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Economics Lecture II
In this lecture I will introduce the concepts of demand and supply as a tool of
understanding how changes take place in a market. This theory should explain how
consumer preferences determine consumer demand for commodities, while the cost of
production and business drive the supply of commodities.

We will start with the theory of demand.

What do we mean by the word demand as it is used in economics? It means desire

backed by an ability to buy. When we say that there is a high demand for 4 wheelers in
the market, we do not mean that there are a large number of people who have a desire
for buying 4 wheeler automobiles but do not have enough money to buy. Demand for
any commodity is something more measurable: it is the sum total of all the people who
have gone to the market with the intention of buying an automobile and has the
required amount of money.

So by demand we don’t mean a daydream. When we use the word demand we mean the
demand to buy a particular good or service by those who can afford to pay for it.

The Demand Schedule or the Demand Curve

Both common sense and careful scientific observation show that the amount of a
commodity people demand and buy depends on its price. The higher the price of a
commodity, other things held constant, lower goes the demand for that commodity.
The lower the market price, the higher goes the demand for that commodity.

We can therefore define the Law of Demand as: Other things held constant, demand
and price are inversely related. That is, if price increases demand decreases, and if price
decreases demand increases.

Below is a diagrammatic representation of the Demand Curve. We can assume any

commodity x for which this is the demand curve.
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As you can see, we are measuring the quantity demanded along the horizontal axis and
the price on the vertical axis. The demand curve DD is shown to be downward sloping
where each point along the demand curve stands for a combination of price and
demand, that is, the price at which a certain quantity is demanded. The curve shows that
at price level 1 the quantity demanded is 50 units, whereas at a higher price of 2
demand decreases to 30 units. Units demanded keeps decreasing as price increases. The
same logic follows in reverse if we start coming down from the price level 5 to the price
level 1. We find that while the units demanded were 10 at price level 5, it gradually
increases to 50 at price level 1.

The quantity demanded tends to fall as price rises for 2 reasons:

1. First is the substitution effect, which happens because now, compared to its
substitute, this commodity is too expensive. For example, if the price of coffee
becomes too high, its demand will decrease because many people will shift to
drinking tea. Most goods have some kind of substitutes, and when its price rises,
people shift to using the substitutes thereby decreasing its demand.
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2. Second is the income effect, which comes into play when the price of a
commodity goes up because it reduces people’s real income as opposed to their
nominal income. Thus, if my income is Rs. 10,000 and I own a car, then if the
price of petrol goes up it does not bring down my actual nominal income which is
Rs. 10,000, but my real income goes down because now I will have less money in
hand due to the higher price of petrol. I will therefore try to reduce my
expenditure on petrol by reducing my demand for it, may be by driving the car
less than before.

Market Demand
So far we have been talking about “the” demand curve. But whose demand are we
talking about? Since we are doing microeconomic analysis here, our interest lies in
understanding both the individual’s and the market’s demand curve for a commodity.
We need to know the market demand curve because the price of a good is ultimately
determined in the market.

So how do we derive the market demand curve? The market demand curve is found by
adding together the quantities demanded by all individuals at a particular price.

We can explain this with the help of a simple example where we assume that there are
only two individuals who go to the market of a particular commodity, the sum total of
the demand of these two people would then represent the market demand for this
commodity. Suppose at the price of Rs. 1 the person A demands 16 units and person B
demands 6 units, then at the price of Rs. 1 the market demand for the commodity would
be 16+6=22. Similarly by adding the demands of person A and B for all other prices we
can derive the entire market demand curve.

What is the Meaning of “Market”

The word “market” is used in economics to mean any place where a particular
commodity is bought and sold within a defined geographical area. This is different from
our everyday use of the word where we mean a particular specified small locality when
we say “market”. When we say “the market for rice in West Bengal” or the “market for
gold in India”, we mean all the places within West Bengal or within India where these
goods are bought and sold.

To explain with the help of an example, in the city of Kolkata various places have the
name “market” like the Vardaan Market, the New Market or the Gariahat Market. Each
of these “markets” sells various kinds of goods within a defined area. But if we want to
understand the relation between price and demand in the “textile market” in Kolkata,
we would take into account all the places in Kolkata where textile is bought and sold,
which will therefore include some of the shops in the Vardaan Market or the New
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Market, but it will be bigger than either of these markets because the word “textile
market” will encompass all the areas in Kolkata where textile is bought and sold. In fact,
online buying and selling of textiles will also come under its purview because even if it
is taking place on the net money is being exchanged and textile is being bought and sold.

Factors Determining Demand

What determines the market demand for cornflakes, or hamburgers, or petrol, or
designer kurtas given a particular price? Below is a list of the most important factors
that determine demand of a commodity at a particular price.

 The average income of consumers is one of the most important determinants of

demand. As people’s income rises people tend to demand more of almost
everything at the same price.
 The size of the market – measured, say, by the population – clearly affects the
market demand. If we imagine that there comes a law that bans all online
marketing, it will definitely reduce the demand for many commodities.
 The price and availability of related goods influence the demand for a
commodity. As we have seen in an earlier example, a change in the price of coffee
will affect the demand for both tea and coffee since these two drinks are
substitutes for each other. If we think of two complementary goods, petrol and
cars that run by petrol are two very complementary goods. If the price of petrol
goes down substantially and people expect that it will stay low, then certainly the
demand for cars will increase.
 Apart from these objective elements, there are subjective elements called tastes
and preferences which represent a variety of cultural and historical influences
on a group of people. The most important influences on taste and preference of
people are artificially contrived demands, such as demand for designer clothes,
or for fancy cars, or for a particular brand of cosmetics etc. Often tastes and
preferences are dictated by status concerns and class habits. They may also
contain a large element of tradition or religion, such as the demand for
vegetarian food among the Jains, sushi among the Japanese, beef among the
Americans and so forth.
 Finally, special influences will affect the demand for particular goods in
particular geographical areas. The demand for fish is much higher in Bengal than
it is in Punjab, while the demand for sour curd is much higher in southern India
than in other parts of India.

Shifts in the Demand Curve

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You will remember that when we were stating the law of demand we had highlighted
the condition “all other things being equal”. It is time we explain the need for that.

The factors we have listed in the earlier section under the title “factors determining
demand” stand for those other things. At every point of time when we are trying to
derive the relation between the price and the demand for a commodity x, we assume
that all the above listed factors are constant, i.e., the level of average income, tastes and
preferences, prices of related goods, will all stay the same for the particular demand
curve that we have derived for commodity x.

But it would be unrealistic to imagine that income or taste or prices of related goods
will forever stay constant. So we must now include in our theory of demand what
happens to the demand curve when any of these factors changes.

Let’s imagine that our economy is doing very well, our GDP is increasing at a high rate,
and therefore our average per capita income will be increasing. Now what will be the
effect of this increase in per capita income on the demand for, let’s say, mutton. We have
already derived a demand curve for mutton by holding all the other factors constant and
seen that we can derive a demand curve for mutton at many levels of prices and we are
satisfied that the law of demand holds in the case of mutton, which means that when the
price of mutton goes up its demand decreases while its price goes down its demand
increases. Suppose at this particular point of time the price for mutton in the market is
Rs. 250/kg and the market demand is 10,000 kgs given an average per capita income of
Rs. 5000.

But as the average per capita income increases to Rs. 8000 with a rising GDP, then at
the same price of Rs. 250/kg more people will demand to buy mutton because now
they can afford to. But then what happens to the earlier demand curve? What happens is
that the earlier demand curve shifts, that is, at the same price now the consumers want
to buy more mutton. Let me present it in the form of a diagram.

As you will see in the diagram below, we had derived an original demand curve DD that
provided us with a relation between price of commodity x and the quantity demanded
of the same commodity when the level of per capita income was unchanging or constant
at a particular level. But if the per capita income increases from that level, then even
though the price of the commodity has not changed still the demand for the commodity
has increased due to a change in one of the determining factors.

The diagram shows us that demand was at the level of 10 units at the price of Rs. 1, but
after the increase in per capita income the demand increased to 15 units without any
change in the price level. The same effect will therefore take place for all the price levels.
In this diagram, we see that while at price level 2 the market demand was 5 units, after
the increase in per capita income the demand has increase to 12 units without any
change in the price level. This will now hold for all the price levels.
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We will therefore derive a new demand curve for the commodity which will have
shifted parallelly from the original demand curve DD rightward or outward to that of
D’D’.

Do keep in mind that a shift in an opposite direction, that is leftward, is also possible if
instead of increasing the per capita income decreased. Then at the same price the
market demand would fall.

The demand curve therefore will shift with any change in the external factors that
determine demand. Whether it will shift rightward or leftward will depend upon which
way the external factor has changed. For example, if people’s taste changes from mill-
produced textiles to hand-woven textiles, then the demand curve for hand-woven
textiles would shift rightward while that of mill-produced textiles will shift leftward.

The Supply Schedule or the Supply Curve

The supply curve for a commodity shows the relationship between its market price and
the amount of that commodity that producers are willing to produce and supply to the
market for selling, all other things being the same.
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The relation between the price of a commodity and its supply is directly related, that is,
the higher the price the greater the supply and lower the price the lower the supply. The
following diagram presents a general supply curve.

It measures the price of

cornflakes along the vertical axis
and the quantity supplied of it
along the horizontal axis. Up to
the price 1, supply is zero because
nothing can be produced at such
a low cost. As the price level rises
from 1, slowly the supply
increases to a positive amount. At
price 2, the quantity supplied is 5
and so on.

Forces behind the Supply

Curve
The major element underlying the
supply curve is the cost of production of the commodity. When the production costs of a
good are low relative to the market price, it’s profitable for the producers to supply a
large amount. Conversely, when production costs are high relative to the market price,
producers produce little, or switch to the production of other products, or may simply
go out of business.

The forces behind the supply curve are therefore the forces that shape the cost of
production of the good. These are:

 Prices of inputs like labour, energy or machinery obviously have a very

important influence on the cost of production.
 Technological advances consist of changes in the quantity of inputs required to
produce a given amount of output or reduce the cost of those inputs themselves.
Such advances include everything from scientific breakthroughs to better
application of existing technology or simply reorganizing the flow of work.

For example, at the time when Henry Ford reorganized the production of
automobiles in America by introducing assembly line production of cars, it
greatly speeded up the time of production of cars and hence reduced the cost of
production of each car.
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 Prices of related goods, particularly goods that are alternative outputs of the
same production process. An interesting example can be found in the US. The US
government, to reduce its dependence on foreign oil, had raised the subsidy for
automotive ethanol. Ethanol is made primarily of corn. The increased demand
for corn (which means an outward shift in the demand curve for corn because an
external factor had intervened) increased the price of corn. To take advantage of
the increased price of corn, farmers started to plant more corn displacing their
normal practice of planting soybeans in their fields. The prices of soybean
therefore rose. Since most of the increased production of corn was used to
produce Ethanol to make use of the government subsidy, both corn and soybean
supply fell in the food market which produced a grim situation as both corn and
soybean are staples for a large number of Americans.

 Government policies have one of the most powerful impacts on supply. The
above example is one of the best examples. Apart from that, environmental and
health considerations often lead to the government dictating what technologies
can or cannot be used, while taxes and minimum wage laws can significantly
affect input prices. Also, government’s trade policy has a major impact on supply.
For example, when a free-trade agreement opens up the Indian market to
Chinese electronic goods, the domestic production and supply of electronic
wares in India decreases.

Shifts in Supply
When changes in factors other than a good’s market price affect the quantity supplied,
we call these changes shifts in supply. Then more (or less) is supplied at the same price
depending on how the change in the factor has affected supply.

We can illustrate a shift in supply for the automobile market. Let’s assume that cost-
saving computerized design and manufacturing reduced the requirement of labour for
producing cars. That is, the factor of technological advancement reduced the cost of
production. Supply would be affected similarly if the labourers as a group agreed to a
pay cut, or the government repealed some environmental regulations on the industry.

Any of these developments would shift the supply curve of automobiles to the right.
That is, as production cost falls, at every given price the producers would supply more
automobiles, thereby shifting the supply curve to the right. The diagram below
illustrates this situation.
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Equilibrium of Supply and Demand

It is time now we bring our understanding of the demand curve and the supply curve
together, because no market ever works without these two forces interacting with each
other. By itself, the demand for any commodity in the market means nothing unless
there is a supply to satisfy it. Similarly, supply by itself is meaningless unless there is
demand to buy it.

Supply and demand interact in the market to produce an equilibrium price and quantity.
The market equilibrium comes at that price and quantity where the forces of supply
and demand are in balance. At that price, the amount that the buyers demand is just
equal to the amount that the sellers want to supply. It is called the equilibrium price
because when the forces of supply and demand are in balance, there is no reason for
prices to rise or fall.

Once again, let’s look at a diagrammatic illustration.

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Let’s first consider the price level 2. At that relatively low price, demand is 15 units
while supply is only 7 units. So there is an excess demand in the market where the
consumers in their eagerness to buy up the good end up bidding the price up until it
increases to 3 at which price both demand and supply are equal at the quantity 12 units.
Conversely, at the price level 5, supply exceeds demand. While the high price brings
forth a low demand of 10 units, it induces the producers to supply 17 units. Since supply
thus exceeds demand, the sellers will be desperate to dispose of their excess supply
even at a low price. So the market price will be pushed down until the point where
demand equals supply, that is, where the price level is 3.

Effect of a Shift in Either Supply or Demand

But do remember, any particular demand or supply curve is drawn under the condition
“everything else being held constant”. So the equilibrium price will hold only as long as
all the external factors are unchanged. But what happens to the equilibrium when the
external factors change either for the demand or for the supply curve?

Let’s once again look at a diagrammatic illustration.

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The solid lines of supply and demand tell us that the original equilibrium was at the
point E where demand is equal to supply. Suppose at this point the government imposes
a tax on one of the inputs of the commodity which effectively raises the cost of
production for the producers. The outcome is that they will not be able to supply the
same quantity as before at the equilibrium market price at E, because now their cost of
production has gone up so they need a higher price to compensate for that. As a result,
the supply curve will shift to the left denoted by the dotted line. As supply reduces in the
market, we are faced with a situation of excess demand at the original price at E.
Therefore, for the market to change to a new equilibrium the price will have to change.
And since it is a situation of excess demand, the new equilibrium has to be at a higher
price to wipe off the excess demand. As the diagram shows, the new equilibrium is at
the point E’, a point much higher than the original equilibrium E.

Let us now look at a diagrammatical representation of a shift of the demand curve.

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In the above diagram, the demand curve has shifted to the right, which means that at the
same price there is now more demand in the market. It could be due to an increase in
per capita income or due to a change in taste and preferences of the consumers or due
to an increase in the price of its substitute. There is therefore an excess demand now at
the original low level equilibrium price at which the market was clearing earlier. With
the rightward shift of the demand curve, now the demand and the supply curve
intersect at a higher equilibrium price level E’. At that price the excess demand has been
partially reduced until it balances the increased supply as a result of the higher
equilibrium price.

Interpreting Changes in Price and Quantity

What is important to understand is how to interpret price and quantity changes in the
market. We do sometimes hear people saying that the demand for petrol does not
follow the law of downward sloping demand because it has been observed that even
when the price of petrol rises its demand does not go down or in some instances
actually goes up.

Such statements have to be answered by pointing out the changes in the other external
factors. When such things happen, it happens because due to some changes in some
external factors, the demand curve had shifted to the right. When that happens, we are
no longer measuring the quantity demanded on the original demand curve but on the
new and shifted demand curve. So the new demand curve dictates a higher demand
even at a higher price.
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For example, if we take the global demand for oil which keeps on increasing even in the
face of rising price of petrol, we must keep in mind that on a global scale, countries like
India and China are rapidly growing and hence using more petrol for many purposes.
This is an example of an external factor on a global scale where the income of a
particular and large group of people has increased and therefore their demand for
petrol has increased. This is a case of a shift in the global demand curve for petrol which
cannot be understood if we seek an answer along movements on the original demand
curve.

Economists deal with these sorts of questions all the time. When prices or quantities
change in a market, does the situation reflect a change on the supply side or on the
demand side? Suppose we find an increase in the price of bread in the market and a
decrease in supply. That would certainly indicate some changes in the external factors
determining supply, such as the prices of inputs or a change in government policy. So
the explanation for a decrease in the quantity supplied even in the face of a price
increase lies in a shift in the supply curve.

Price Elasticity of Demand

We now know how prices and quantities demanded or supplied of a commodity may
change. What we need to know now is the degree to which they may change. We want to
have some answer to questions such as, if the price level of a good changes by 1%, by
what percentage would the quantity demanded change?

The concept of price elasticity of demand can give us some ideas about answering
such questions. The price elasticity of demand (sometimes simply called price
elasticity) measures how much the quantity demanded of a good changes when its
price changes. The precise definition of price elasticity is the percentage change in
quantity demanded divided by the percentage change in price.

Goods vary enormously in their price elasticity. When the price elasticity of a good is
high, we say it has “elastic” demand. When it is low, we say its demand is “inelastic”.

What are the factors that determine the price elasticity of a good? These are:

 Goods that have ready substitutes tend to have an elastic demand. That’s
because it is easy for people to switch between the substitutes in the case of
price changes. That’s why we find that goods that are close substitutes of each
other have very similar prices. A very good example is the elasticity of demand
for Coke and Pepsi. The beverages are very close substitutes, and so if one of
them increases price to a level where it will be considered expensive as
compared to the other, consumers will quickly change their demand to the other
product. Another good example is the relation between tea and coffee.
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 Food items that are staples or everyday-use commodities that are

essentials will have an inelastic demand. Salt is a good that’s essential and
hence has a very inelastic demand. In large parts of India rice is a staple food and
hence will have an inelastic demand, though it may have a little more elastic
demand than that of salt. But as compared to avocados, rice will have a very
inelastic demand.

 The length of time that people get to respond to a price change also determines
the level of elasticity. A good example is consumer durables like fridge or air
conditioner. Most people change them after several years. When they look for a
new one after let’s say 5 years, they may have developed new tastes or
preferences or needs and hence they may not buy the same type of machine as
before. This means that the elasticity for each model will be high since people
may move to a new type of model after 5 or 10 years.

Remember though that this does not mean that the demand for consumer
durables as a whole will be elastic. The demand for refrigerators and TVs and
ACs as a whole will be more or less inelastic because we are all used to them. But
the demand for different models and brands will tend to be elastic.

Another example of elasticity of demand changing in the long run is that of the
demand for petrol. People cannot change their level of use of petrol-driven
automobiles as soon as the price of petrol increases. But over a period of time
people may gradually reduce their demand by shifting to other modes of travel
like public transport or bicycles or motorbikes or simply arrange their lives in
such a manner that they have to use less of their cars. One can therefore say that
in the long run the elasticity of many goods will be higher than it will be in the
short run.

By this logic, perishables in the market will have a very high elasticity while non-
perishables will have a comparatively low elasticity in the short run.

Calculating Elasticity

We know that the value of price elasticity of demand in the simplest sense is the
percentage change in the quantity demanded divided by the percentage change
in the price. That is

Ed = percentage change in quantity demanded/percentage change in price

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On the basis of this formulation, we can now state

 When a 1 percent change in price brings forth a more than 1 percent change in
the quantity demanded, then the commodity has a price-elastic demand.

 When a 1 percent change in price brings forth a less than 1 percent change in the
quantity demanded, then the commodity has a price-inelastic demand.

 When a 1 percent change in price brings forth an exactly 1 percent change in the
quantity demanded, then it is a special case of unit-elastic demand.

We may now proceed to formulate how to mathematically calculate price-elasticity of

demand of a commodity. We will take the help of the following diagram for that
purpose.

We can see in the above

diagram that price has
increased from 90 to 110;
thereby causing a decrease in
demand from 240 to 160, i.e.,
demand has changed along the
demand curve from point A to
point B. An increase in price
from 90 to 110 is a 20%
increase, whereas a decrease in
quantity demanded from 240
to 160 is 40%. Since we have
defined price elasticity as
percentage change in quantity
demanded divided by
percentage change in price, in
this case the price elasticity will be 40/20 = 2, which tells us that demand for this
commodity is elastic at this price.

This is the simplest formulation for evaluating the price elasticity of demand at a
particular price. But it is a bit too simple. We need to introduce some complications in
our formulation in order to arrive at a more accurate estimate.

 Recall that the relation between price and demand is inverse, that is, when price
increases demand decreases and price decreases demand increases. Therefore in
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any situation of change in price, one of the factors, either demand or price, will
have a negative value. As in our diagram, price increases from 90 to 110, a
positive value of 20, leading to a decrease in demand from 240 to 160. The value
of change in demand is therefore negative, it is – 80.

When we measure the degree of elasticity, however, we disregard the negative

sign. Thus even though in terms of the direction of change the percentage change
in demand here is negative, we will consider only the absolute value, i.e., 80 or
40%. Therefore we will derive the value of elasticity at this point as an absolute
value, which is 40/20 = 2

 Note that the definition of elasticity uses percentage changes in price and
demand rather than absolute changes. This is because we want to avoid getting
different values for price elasticity depending on the units we use for price. For
example, if the unit of price in our above example is Rs. 1, then the change in
price is 20. But if the unit of price is 1 paise, then the change in price is 12000 –
9000 = 11,100.

This, however, is unacceptable. There cannot be two different values of elasticity

for the same point. That is why we take the percentage change in both price and
demand so that the value of elasticity stays the same regardless of the unit of
price.

 Note that we have to measure elasticity as the ratio of δD/D and δP/P. Now the
values of change in D and change in P are easy to calculate. According to our
diagram, they are 80 and 20 respectively. But what would be the value of δD?
Would it be 160 or 240? Similarly, what would be the value of δP? Should it be 90
or 110? To solve this problem, what we do is that we take the average of the two
values of demand and price. Thus, for P we take (90+110)/2 and for D we take
(160+240)/2.

Therefore, the value of elasticity for our example between the points A and B
would be
[80/(160+240)/2]÷ [20/(90+110)/2] = 80/200 ÷ 20/100 = 4/10 ÷ 1/5 = 2

The exact formula for calculating elasticity is therefore

Ed = [δQ/(Q1 + Q2)/2] ÷ [δP/(P1 + P2)/2],

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Where P1 and Q1 stand for the original price and quantity demanded respectively,
and P2 and Q2 stand for the changed new price and quantity respectively.

Price Elasticity in Diagrams

It is possible to determine price elasticities in diagrams as well. The three

diagrams below illustrate the three cases of elasticities. In each case, price is cut
in half and consumers change their quantity demanded from A to B.

In diagram (a), a halving of price has tripled the quantity demanded. This is therefore a
case of highly elastic demand.

In diagram (b), a halving of the price has resulted in a doubling of the demand. It is
therefore a case of unit elasticity of demand.

In diagram (c), a halving of the price leads to only a 50% increase in demand. This is
therefore a case of inelastic demand.

Elasticity and Revenue

It is important for businesses to know whether raising the prices of their product will
increase or decrease their revenues. This question is of strategic importance for
businesses because they must periodically reconsider their prices but must also have an
idea of what will happen to their total revenue as a result.

Total revenue is, by definition, equal to price times quantity or P x Q. If consumers buy
5 units of a product at Rs. 3 each, then the total revenue for the seller is 3 x 5 = Rs. 15.

This is where knowing the value of the price elasticity of demand for a product helps in
getting a sense of where the total revenue might go.
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1. When demand is price-inelastic, a price decrease reduces total revenue.

This is because when demand is inelastic, then after decreasing their price the
business finds that the demand has increased by a lesser percentage than the
price. Therefore, they are selling their product at a lower price but only to a
marginally increased demand. Since Total Revenue = P x Q, therefore the total
revenue decreases when the decrease in P is not compensated by an equal or
increased percentage of Q.

2. When demand is price-elastic, a price decrease increases total revenue.

By the same logic, when demand is elastic, then after decreasing the price the
business finds that the quantity demanded has increased by a percentage larger
than the decrease in price. Therefore P x Q is larger than before because the
decrease in P is more than offset by the increase in Q.

3. In the case of unit-elasticity of demand, a price decrease leads to no change in

total revenue. This should be obvious. Since the decrease in P is exactly
compensated by the increase in Q, therefore P x Q stays the same.

The concept of price elasticity is widely used today as businesses attempt to separate
customers into groups with different elasticities. The technique has been pioneered by
the airlines by charging a relatively high price to business travellers whose demand is
inelastic precisely because it is paid for by their employers. But they charge their other
passengers a lower price to fill up all other empty seats.

The Paradox of the Bumper Harvest

The concept of price elasticity can also be used to illustrate a paradox called the
“paradox of the bumper harvest”. Imagine that in a particular year there has been a
bumper harvest of a staple crop like wheat. At a given market price the farmers
therefore expect a higher income that year because they count that they will be selling
more. But as they start sending their produce to the market in truck-fulls, they find
insufficient demand for their excess supply. They have no other option but to reduce the
prices for their crop in order to sell their extra produce and as a result end up with
reduced total revenue for the year.

Why did this happen? It happened because the demand for staple foodstuff like wheat is
relatively inelastic. People generally do not increase their consumption of wheat by a
great amount just because the prices are low. While the increase in supply arising from
an abundant harvest tends to lower the price, the lower price does not increase quantity
demanded very much.
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Price Elasticity of Supply

We know that consumption is not the only thing that changes when prices go up or
down. Businesses also respond to price in their decision about how much to produce.

Price elasticity of supply is the percentage change in quantity supplied divided by the
percentage change in price.

Just as with demand elasticities, there are polar extremes of high and low elasticities of
supply. Suppose the amount supplied is completely fixed, as in the case of perishable
fish brought to the market to be sold at whatever price they will fetch. This is the case of
completely inelastic supply with a vertical supply curve.

At the other extreme, a small increase in price may bring about a sizable increase in
supply for some commodity like computers, because the supply of inputs like chips can
be increased by a greater percentage with a relatively small increase in price. This is a
case of elastic supply.

And in the border-line case, the increase in price results in exactly the same percentage
increase in supply. This is the case of unit-elasticity of supply.

What are the factors that determine the degree of elasticity of supply? The major factor
influencing supply elasticity is the ease with which production in the industry can be
increased. If all inputs can be readily found at the going market price, as is the case for
the textile industry, then output can be greatly increased with little increase in price. In
such cases supply elasticity will be relatively large.

On the other hand, if production capacity is severely limited, as is the case for gold
mining, then even sharp increases in the price of gold will bring about only a small
response in gold production. This is therefore an example of inelastic supply.

Another important factor in supply elasticity is the time period under consideration. A
given change in price tends to have a larger effect on the amount supplied as the time
for suppliers to respond increases. For a short period after an increase in price, firms
may be unable to increase their inputs of labour, materials and capital. So in the short
run supply may be price inelastic. As time passes, however, businesses can hire more
labour, build new factories and expand capacities, supply elasticities tend to increase.