Send us your blog post, blog address, address of other great sites or suggestions by email.

Sunday, September 9, 2012

Elasticity of Supply and Demand

We take now a further important step in our investigation with the establishment of the fact that the degree to which supply and demand react to price changes differs on different markets. On one market a twofold increase in price results in a somewhat less than twofold increase in supply, and reduces demand somewhat less than half; on another market changes in supply and demand will exceed markedly (in quantitative terms) the price changes that have given rise to them. The elasticity of supply and the elasticity of demand are in the first case low and in the second, high. The degree of elasticity of supply and demand (coefficient of elasticity) has, in turn, a significant bearing on the character of price formation on the several markets. A simple example will make this clear.
The Christmas season is hardly a period in which we could expect that people, preoccupied as they generally are with other thoughts, would take the time to reflect on an interesting Christmas problem in economics, namely, the peculiar situation of the Christmas tree market on the day before the holiday. The first thing we find is that the elasticity of demand for Christmas trees is indubitably low. This is so because it would require a very marked rise in price to make the average family give up the idea of having a Christmas tree and, on the other hand, because it would require a very marked decrease in price to induce the average family to buy more than one. The day before Christmas, the supply of Christmas trees is inelastic too, seeing that it cannot be increased by additional cutting of trees nor diminished by putting them in storage. Twenty-four hours later the trees are no more than ordinary cut pines which can be used, at best, only as a covering for rose bushes or as firewood. The effect of this two-sided inelasticity on the Christmas tree market is clear: if there are too few trees on the market, a very marked rise in price is required to equate supply and demand; if there are too many trees a very pronounced fall in price is needed, a fall which may even reach the “firewood” point. Everyone, in fact, has had the experience of discovering that just before the holiday, Christmas trees are ordinarily either very cheap or very expensive. Supply and demand, given their inelasticity, cannot yield. Hence it is the price which must yield all the more in order to reestablish market equilibrium. The smaller is the elasticity of supply and demand, the greater is the flexibility of prices. This principle allows us to understand more precisely the characteristics of the several different kinds of market.2
Of special interest to us is the agricultural products market. Corresponding to the low elasticity of demand for food (of which we have already spoken in Chapter I), the elasticity of demand for agricultural products is generally not very high. Although we should not underestimate the elasticity of demand for the more expensive quality products of agriculture (butter, eggs, vegetables, meat, etc.), this elasticity is certainly low for the various bread grains. Since in the short run the supply of grains is also very inelastic, we can understand why as early as the 17th century an English statistician, Gregory King, could formulate the rule that the price of grains is usually subject to fluctuations greater than the corresponding harvest fluctuations (King’s rule). If the supply is too great, a sharp fall in price is needed to stimulate demand sufficiently to clear the market, and if the supply is too small an equally sharp rise in price is necessary to restrain demand sufficiently. From which it follows that the farmers, under certain circumstances, may stand to gain more from a poor harvest than from an abundant one. Proof (among others) of this fact is supplied by the American cotton farmers in the state of Alabama who in 1919 raised a monument in honor of a harmful insect, the boll weevil, in gratitude for its partial destruction of the huge price-depressing cotton crop of that year. If we add that the agricultural markets are characterized by still other anomalies, we can readily see that they represent a case apart in the formation of prices, a circumstance which confronts the agricultural policymakers with a number of crucial and important tasks.3
The labor market must also, as a rule, be considered as presenting a special and difficult type of price formation, though the laws of price can be applied to it in the same way as to the commodities market. While the elasticity of demand for labor differs in the different phases of a cyclical movement, declining to a very low point in the depression phase, the elasticity of supply, at least for the skilled trades, may be said to be decidedly low. This is so because human labor, lacking financial reserves for the most part, cannot be put in “storage” for very long. Then again, due to the time required for its training and to its great immobility, the labor force can be expanded over the short run only within narrow limits. This low elasticity of the labor supply can be increased by all sorts of politico-social measures such as aid to the unemployed which augments their “storageableness,” by retraining programs, establishment of more effective communication between the supply and demand sides of the labor market via improvements in employment agencies’ techniques, etc. The longer the period of training required for a given kind of labor, the more delayed will be the adaptation of supply to the market situation and, by the same token, the more difficult it will be. A good example of this is the academic labor market, in the several branches of which conditions of oversupply are easily changed to situations of shortage and vice versa; and we can appreciate that the advice of a wise uncle to his nephew, to study for the profession most in vogue at the moment, will remain wise advice only so long as there are not too many such uncles and nephews.
There are some special considerations respecting the elasticity of supply which merit our attention here. The most important of these is that elasticity is ordinarily smaller in the short run than in the long run. This is all the more likely to be the case the longer the time required to produce or to transport the goods to market, and the bigger the losses that would be sustained by withholding them from the market. This is why supply on the fish markets is, at any given moment, extraordinarily inelastic and subject to the caprice of demand, while from one fishing day to another, it can recover all its elasticity. The same is true for practically all the food markets—the result of which may be the appearance of vexatious disturbances and bottlenecks in such markets. Their elimination is an important task of economic policy. The stock exchanges, also, offer us examples of markets on which supply, during trading hours, is usually very inelastic, a circumstance which can occasionally lead to unexpected and possibly dangerous fluctuations in stock-market quotations. Such fluctuations are especially likely to occur when brokers are receiving from their clients a large number of orders to sell without any specification as to minimum price. In all such cases of “unlimited” supply, elasticity is reduced to zero, a phenomenon which may be observed with particular clarity at an auction (abstracting from those cases in which the owner sets the minimum bid).
The cases of totally inelastic supply, as well as of totally inelastic demand, border upon the domain of price curiosities. Also to be included in this latter category are the cases of inverse inelasticity in which supply and demand respond to price changes in a direction opposite to the usual one. It is quite possible, for example, that a fall in agricultural prices may provoke an increase rather than a reduction in cultivation as a consequence of each farmer seeking to compensate for price declines by raising his output. Official exhortations to restrict crop acreage can, in this situation, produce the opposite effect since many farmers would probably expand production in the expectation that all the other farmers would obey the official entreaties. Cases of this kind have actually occurred in the United States. A similar process may be observed on the labor market where price (wage) declines may result in increased labor productivity as each worker strives to maintain his existing income. An example of the inverse elasticity of demand is the familiar case in which an increase in prices causes an increase in demand because of speculation that prices will increase still further in the future.
Let us take note, finally, of the fact that the elasticity of demand can be used in quite another sense than that in which we have thus far used it. Having defined elasticity as the degree to which demand reacts to price changes, we may also speak of an elasticity of demand in terms of the degree to which the demand of individuals reacts to changes in their incomes. We distinguish in this case the price elasticity of demand from income elasticity of demand. This latter case involves considerations with which have already dealt.

Economics of the Free Society

No comments:

Post a Comment