Elasticity of Supply
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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I am confused by the statement that time horizon influences the elasticity of the curve. I understand that the supply curve is a function
Q = f( P ).
How one can get Q( P1 ) - Q( P2 ) at different times if Q does not depend on time?
And if Q does depend on T,
Q = f(P, T),
then there are immediately questions of direction of the change it time, causality, etc, etc.
I believe this point deserves a much more careful treatment than what is being said in this video.
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.
Could answer Goolsbee question based on data provided but still found it confusing. What physical quantities would appear on the supply curve for this example? Net income (vertical) vs. taxable income possibly? Shouldn't be taxes or tax rates on vertical since supply and price should move together (positive slope). Previous question statement regarding Clinton tax hikes was also confusing to me but Goolsbee question at least showed how it should be addressed!
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
I am confused with the following question from the practice part:
Q. In 1993, then President Clinton passed a law raising income taxes. This tax hike was fully expected: He campaigned on it in 1992. What do you expect happened to executive income in the first year of the tax increases? What about in subsequent years? Hint: Top executives have a lot of power over when they get paid for their work: They can ask for bonuses a bit earlier, or they can cash out their stock options a bit earlier. Literally, this isn’t their “labor supply,” it’s more like their “income supply.”
Could you explain why would income decrease in the first year, but in a long term, there would be no significant effect?
Thank you in advance
For first year, individual can respond to the coming increased tax on earnings by taking some earnings early (that is, in the previous year; see above regarding executive power to take payments early). Thus a higher tax (decreased net income) can produce a greatly reduced taxable income. After the first year, many of these tax-avoidance strategies will not be available any more (since taxes for every year are now higher). So, taxable income will remain nearly the same for subsequent years (unless there's another really big tax rate hike). Thus an elastic supply curve for first year becomes inelastic over long term. But I understand your confustion (see my own question below, but I think this is the answer).
Thank you for the videos! Can you please give some examples of products with elasticity of supply and elasticity of demand equaling 1?