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M05.L05 — Price Elasticity of Supply; Income and Cross-Price Elasticity

Module: Module 05 — Economic Surplus and Elasticity Lesson: L05 of 06 Duration: ~30 minutes Level: Introductory Provenance: MIT OCW 14.01 Principles of Microeconomics | Principles of Microeconomics (Curtis and Irvine)

Learning Objective

Calculate price elasticity of supply (PES), income elasticity (YED), and cross-price elasticity (XED) for Australian markets.

Price Elasticity of Supply (PES)

PES measures how quantity supplied responds to price changes: \( PES = \frac{\%\Delta Q_s}{\%\Delta P} \). - Time horizons: Short-run PES is low (fixed capacity); long-run PES is higher (adjustable inputs).

Income Elasticity (YED)

YED measures how demand changes with income: \( YED = \frac{\%\Delta Q_d}{\%\Delta Y} \). - Normal goods: YED >0 (e.g., cars). - Inferior goods: YED <0 (e.g., instant noodles).

Cross-Price Elasticity (XED)

XED measures how demand for Good A responds to price changes in Good B: \( XED = \frac{\%\Delta Q_{dA}}{\%\Delta P_B} \). - Substitutes: XED >0 (e.g., butter vs. margarine). - Complements: XED <0 (e.g., petrol vs. cars).

Australian example: Housing supply elasticity varies across cities (Sydney vs. Adelaide).

Worked Example

Calculating PES for Australian Wheat

  1. Initial Price (P1): $200/tonne, Quantity (Q1): 1,000 tonnes.
  2. New Price (P2): $220/tonne, Quantity (Q2): 1,100 tonnes.
  3. PES: \( \frac{(1100-1000)/1050}{(220-200)/210} \times 100 = 1.0 \) (unit elastic).

Common Misconception

"All goods have positive income elasticity."

Inferior goods (e.g., used cars) have negative YED as demand falls with rising income.

Key Takeaways

  • PES depends on time horizon and input flexibility.
  • YED classifies goods as normal or inferior.
  • XED identifies substitutes and complements.
  • Australian housing markets show low short-run PES.

Practice

  1. If PES = 0.5 and price rises 10%, what happens to Qs?
  2. Calculate XED if the price of tea rises 5% and coffee demand rises 3%.
  3. Why is Sydney housing supply inelastic?

Further Resources

Provenance: MIT OCW 14.01 Principles of Microeconomics | Principles of Microeconomics (Curtis and Irvine)