Econ

Document Sample
Econ Powered By Docstoc
					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.

				
DOCUMENT INFO