Question

1) In your own words, explain what elasticity of supply is signifying. (Put in your own words – just don’t copy and paste the notes.)

2) Explain why a tax levied on a good with elastic supply will bring in less revenue for the government than one placed on a good with inelastic supply.    

3) Briefly explain why both the Elasticity of Demand and the Elasticity of Supply are greater (that is, more elastic) at longer time horizons compared to shorter ones.

4) Consider a firm in a market with rising production costs. Using a supply-demand graph and briefly explaining in words, explain why this firm would be less hurt if demand is inelastic than if demand is elastic.

5) Around 1990, Congress restricted the amount of old growth forest that could be harvested for timber in order to protect the spotted owl. Lumberjacks and sawmill workers protested the restriction whereas owners of timber companies remained silent and did not protest that much. Answer the following questions to help explain why workers and owner saw things differently.

a) Due to the restriction on land use, what happened to the price and the quantity of timber sold? Show on a supply and demand graph.

b) Assume that the demand for lumber is inelastic (at least in the short run). Explain what happened to revenues for timber companies?

c) After the decrease in the amount of forest that could be cut, what happened to the number of lumberjacks hired and to the wages which they received? Using a supply and demand graph for the market for lumberjacks, show what happened to wages and employment for lumberjacks. Briefly explain in words what happened.    

Answer 1

1. Elasticity of supply is the responsiveness of quantity supplied to price of the good. Formula for elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. The elasticity of supply can be perfectly elastic, which means that a small percentage in price will cause a huge percentage change in quantity supplied. The elasticity of supply can be perfectly inelastic which means that supply remains the same irrespective of the price. If the elasticity is unit elasticity, that means a one percent change in price will cause a one percent change in quantity supplied. If the elasticity of supply is greater than one, it means that the percentage change in quantity is greater than the percentage change in price.

If the elasticity of supply is less than one, it means that the percentage change in quantity is less than the percentage change in price.