Teaching notes:

Lesson time: 30 minutes

Learning objectives:

Explain, using the elasticity formulae, why the price elasticity of supply and demand varies along the supply / demand curve.

Lesson notes:

Class handout

A mathematical note about elasticity

It is normal for IB economics students to make the assumption that elasticity curves are linear i.e. that the PES / PED elasticity for any product is constant.  In reality this is not the case and are only drawn as straight lines for simplicity to represent lines of best fit as the following diagrams illustrate.

Price elasticity of demand (PED)

From diagram 1, you can observe that the PED for any product actually falls as price falls and rises as the price increases.  This is because low priced items are less PED elastic, since any change in the price will have a smaller impact on the consumer at lower prices than higher ones.  For example a rise in the price of a good from $ 4 to $ 5 (25%) will have less significance than a similar % rise from $ 80 to $ 100.  This is illustrated on diagram 1 where a rise in price of the good from P1 to P2 has only a minimal impact on quantity demanded − Q1 to Q2, where as a rise in price from P3 to P4 has a much larger impact, represented by Q3 to Q4. 

Price elasticity of supply (PES)

Similarly, the supply curve is also non linear. This is because as more factors of production are used up those resources used to make the goods and services become scarcer. As always in economics we make the assumption that the increasing scarcity of those resources will also tend to make those resources more expensive to obtain, raising production costs disproportionately.  This means that supply will become less price elastic, at higher prices, as it becomes increasing difficult (and therefore more expensive) to obtain those resources at higher output levels, discouraging the entrepreneur from raising output levels.

This is illustrated on diagram 2, where at Q1, there are ample factors of production available, allowing firms to easily change production levels when the selling price changes.

As price rises, however, the resources needed for production become scarcer and the firms supply becomes less elastic – falling to <1 at Q2, P2.