Elasticity in action
Elasticity explains puzzles: why good harvests can hurt farmers, why drug enforcement can backfire, and why some taxes raise little revenue.
The farm paradox
Demand for staple crops is inelastic. A bumper harvest increases supply, and because buyers barely respond, price falls steeply, so farmers' total revenue can fall even though they grew more. This is one reason governments have historically supported farm prices.
Oil price shocks
In the short run, demand and supply for oil are both inelastic: people still need to commute, and new wells take years. Small supply disruptions therefore cause large price spikes, as in the 1970s and 2022. Over time, demand becomes more elastic as people buy efficient cars and switch fuels.
Sin taxes
Taxes on cigarettes and alcohol raise revenue because demand is inelastic, and they modestly reduce consumption, especially among price-sensitive young people. Studies suggest a 10% price rise reduces youth smoking by a larger percentage than adult smoking.
Price discrimination and elasticity
Firms that can separate customers charge more to those with inelastic demand. Student and senior discounts, early-bird pricing, and airlines' fares that rise as departure approaches all target differences in elasticity. Those with fewer alternatives or more urgency pay more.
Elasticity and public transport
If demand for bus travel is inelastic, a fare increase raises revenue but hurts riders with few alternatives. If demand is elastic, cutting fares could raise ridership enough to increase revenue and reduce congestion. Cities use elasticity estimates to plan fares.
Estimating elasticities
Economists estimate elasticities from data on prices and quantities, using statistical methods that try to separate demand responses from other changes happening at the same time. Online retailers run price experiments, showing different prices to different shoppers to measure responses directly.
Limits of elasticity
Elasticity is a local measure: it can change as price or conditions change. Predictions for large price changes, or for new products without data, are uncertain. Behaviour can also shift with habits, information, and social trends that simple elasticities do not capture.
Worked example
A city's metro has 1 million riders a day at a fare of 2 dollars, and demand elasticity is about 0.3. A 10% fare rise to 2.20 would cut ridership about 3%, to 970,000. Revenue rises from 2.00 million to about 2.13 million dollars a day. But 30,000 people switch to other transport, perhaps cars, adding congestion.
Key takeaways
With inelastic demand, bumper harvests can lower farm revenue. Inelastic short-run oil markets produce price spikes. Sin taxes raise reliable revenue and modestly cut use. Price discrimination charges more to inelastic buyers. Transport and tax policy rely on elasticity estimates, which are local and uncertain for large changes.
Flashcard
Bigger harvest, lower farm revenue
Check your understanding
Why can a record wheat harvest leave farmers worse off?