Economics – Price elasticity of supply | e-Consult

Answer: While relative percentage changes in demand and supply offer a useful initial indication of the likely impact on equilibrium price and quantity, they are insufficient on their own to provide a definitive answer. The key limitation is that they do not reveal the price elasticity of supply and demand. The effect on equilibrium is determined by the interplay between the elasticities.

Explanation:

• Relative Percentage Changes: A 5% increase in demand and a 2% increase in supply suggest that demand is relatively more responsive to price changes than supply. This implies that the equilibrium price will likely rise.
• Price Elasticity of Demand (PED): If PED is relatively elastic (e.g., PED > 1), a relatively small change in price will lead to a proportionally larger change in quantity demanded.
• Price Elasticity of Supply (PES): If PES is relatively inelastic (e.g., PES

• Combined Effect: The impact on equilibrium depends on the relative magnitudes of PED and PES. For example:

  • If PED is very elastic and PES is very inelastic, the price will rise significantly and the quantity will fall significantly.
  • If PED is inelastic and PES is elastic, the price will rise moderately and the quantity will fall moderately.

• Limitations: Relative percentage changes do not tell us about the shape of the demand and supply curves. They don't indicate how sensitive consumers and producers are to price changes. Without knowing the elasticities, we cannot accurately predict the magnitude of the price and quantity changes. Other factors, such as changes in consumer income or tastes, could also influence the outcome.

Conclusion: Relative percentage changes provide a starting point, but a full analysis requires consideration of price elasticities of supply and demand. Therefore, relative percentage changes alone are not sufficient to determine the impact on equilibrium.