In the previous tutorial we defined the concepts of supply and demand, and saw how they correlate.
But what causes supply and demand to change?
Well to answer that, we must learn about elasticity.
Elasticity is the measurement of the percentage change of one economic variable in response
to a change in another.
In other words, it involves looking at how much one thing has changed based on an incremental
change for some other thing.
Let’s now look at two types of elasticity.
Rather predictably, these are elasticity of supply, and elasticity of demand.
Elasticity of supply measures how producers will respond to changes in the price of a
good or service.
The key factor influencing elasticity of supply is time.
In the short run, some producers can’t easily change their output levels, and therefore
their supply is inelastic, whereas in the long run, adjustments can be made to make
supply more elastic.
An easy example to demonstrate this is farmers.
Say a farmer’s crops fail due to a drought.
Well, that farmer is going to make dramatic adjustments, or they might end up losing a
lot of money, but those adjustments won’t pay off until long after the drought is over.
In the long run, the farmer might be able to take measures to prevent the loss of crops
in the case of future droughts, or perhaps the farmer might adjust the types of crops
that are planted.
Regardless, in this case, in the short run supply is inelastic, and in the long run supply
is more elastic.
Elasticity of demand measures how consumers will want more or less of something when the
price rises or falls.
If people buy the same amount or just a little less of a good or service after a large price
increase, the demand is inelastic, meaning it doesn’t change much.
If people buy much less of a good or service after a small price increase, the demand is
elastic, meaning it can change a lot.
For example, if movie tickets went up from $12 to $15, but you don’t care because you
really want to see the latest blockbuster movie on the big screen, then your demand
is inelastic.
However, if movie tickets went up from $12 to $12.50, and that small increase caused
you to avoid going to the movies, then your demand is elastic.
So clearly, the big question is: What influences elasticity?
For consumers, it comes down to preference for the good in question.
For producers, it comes down to what it costs to produce something.
This is also known as input costs.
With elasticity understood, let’s focus on changes in supply.
First, let’s stay with the influence of input costs.
Often, input costs can drop due to advances in technology.
Automation, including the use of artificial intelligence and robots, has made the manufacturing
process more efficient, thus saving on labor costs.
Because of this, producers can produce more for less money.
Government policies can also change the supply of a good or service, in both a positive and
negative way.
For example, a government can provide subsidies.
A subsidy is essentially money from the government intended to give a boost to certain businesses
or industries.
Conversely, governments can also establish excise taxes, meaning taxes on the production
or sale of a good which reduce production.
Other supply determinants, or influences which affect supply, include expectations about
what a price might be and the number of competitors also producing the same good or service.
Next, let’s examine changes in demand.
Assuming all other factors don’t change, here are the five determinants of demand.
Number one: Changes in a consumer’s income.
The more money consumers make, the more they will demand goods and services, and the less
money they make, the less they will demand goods and services.
Number two: Consumer expectations.
Our expectations, whether they are hopes or concerns, can affect our demand for certain
goods and services today.
For example, an expectation that there will be a shortage in a particular product may
influence consumers to buy more of it now.
Number three: Changes in demographics and population size can also affect demand.
For example, if a real estate developer wants to invest in Texas, they have to look at the
growing Hispanic-American population there to have a better prediction of what demand
will specifically look like.
Number four: Changing tastes and advertising.
Keeping up with social trends and general preferences help predict what demand will
look like.
And finally, number five: Prices of related goods.
Demand can simply shift in response to a change in the demand for another related good.
There are two types of related goods that interact in this way: complements and substitutes.
Complements are two goods that are bought and used together.
They complement each other, hence the name.
When we consider the demand for tennis rackets, tennis balls are considered a complement,
since playing tennis requires both items.
Substitutes are goods that are used in place of one another.
They substitute for each other, hence the name.
If demand for racquetball rackets went up, that could lower demand for tennis rackets,
as racquetball rackets would act as a substitute for tennis rackets.
On a graph, whenever supply increases, the supply curve shifts to the right.
Whenever it decreases, the supply curve shifts to the left.
The same goes for the demand curve.
Whenever demand increases, the demand curve shifts to the right.
Whenever it decreases, the demand curve shifts to the left.
All of these changes in supply and demand result in changing prices, and as consumers
we are always interested in how much things cost.
So let’s move forward and get a closer look at prices.