## Elasticity of Supply

Instructor: Alex Tabarrok, George Mason University

When is a supply curve considered elastic? What are determinants of elasticity of supply? Let's compare Picasso paintings and toothpicks. Which has an elastic or

When is a supply curve considered elastic? What are determinants of elasticity of supply? Let's compare Picasso paintings and toothpicks. Which has an elastic or inelastic supply? For which good could you increase production at a low cost? We also go over how to calculate the elasticity of supply, including using the midpoint formula.

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Good question. The supply and demand curve are theoretical constructs or tools for thinking. When we say that at a higher price the quantity demanded would be less or the quantity supplied would be more, we are talking about a counter-factual state of affairs in which all else is equal except for the change in the price. Thus, when we say the long-run supply curve is more elastic than the short run supply curve we are saying that people will respond more given greater time but again we are holding all else constant.

When we want to estimate demand and supply curves then you are absolutely right we rarely have all-else-equal experiments and so other things change as time changes. As a result, when estimating supply and demand curves we need to bring to bear the tools of econometrics and statistics to control for other factors and to focus in on the data in a way which handles causality. We hope to cover econometrics in another course but fortunately there is plenty to learn from theory before we get to estimation.

In the real world, as opposed to theoretical constructs, there are many factors that affect the final results. So far, the lessons are based on an all else being equal basis. The only things being changed are demand and supply as affected by price.

In the example of taxes, higher taxes means that the employee takes less money home at the same compensation level.

Given that various sorts of compensation have different tax rates, they may prefer that a raise be in terms of a better health insurance plan, which is not taxed, than in take home pay, which is. Or they may prefer stock options that can be exercised at whatever point in the future does them the most good financially, but profits from exercising those options isn't taxed at the time.

For some people, part of their compensation isn't based directly on time worked or when that work takes place. So if a tax increase is announced in July for the following year and the normal time that bonuses are given out is in January, those bonuses might be distributed in December instead, when they would be taxed at the current lower rates.

In order to get a higher take home pay, a person may have to work more and decide that, given the higher tax rate, it's just not worth the extra hassle.

Those are just a few ways that people respond to a change in tax rates. Given the complexity of the tax code and the various values individuals place on different types of income, there are thousands of combinations of changes any particular person may choose. It's impossible to predict exactly what the net changes in the real world will be because everything is always changing. At best, numerical economics is useful for generalizations, for understanding the directions and magnitudes that various changes will most likely change outcomes.

Real world curves are never straight lines. They aren't even smooth curves. People aren't machines and no one can have all the knowledge available to know exactly what the final outcome will be, especially when you look at longer time frames where the market (at least a free market), both buyers and sellers, are always trying to come up with new substitutes and more efficient ways to use any given good. In general, the less elastic a curve, the more effort is put into making it more elastic so it can better respond to changes in the market of any kind. That's just as true for taxes as any more tangible item.

For second last question, I think it can be explained with time horizon. As the tax incresea, in short run, people's income will decrease. In long run, people will find way to reduce their taxed amount, such as cash out part of it. Eventually, the taxed income for the government will be less higher than when the policy was initiated.

For the last one , basically just use the formula: Elasticity=ΔQ/ΔP
In short run: 1.4= ΔQ/10;
In long run:0.1=ΔQ/10