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MARGINAL COST CURVE: A curve that graphically represents the relation between marginal cost incurred by a firm in the short-run product of a good or service and the quantity of output produced. This curve is constructed to capture the relation between marginal cost and the level of output, holding other variables, like technology and resource prices, constant. The marginal cost curve is U-shaped. Marginal cost is relatively high at small quantities of output, then as production increases, declines, reaches a minimum value, then rises. This shape of the marginal cost curve is directly attributable to increasing, then decreasing marginal returns (and the law of diminishing marginal returns).

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ELASTICITY DETERMINANTS:

Three factors that affect the numerical value of the price elasticity of demand and the price elasticity of supply--availability of substitutes, time period of analysis, and proportion of budget. The price elasticities of demand and/or supply for a good can change if these determinants change. The first two determinants are important to both price elasticity of demand and price elasticity of supply, while the third relates specifically to the price elasticity of demand.
The three elasticity determinants--availability of substitutes, time period of analysis, and proportion of budget--affect, or determine, the values of the price elasticities of demand and supply. The key to these determinants is the ability to respond to price changes. If buyers and sellers can respond more easily, then the respective demand and supply elasticities are greater.

As a general rule, if buyers have a greater choice among close substitutes-in-consumption, with more time to respond to price changes, and the expense of buying the good is relatively small, then the demand elasticity is higher. On the supply side, if producers can easily move resources between substitutes-in-production and have more time to respond to price changes, then the supply elasticity is also higher.

Availability of Substitutes

Demand and supply elasticities depend on the ease with which buyers and sellers can switch between substitute goods. Greater choices mean more elastic and fewer choices mean less elastic.
  • Elastic Demand: In terms of price elasticity of demand, a good with many close substitutes-in-consumption tends to be very elastic.

    Consider the example of Auntie Noodles Frozen Macaroni Dinner, an enjoyable, nutritious, and satisfying meal. Unfortunately for the Auntie Noodles company, it is only one of thousands of comparable food products on the market, making demand extremely elastic.

    A buyer can easily opt for Uncle Doodles Frozen Macaroni Dinner or Grammy Poodles Frozen Macaroni Dinner, both of which are equally enjoyable, nutritious, and satisfying meals. A whole bunch of enjoyable, nutritious, and satisfying non-macaroni pasta meals, such Freddie Franks Linguini and Delicious Daves Spaghetti, are also available. Other substitutes include frozen meat entrees, TV dinners, boxed noodle packages, and meat helpers. Then there are fast food franchises, take-out delicatessens, fancy-schmancy dine-in restaurants, and other food eating alternatives.

    The wide range of very close substitutes for Auntie Noodles Frozen Macaroni Dinner means that the price elasticity of demand for Auntie Noodles Frozen Macaroni Dinner is quite high. Should Auntie Noodles Frozen Macaroni Dinner prices increase even a small, teeny, tiny bit, potential buyers are bound to forego Auntie Noodles Frozen Macaroni Dinner in favor of the very close substitutes.


  • Inelastic Demand: Alternatively, a good with few close substitutes-in-consumption tends to be more inelastic.

    Consider the market for Merciless Monolithic Media Masters (4M) Cable Television services offered to the television-watching citizens of Shady Valley. As the only provider of cable television in Shady Valley, the good folks of 4M provide a unique service with very few close substitutes.

    The best substitute comes from the national broadcast networks relayed through the local affiliates in nearby Oak Town. The reception is bad, only five channels are available (compared to 100 offered by 4M). Other entertainment activities are available in Shady Valley, including the summer time athleticism of the Shady Valley Primadonnas baseball team (featuring Harold "Hair Doo" Dueterman), the Shady Valley Cineramaplex (with 20 movie screens featuring the latest Brace Brickhead adventures), and the Shady Valley Dinner Theater (with performances by Max Mulroney and his Shakespearean Players).

    These are not very close substitutes for 4M cable television. Seeing the Shady Valley Primadonnas in person is not the same as watching the New York Yankees play on cable television. Sitting in a movie theater among a bunch of popcorn-chomping, soda-pop-slurping, baby-crying, end-of-the-movie-away-giving Cineramaplex patrons is not the same as watching a first run Brace Brickhead feature film on pay-per-view cable with a well-stocked refrigerator nearby. And the entertainment value offered by the performances of Max Mulroney and his Shakespearean Players is quite different from watching television sit-coms.

    The lack of close substitutes means the price elasticity of demand for 4M cable television services is very small. 4M cable television can raise prices substantially without seeing many people switch to the alternatives.


  • Elastic Supply: In terms of price elasticity of supply, a good with many close substitutes-in-production tends to be very elastic. The key for supply is the ease of switching resources between the production of two or more goods

    The production of Manny Mustard's Deluxe Club Sandwiches has a lot of very close substitutes. The labor (tomato slicers, lettuce washers), capital (knives, toasters), and materials (ham, lettuce, cheese, barbecue sauce) used to produce Manny Mustard's Deluxe Club Sandwiches can be switched easily between other goods. By tomorrow the guy who slices tomatoes for Manny Mustard's Deluxe Club Sandwiches can be selling hot dogs at the Shady Valley Primadonnas baseball stadium. Barbecue sauce that could have been used as a condiment for Max Mulroney's Pretzels-on-a-stick is easily switched to the production of Manny Mustard's Deluxe Club Sandwiches.

    As such, the price elasticity of supply of Manny Mustard's Deluxe Club Sandwiches is likely to be quite high. Relatively small changes in the price of Manny Mustard's Deluxe Club Sandwiches is bound to trigger relatively large changes in the quantity supplied as resource inputs are easily switched among substitutes.


  • Inelastic Supply: Alternatively, the production of a good with few close substitutes-in-production tends to have a relatively small price elasticity of supply.

    The entertainment provided by the Shady Valley Primadonnas baseball team offers an example. Super star players like Harold "Hair Doo" Dueterman are rare. The skill, talent, and experience of Hair Doo cannot be found easily in the production of other goods. The guy who slices Manny Mustard's tomatoes is not likely to join the Shady Valley Primadonnas and perform at the super star status of the rest of the team without considerable training and practice.

    As such, the price elasticity of supply of Shady Valley Primadonnas baseball entertainment is likely to be quite low. Relatively large changes in the price of Shady Valley Primadonnas baseball entertainment is needed to induce relatively small changes in the quantity supplied.

Time Period of Analysis

The longer the time period of analysis, the more responsive quantities are to price changes, for both price elasticity of demand and price elasticity of supply. Brief periods do not allow buyers and sellers the time needed to adjust their consumption and production decisions to price changes. Buyers need time to find substitutes-in-consumption. Sellers need time to find resources used for substitutes-in-production. Longer time periods, however, allow buyers and sellers the time needed to find alternatives.

  • For Demand: The demand for 4M Cable Television is clearly not very elastic. Given the lack of close substitutes, buyers continue buying even though prices rise. This is especially true for brief periods like weeks or months. But given enough time (years? decades?) buyers are able to seek out alternatives and thus change their quantity demanded.

    If 4M Cable Television raises prices, buyers will eventually buy season tickets to the Shady Valley Primadonnas baseball team, season tickets to the Shady Valley Dinner Theater, and spend a lot of time at the Shady Valley Cineramaplex. Buyers might even purchase a satellite dish system or explore other emerging entertainment technologies.


  • For Supply: The supply of Manny Mustard's Deluxe Club Sandwiches is quite inelastic if the time period is limited to a few hours. In this short time frame Manny is unable to acquire the resources needed to increase the quantity supplied even with substantial price increases. The price might double, but Manny simply cannot find the resources needed to expand production.

    However, if Manny has a longer time period to adjust, say a couple of months, then he will have the time needed to respond to the higher price. Good-bye Shady Valley Primadonnas stadium hot dog vendor, hello Manny Mustard tomato slicer. Less barbecue sauce for Pretzels-on-a-stick, and more barbecue sauce for Deluxe Club Sandwiches.

Proportion Of Budget

The price elasticity of demand is affected by the proportion of a buyer's budget that is devoted to a good. The rule is this: The larger the portion of the budget, the more responsive quantity demanded is to price changes. A house, for example, is a BIG budget item for most normal human beings. A relatively small change, say 1 percent on a $100,000 house, can make a BIG difference in a buyer's decision to buy. As such, relatively small changes in price are likely to induce relatively large changes in quantity demanded.

Alternatively, a good like salt is a relatively small portion of most buyers' budgets. As such, relatively large changes in price are needed to induce much of a change quantity demanded. A 1 percent increase in the price of a 50 cent box of salt will probably go undetected by most buyers. A 100 percent increase in the price of salt probably is not likely to discourage many buyers from buying the one box of salt they buy each year.

<= ELASTICITY AND SUPPLY INTERCEPTEMPIRICAL =>


Recommended Citation:

ELASTICITY DETERMINANTS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: November 24, 2014].


Check Out These Related Terms...

     | elasticity | elastic | inelastic | price elasticity of demand | price elasticity of supply | income elasticity of demand | cross elasticity of demand | coefficient of elasticity | elasticity alternatives |


Or For A Little Background...

     | determinants | substitute-in-consumption | substitute-in-production | market | price | quantity | demand | law of demand | demand curve | supply | law of supply | supply curve | cause and effect |


And For Further Study...

     | elasticity and demand slope | elasticity and supply intercept | demand elasticity and total expenditure | utility and demand | consumer demand theory |


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