Question

If demand is elastic, will shifts in supply have a larger effect on equilibrium quantity or on price?

Short answer

In the case of elastic demand, shifts in supply will have a larger effect on the equilibrium quantity than on the price. This is because, with elastic demand, consumers are highly responsive to changes in price, leading to significant changes in the quantity demanded when supply shifts either positively (increase in supply) or negatively (decrease in supply).

Step-by-step solution

Understanding Elastic Demand

Elastic demand refers to a situation where the quantity demanded of a good or service is highly responsive to changes in its price. In other words, when the price of a product increases, the quantity demanded decreases significantly and vice versa. This is represented by a demand curve that is relatively flat or has a high price elasticity of demand (coefficient greater than 1 in absolute terms).

Shifts in Supply

A shift in supply means that there is a change in the quantity of a good or service available in the market at various prices. This can occur due to a number of factors such as changes in production costs, technological improvements, or changes in the number of suppliers. A shift can be positive (increase in supply) or negative (decrease in supply), represented by a rightward or leftward shift of the supply curve, respectively.

Effect on Equilibrium Quantity and Price

When there is a shift in supply, it will lead to a change in the market equilibrium point, where the quantity demanded equals the quantity supplied. To analyze the impact of supply shifts on equilibrium quantity and price, it's important to consider the elasticity of demand.

Elastic Demand and Supply Shifts

In the case of elastic demand, consumers are highly responsive to price changes. Therefore, when there is a shift in supply: 1. Positive Supply Shift (increase in supply): With an increase in supply, the supply curve shifts rightward, leading to a lower market price. Since demand is elastic, consumers will be highly responsive, and the quantity demanded will increase significantly. The effect on the equilibrium quantity will be larger than the effect on the price. 2. Negative Supply Shift (decrease in supply): With a decrease in supply, the supply curve shifts leftward, leading to a higher market price. As the demand is elastic, consumers will be highly responsive, and the quantity demanded will decrease significantly. Similar to the positive supply shift, the effect on the equilibrium quantity will be larger than the effect on the price. To summarize, when demand is elastic, shifts in supply will have a larger effect on the equilibrium quantity than on the price.

Key concepts

Equilibrium Quantity

Equilibrium quantity is the amount of a product or service where demand and supply meet, establishing a market price. When the demand for a product is elastic, the quantity of goods that buyers are willing to purchase changes significantly with a slight fluctuation in price. This high sensitivity can lead to major changes in the equilibrium quantity, especially when the supply shifts.

Imagine a street market where different vendors sell oranges. If numerous vendors suddenly enter the market, increasing the overall supply of oranges (shift rightward), and assuming the demand for oranges is elastic, consumers will be more inclined to buy much more due to the lower prices. Conversely, if some vendors leave, the supply decreases (shift leftward), and the prices go up. Nonetheless, because the demand is elastic, buyers will buy significantly fewer oranges. This scenario demonstrates that shifts in supply can have a dramatic impact on the equilibrium quantity when dealing with elastic demand products.

Supply Shifts

Supply shifts occur when the availability of a product changes due to external factors, such as advances in technology, alterations in production costs, or changes in the number of suppliers. These shifts can be illustrated graphically by a supply curve moving either to the right (increase in supply) or left (decrease in supply).

For example, consider advances in farming technology. These innovations can lead to a positive shift in the supply of crops, resulting in more produce available in the market at lower prices. On the other hand, if there's a sudden increase in the price of oil, transportation costs rise, production costs go up, and farmers may be unable to supply the same quantity of crops at previous prices, leading to a negative supply shift. In both scenarios, the intersection point between the demand and the new supply curve will establish a new equilibrium quantity and price.

Price Elasticity of Demand

Price elasticity of demand showcases how the quantity of a good demanded responds to changes in its price. In essence, it measures the receptiveness of consumers to price movements. If the demand for a product is deemed elastic, like in our previous examples, a relatively small price decrease will lead to a disproportionately larger increase in the quantity demanded.

For instance, let's take another look at the orange market. If the price of oranges goes down by 10%, and consumers respond by purchasing 20% more oranges, the price elasticity of demand for oranges would be considered elastic because the percentage change in quantity demanded (20%) is greater than the percentage change in price (10%). This strong response to price changes is a pivotal factor when evaluating the implications of supply shifts on market outcomes, particularly the equilibrium quantity, as it dictates how the market adjusts to new conditions.