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Reading and Homework Problems on Long-Run and Short-Run Supply and Demand Curves READING The elasticity of demand depends on the amount of time that has elapsed since a price change. In general, the greater the lapse of time, the higher the elasticity of demand. The reason is related to substitutability. The greater the passage of time, the more it becomes possible to develop substitutes for a good whose price has increased. For example, in the month or two following an increase in the price of natural gas or electricity used in home heating, consumers can turn down the thermostat or turn off the heat in seldom-used rooms. If the price increase continues, then consumers can also add insulation and storm windows and purchase more efficient furnaces. (Before the 1970s few homes in this area of North Carolina had storm windows. After the 1970s almost all homes are constructed with storm windows or insulated glass.) Over a longer time period, there can be changes in construction techniques. An example of the relationship between the short run and long run demand schedules starting from a price of $6 per unit is shown below.r Short Run and Long Run Demand 10 D: One year after 8 price change D: 5 years after price change Price 6 4 2 0 0 40 80 120 160 200 240 280 Units/year Suppose that we begin at a price of $6 and this price has been in effect for a relatively long period of time. The graph above shows the demand schedules one year and five years after a price change. If the price increased to $8, the graph shows that the quantity demanded one year later is approximately 70. If the price increased to $8, then 5 years later the quantity demanded is approximately 30. With a longer time to react to the price change, the quantity demanded falls more. More generally we can think of three time frames when discussing the elasticity of supply: i. Momentary supply ii. Short-run supply iii. Long-run supply In explaining these different supply curves, it is easier to discuss the cases of no possible adjustment (momentary supply) and all technologically feasible adjustments (long-run supply) before the short-run supply curve. When the price of a good first changes, we use the momentary supply curve to describe the initial change in the quantity supplied. The momentary supply curve shows the response of the quantity supplied immediately following a price change. Some goods, such a fruits or vegetables, have a perfectly inelastic momentary supply curve. The quantities supplied depend on the crop-planting decisions made months earlier and cannot change instantaneously. The long-run supply curve shows the response of the quantity supplied to a change in the price after all the technologically possible ways of adjusting supply have been exploited. This would include adding capacity, closing plants, or relocating facilities. For some industries, such as electric poser generation, this process could take ten to fifteen years or possibly longer. For other industries, including sandwich vendors or copy services, the process would be far shorter. The short-run supply curve shows how the quantity supplied responds to a price change when only some of the technologically possible adjustments have been made. One of the first adjustments that might be possible in response to a price change is in the amount of labor employed. To increase output in the short run, firms can hire more workers or hire the current workers for overtime but could not change the amount of some capital goods. To decrease their output in the short run, firms can lay off workers or reduce their hours of work. The supply elasticity in the short run is between that for the momentary run and the long run. In some cases, it might be relevant to think of several different classes of short run adjustments ranging from a time period in which a firm's only possible response is in the number of workers that it hires to a somewhat longer time period in which the firm could do some partial retooling. The longer the time period that the firm has to make adjustments, the more price elastic the supply curve. Suppose that the price has been at $6 for a long period of time and that purchasers have been able to adjust to this price. The momentary and short-run supply curves below show how the quantity supplied assuming that firms have either no time to make changes or a relatively short time to make changes beginning from the price of $6. Suppose instead that the price has been at $8 for a long period of time. The long-run supply curve is the same as shown above. The momentary and short-run supply curves show the changes in the quantity supplied given that the firms had made long-run adjustments to a price of $8/unit. The long run supply schedule is the same on both of the above supply graphs. The short run and momentary run supply curves differ. 1. The graph below shows the long run and short run supply schedules for housing. Provide an intuitive explanation for why the long-run and short-run demand curves for housing might differ. The market is initially in long run equilibrium at a price of $800 per rental unit. The government then sets a price ceiling below the equilibrium price. Use the graph to explain the short-run and long-run effects of the price control. What groups are likely to benefit from the price controls? 2. The graph to the right shows the long run supply curve for widgets. The graph also shows two short run supply curves. The curve S-SRA is the short run supply curve for the case in which the market was initially at the point A on the long run supply curve. This curve shows the relationship between the price of the product and the quantity demanded when the market is initially at A. The short-run supply curve S-SRB is defined similarly. The second graph shows the short- run and long-run supply curves and the market demand curve. We assume that the long run and short run demand schedules are the same. This means that it takes only a short period of time for consumers to make a complete adjustment to a price change. a. The demand curve is initially D. Identify the initial long-run equilibrium. b. Suppose that the demand curve shifts to the left. Compare the SR and LR effects on the equilibrium price. d. Assume now that the demand curve shifts back to its original position. Use the graph to explain the long run and short run effects of the shift back in demand on the equilibrium price. 3. Assume that the market for accountants is competitive. The salary and number of accountants employed is determined by supply and demand. We will make the simplifying assumption that all accountants are identical. (Alternatively, we could define different markets for accountants of varying “quality”. Demanders would regard accountants of various qualities as substitute goods.) The market is initially in long-run equilibrium. a. Construct a graph on which you show the supply and demand schedules for accountants. Label the axes. Label the market equilibrium as E. We will assume that the supply curve that you have drawn is the long-run supply curve. Also show the short-run supply curve through point E. Provide a common-sense explanation for why the short-run supply curve for accountants is steeper than the long-run supply curve. b. Let's suppose that there is a leftward shift in the demand curve for accountants. For example, new computer programs might allow low-skilled clerks to perform duties formerly done by accountants. For simplicity, we will ignore any difference between the short-run and long-run demand curves. We will assume that the demand curve you constructed is the long-run demand curve, and we will deal only with the long-run demand curve. Use your graph to explain the short-run and long-run effects of the shift back in demand. c. Let's suppose that the salaries of statisticians and accountants were initially the same (prior to the shift back in demand). We also assume that many students regard accounting and statistics courses as equally difficult and equally interesting; they also regard accounting and statistics jobs as equally appealing. Would their salaries necessarily be the same in the short-run period immediately following the shift back in the demand for accountants? In the long run? Explain.
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