelastic?
   1. More elastic
   2. More inelastic
6. If pesticides and fertilizers are banned, will the supply curve for food become more elastic or more inelastic?
   1. More elastic
   2. More inelastic
7. If a larger share of oil output is required to make plastic, will the supply curve for plastic become more elastic or more inelastic?
   1. More elastic
   2. More inelastic
8. In 1993, then President Clinton passed a law raising income taxes. This tax hike was fully expected: He campaigned on it in 1992. What do you expect happened to executive income in the first year of the tax increases? What about in subsequent years? Hint: Top executives have a lot of power over when they get paid for their work: They can ask for bonuses a bit earlier, or they can cash out their stock options a bit earlier. Literally, this isn’t their “labor supply,” it’s more like their “income supply.” 
   1. In the first year income will decrease; in the long run it will decrease
   2. In the first year income will decrease; in the long run it will remain nearly the same
   3. In the first year income will increase; in the long run it will decrease
   4. In the first year income will increase; in the long run it will remain nearly the same
9. Economist Austen Goolsbee estimated that the short-run elasticity of “income supply” for these executives was 1.4, while the long-run elasticity of “income supply” was 0.1. (Note: Goolsbee used a variety of statistical methods to look for these elasticities, and all came to roughly the same result.) If taxes pushed down their take-home income by 10%, how much would this cut the amount of income supplied in the short run? In the long run?
   1. Short run income would decrease 10%; long run income would decrease 1%
   2. Short run income would decrease 14%; long run income would decrease 1%
   3. Short run income would decrease 10%; long run income would decrease 2%
   4. Short run income would decrease 14%; long run income would decrease 2%
10. For which of the following products would you expect the largest increase in price for the same increase in demand?
    1. Flashlights
    2. Pens
    3. A first edition of Adam Smith’s The Wealth of Nations
    4. Jeans
11. A good is more elastic when
    1. it is easy to produce more at the same cost
    2. it is made from rubber
    3. it is difficult to produce more at the same cost
    4. the marginal cost is equal to the price
12. In the world of fashion, the power to imitate a trendy look is the power to make money. Stores like H&M and Forever 21 focus on imitating fashions wherever possible: As soon as they see that a new look is coming along, something people are willing to pay a high price for, they start cranking out that look. Do these imitation-centered stores make the supply of clothing more elastic or more inelastic?
    1. More elastic
    2. Less elastic 
13. A lot of American action movies are quests to eliminate a villain. If in real life villains are elastically supplied (like guns for buyback programs), should we care whether the hero captures a particular villain?
14. Suppose that drug addicts pay for their addiction by stealing: So the higher the total revenue of the illegal drug industry, the higher the amount of theft. If a government crackdown on drug suppliers leads to a higher price of drugs, what will happen to the amount of stealing if the demand for drugs is elastic?
    1. The overall amount of stealing will decrease
    2. The overall amount of stealing will increase
    3. The overall amount of stealing will remain the same
15. Suppose that drug addicts pay for their addiction by stealing: So the higher the total revenue of the illegal drug industry, the higher the amount of theft. If a government crackdown on drug suppliers leads to a higher price of drugs, what will happen to the amount of stealing if the demand for drugs is inelastic?
    1. The overall amount of stealing will decrease
    2. The overall amount of stealing will increase 
    3. The overall amount of stealing will remain the same
16. Immigration is a fact of life in the United States. This will lead to a big boost in the labor supply. What field would you rather be in?
    1. A field where the demand for your kind of labor is elastic
    2. A field where the demand for your kind of labor is inelastic
17. We saw that a gun buyback program was unlikely to work in Washington, D.C. If the entire United States ran a gun buyback program, would that be better at eliminating guns or worse? Hint: Is the supply of guns at a national level more elastic or more inelastic?

Source

Alex Tabarrok, Elasticity of Supply, Marginal Revolution University, 14-minute video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/elasticity-supply-midpoint-formula, accessed 28 April 2016.

Tyler Cowen, Elasticity and Slave Redemption, 5-minute video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/elasticity-example-slave-redemption-sudan, accessed 28 April 2016.

Alex Tabarrok, Applications Using Elasticity, Marginal Revolution University, 16-minute video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/elasticity-examples-applications, accessed 28 April 2016.

Atlas topic and subject

Consumer Theory and Elasticity of Demand and Supply (core topic) in Economic Analysis.

Page created by: Ian Clark, last modified on 28 April 2016.

Image: Minute 0.50 of MRU Video,at http://www.mruniversity.com/courses/principles-economics-microeconomics/elasticity-supply-midpoint-formula, accessed 28 April 2016.