Elasticity and surplus
Definition
Price elasticity of demand (PED): the responsiveness of quantity demanded to a change in price.
Price elasticity of supply (PES): the responsiveness of quantity supplied to a change in price.
- When demand or supply shifts, these elasticities determine how the change splits between price and quantity.
- It is the elasticity of the curve that does not shift which governs this split.
- That split in turn decides how much consumer and producer surplus change after the shift.
Key Idea
- Inelastic: a shift causes a large price change and a small quantity change.
- Elastic: a shift causes a small price change and a large quantity change.
- The more elastic the curve, the larger the change in quantity and in surplus for a given shift.
How elasticity splits a shift
- When the non-shifting curve is inelastic it is steep, like demand for insulin, so a shift moves price a lot and quantity little.
- When it is elastic it is flat, like demand for one brand of fizzy drink among many, so a shift moves quantity a lot and price little.
- So read the split from the elasticity of the stationary curve, not the one that shifts.
Effect on the size of surplus change
- For a given fall in price, more elastic demand means a larger rise in the quantity bought.
- That extra quantity adds more consumer surplus, so the surplus change is larger.
- When demand is inelastic, quantity barely moves, so most of the change is just the price saving on units already bought.
Example
- Extra supply cuts the price 20% from £10 to £8 in two markets, so the price saving is £2 per unit in each.
- Inelastic demand: quantity rises only from 100 to 104 units.
- Elastic demand: quantity rises from 100 to 140 units.
- The elastic market gains £240 against £204, because the extra 40 units of trade add surplus the inelastic market never captures.
Why it matters
- It explains why identical shocks produce mild effects in some markets and severe ones in others.
- It lets firms and governments predict whether price or quantity will move most after a shock.
- It also shows how much welfare is redistributed between buyers and sellers.
Note
- A supply shift in an inelastic market such as UK housing mainly changes price, so surplus shifts sharply between the two sides.
- The same shift in an elastic market mainly changes quantity, so more of the surplus change comes from extra trade.
Evaluation
- It gives a clear guide to the direction and rough size of the surplus changes.
- But elasticities are hard to measure and can change over time, so it depends on the time horizon: demand and supply are more elastic in the long run.
- And other things rarely stay equal, so real outcomes may differ from the model.
Exam technique
- Say whether the non-shifting curve is elastic or inelastic.
- State whether price or quantity bears most of the change.
- Link this to the size of the change in consumer and producer surplus.
Common Mistake
- Do not judge the size of a surplus change without considering elasticity.
- The same shift changes price or quantity by very different amounts depending on elasticity.
- Do not read the split from the shifting curve's elasticity.
Self review
- How does elasticity split a shift between price and quantity?
- Which curve's elasticity determines the split?
- For the same price fall, why does more elastic demand give a larger rise in consumer surplus?
- Why do identical shocks affect different markets by different amounts?
- Give one limitation of using elasticity to predict the effect.
