Economics – Consumer and producer surplus | e-Consult

Price Elasticity of Demand: Price elasticity of demand measures the responsiveness of quantity demanded to a change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. Elastic demand means a large change in quantity demanded for a small change in price; inelastic demand means a small change in quantity demanded for a large change in price.

Relationship to Producer Surplus: The relationship is indirect but important. Generally, inelastic demand is beneficial for producers. If demand is inelastic, producers can increase prices without significantly reducing quantity demanded, leading to a larger producer surplus. Conversely, elastic demand is detrimental to producer surplus because any price increase will lead to a large decrease in quantity demanded, reducing producer revenue.

Government Intervention & Price Elasticity: The optimal level of government intervention depends on the price elasticity of demand.

• Inelastic Demand: In a market with inelastic demand, government interventions like price ceilings are less likely to be beneficial and may even be harmful (leading to shortages). Price floors might be more appropriate to support producers.
• Elastic Demand: In a market with elastic demand, price ceilings might be considered to protect consumers, but they could significantly reduce producer surplus. Government subsidies might be more effective in supporting producers.

Example: The Pharmaceutical Industry: Consider a life-saving drug with inelastic demand. Patients with a need for the drug are unlikely to reduce their consumption significantly even if the price increases. In this case, a price floor might be implemented to ensure that pharmaceutical companies can still make a profit and continue to produce the drug. However, a price ceiling would likely lead to a shortage, as producers would be unwilling to supply enough of the drug at a lower price. This illustrates how the elasticity of demand influences the effectiveness of different government interventions.