Chapter 5: Problem 18

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

Short Answer

Expert verified

In conclusion, when supply is inelastic, shifts in demand have a larger effect on the equilibrium price compared to the effect on equilibrium quantity. This is due to the steepness of the inelastic supply curve, where changes in demand lead to relatively large changes in price while the changes in quantity remain relatively small.

Step by step solution

Understand Inelastic Supply

Inelastic supply means that the producers' ability to increase or decrease the production of a good is limited in response to changes in its market price. This can occur for various reasons, like limited availability of inputs, production processes that take a long time to scale, or situations where production cannot be easily varied. When supply is inelastic, the supply curve is steeper than a typical supply curve, illustrating that even a significant change in price will lead to a relatively small change in quantity supplied.

Shifts in Demand

A shift in the demand curve represents a change in the quantity demanded at each possible price level. This can be due to various factors, such as changes in income, tastes and preferences, price of related goods, or expectations about future prices. A rightward shift in the demand curve indicates an increase in demand, while a leftward shift indicates a decrease in demand.

Impact on Equilibrium Price and Quantity

When there is a shift in demand, the equilibrium point (where supply and demand curves intersect) will change, which will lead to changes in both the equilibrium price and quantity. In the case of inelastic supply, the supply curve is steep, meaning that any change in demand will have a relatively large effect on the equilibrium price, and a smaller effect on the equilibrium quantity.

Effects of an Increase in Demand

Let's consider an increase in demand (a rightward shift in the demand curve). In the case of inelastic supply, the new equilibrium point will be higher up on the supply curve, indicating a higher price level. However, the change in equilibrium quantity will be relatively small due to the steepness of the supply curve. So, when supply is inelastic and demand increases, the equilibrium price will have a larger increase, while the increase in equilibrium quantity will be smaller.

Effects of a Decrease in Demand

Now consider a decrease in demand (a leftward shift in the demand curve). Similarly, due to the steepness of the inelastic supply curve, the new equilibrium point will be lower on the supply curve, indicating a lower price level. The change in equilibrium quantity will also be relatively small. Hence, when supply is inelastic and demand decreases, the equilibrium price will have a larger decrease, while the decrease in equilibrium quantity will be smaller. In conclusion, when supply is inelastic, shifts in demand will have a larger effect on the equilibrium price compared to the effect on equilibrium quantity.