elasticity Page 1 of 5

Narrator, Male, Female

Narrator: Elasticity is a favored term in economics meaning responsiveness.

It’s why supply and demand schedules are usually sloped, because
quantity supplied or demanded usually responds to changes in
price.

Take ice cream cones. The more they cost, the fewer people buy.
That’s what the slope suggests. As the price goes up, fewer and
fewer ice cream cones are purchased. As the price goes down, the
quantity demanded increases. So consumers respond to price.
How muc h the respo nd is known as the pr ice elasticity of demand.

The supply curve also slopes because of suppliers’ responsiveness

to price, with quantity supplied increasing as the price rises. So
suppliers, too, s how some price elasticity. If they didn’t the supp ly
schedule would be perfectly vertical, a price elasticity of zero.
That is, the same quantity of ice cream supplied, no matter what
the price.

Similarly, if demand were unresponsive to price or totally prince

inelastic, the demand schedule, too, would be a vertical line with a
price elasticity of zero. The same quantity of ice cream demanded
no matter what the price. Notice, though, that when either
schedule slopes and indicates some degree of elasticity, the actual
angle depends on the scale. The angle is steeper if a $5.00 price is
up here, but if we use a scale that puts $5.00 lower down, the angle
is more horizontal. That’s why elasticity is always measured in
terms of percentages, p ercentage change in q uantity over
percentage change in price, a calculation the textbook explains and
that the DiscoverEcon software allows you to practice.

For our purposes, though, the importance of elasticity is how it

helps explains the real world. So the rest of this segment is
devoted to solving a real-world economic puzzle, why, in the
winter of 2000-2001, did natural gas prices spike to historically
unheard of levels? The first reason was the weather. It go so cold
in my native New England, for instance, that even Frosty bundled
up. Meanwhile, California was so hot that air conditioners
overloaded the power grid, and in the northwest, it was so dry that
hydro power plants couldn’t provide extra power.

Okay, so far, so simple. In the winter of 2000-2001, severe

weather and less energy from substitute sources increased the
demand for gas. More demand, the demand curve shifted to the
right. So the quantity of gas purchased rose sudde nly from its then
current level.

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 elasticity Page 2 of 5
Narrator, Male, Female

Now the way we’ve drawn this graph, it suggests that equilibrium,
price should rise modestly for a modest increase in demand. But,
in fact, the price spiked to over $8.00. So what’s wrong with this
picture? Well, for one thing, it visually misrepresents the price
elasticity of demand for natural gas. So let’s back up a step. The
key question abo ut elasticity is: how elastic? That is, how
responsive is demand, or for that matter, supply, to changes in
pr ice? But remember, the answer is measured in percentages.

Using percentages then, let’s look at major league baseball. In

2003, the average ticket price was about $20.00, average
attendance about 28,000 people per game. What do you guess
would happen if the league upped the price to $20.20 a ticket, a
1-percent price increase? Well, according to current data, ticket
sales would drop by about 64 fans per game, a change of just under
a quarter of a percent. So q uantity cha nges less than price in this
case, resulting an elasticity coefficient of .23.

Now, and elasticity coefficient of less than one is the same as

saying inelastic. So at current prices, the demand for basketball
tickets price inelastic. If a 1-percent price rise were to cause
exactly a 1-percent decrease in ticket sales, we’d call the demand
for tickets unit elastic, sometimes referred to as an elasticity of
one. And, finally, if a 1-percent price increase we’re to cause more
tha n a 1-percent dip in quantity demanded, we’d have an elasticity
coefficient of more than one, and demand would be price elastic.

So now that you know this, let’s see how you do in our big league
elasticity quiz. Take a guess at elasticity coefficients for the
following items at current prices. Bread: elastic or inelastic?
Actually, .15, way less than 1, and, thus, inelastic. The demand for
bread is not very responsive to price.

Auto repair: elastic or ine lastic? .4, still relatively inelastic. Movie
tickets: .87, a lmost unit elastic, but not quite. Finally, a restaurant
meal: 2.27, quite elastic. That is, Americans would cut back a lot
on eating out if current prices rose.

Now elasticity coefficients are given at the current price is, that is
at equilibrium. The reason is because of a frustrating fact about
elasticity when it’s depicted simply by a straight line, as here with
the demand curve. On a straight line, elasticity change s as you
move up and down. This demand schedule, for instance, is much
more elastic at the top than at the bottom.

Take price. It’s at the top o f its range. Thus, any move up here

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Narrator, Male, Female

from say $10.00 to $9.00 is a relatively small change, in

percentage terms, 10 percent. However, you can see that this
causes a change quantity demanded from one movie ticket to two.
That’s a change of 100 percent. When quantity demanded changes
more than price in percentage terms, demand is price elastic.

Meanwhile, down here the opposite occurs. We’re in the price

range that changes a lot in percentages. It doubles from $1.00 to
$2.00, yet the quantity demanded only drops from $10.00 to $9.00.
So here in pe rcentage terms, q uantity de manded c hanges less than
price, and is price inelastic, just because of where we are on the
line. But all else equal, a linear demand schedule becomes more
inelastic the more vertical its slope. Quantity demanded is less
responsive here than it was here, which may begin to help illustrate
our stor y.

Since the de mand for natural gas could be unusually inelastic,

which it would be easy to depict as unusually vertical, in plain
English, consumers would be unusually dependent on this product,
and, therefore, they wouldn’t cut back much on their demand for
natural gas if the current price went up. Consumers would demand
this quantity when prices were low, a nd just a little less when
prices were higher. In other words, the quantity demanded
wouldn’t respond much to price. Or, in personal terms, I’m not
about to lower my gas consumption by turning down my
thermostat, say, to 55.

Natural gas isn’t the only de mand curve that’s generally p rice
ine lastic. People are also generally unresponsive to price when it
comes to lifesaving medical care, or addictive substances, like
tobacco or alcohol, which you don’t tend to buy muc h less of when
the price goes up. That is, the more you rely on something for
which there are no suitable substitutes, the more unresponsive you
are to changes in price, the more inelastic your demand almost
anywhere on the schedule.

So now have we solved the puzzle we started with, why natural gas
prices shot up so high in the winter of 2001. Well, not really,
because look what happens to price when our now even more
inelastic demand curve shifts to the right. It goe s past the
equilibrium point we drew earlier when told you there was
something wrong with the picture, a demand curve that looked too
elastic. However, even in this picture, price still doesn’t rise nearly
enough to reflect the enor mous jump that occurred in real life. So
what is still wrong with the picture?

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Narrator, Male, Female

Well, let’s look at the supply curve here. It look s relatively elastic,
suggesting that suppliers are quite responsive to price, just as we’d
image. A higher price, a lot more quantity supplied. And, in fact,
isn’t that the beauty of a marke t system? Prices go up because we
consumers want more of something. Supp liers respo nd to the cue
by giving us more of what we want.

Well, not necessarily because in the short run, supp ly is often

price- inelastic, too.

Male: You seeing that natural gas drilling going on?

Narrator: Back in 1992, when energy prices were low, Larry Strayhand had
taken us on a tour of drilling rigs standing idle on the Gulf Coast.
Nine years later, prices were high enough to justify pressing them
back into service to help increase the supp ly of fossil fuel for
heating the northeast. But the rigs were no longer available. After
years of low prices, these very rigs had been recycled as scrap
metal. Eleven hundred rigs were drilling in the US by the winter
of 2001, double the number just a few years before, but says
Strayhand –

Male: Compare that with 4,500 to achieve the level we were at in 1983.
Try that. I mean, to catch up, it’s gonna take us two years from the
day we start drilling to go online with the natural gas we have.

Narrator: Another reason supply hadn’t responded to higher prices, he says,

is that oil and gas drillers like Strayhand himself, had long since
take n other jobs.

Male: Oh, yeah. We build drilling equipment. The problem is we can’t

anybody to run it in today’s world. So there’s nobod y left out here
to do this.

Narrator: So here, at last, is the answer to our question. What was wrong
with this picture? Basically, both the supply and demand curves
were drawn as relatively price-elastic straight lines, when, in fact,
both were curvy, and after a certain point, almost completely
pr ice- inelastic. This may be more than you want to know abo ut
natural gas, but the real supp ly curve look s more like this. At low
prices, supply responds a lot to changes in prices because it’s
cheap to bring more gas to market.

A small price change brings lots more gas out of the ground. But
past here, today’s wells and pipelines are running a capacity.
There’s no more gas in storage. To get more supply is almost

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Narrator, Male, Female

impossible so the curve becomes almost totally inelastic.

Meanwhile, the real demand curve looks like this. We’re not
going to explain all the kinds, but the general idea is clear. Give n
the weather, there’s a certain qua ntity of natural gas which
Americans in the short run are willing to pay almost anything for.

And when you combine ine lastic supp ly with inelastic de mand,
you’ve got the po tential for big pr ice moves, big trouble, especially
for those of us subject to the big chill of a New England winter as
in our example, the winter of 2000-2001. To simplify, the weather
was getting colder and colder, meaning more demand, meaning the
demand curve kept shifting to the right. For a while, price rose
gradually, but the demand curve finally reached the point at which,
in essence, the gas ran out.

The point at which the supply curve becomes almost totally

ine lastic. That was also the po int on the qua ntity axis be low which
people that winter would freeze, below which, in other words, the
demand curve was almost totally inelastic. When it got colder still,
and, of course, people still needed to stay just as warm, demand
shifted e ven more. The result was a stunning spike in price.
Natural gas just abo ut quadr upled in a month. And, indeed, for a
few days it went higher still, the result of market manipulation it
seems, to keep even more gas off the market. Less gas, a shift to
the left, driving prices out of sight.

In the long run say, economists, higher prices will enable gas
producers to use new technology like 3D imaging of the earth’s
crust to see quickly where it’s best to drill. Producers will also be
able to drill deeper, build more pipelines and so on, and ultimately
all this will allow them to produce more gas.

Now in terms of our graph, this means the supp ly c urve, e ven
though it, too, is relatively inelastic, shifts to the right. And given
the inelastic segment of the demand curve, this should bring prices
back down, way down, and, by the way, eliminate opportunities for
market manipulation. So in the long run, the marke t can be pretty
effective at giving what we want. So economics works in the long
run. On the other hand, in the shor t run, a lot of people who can’t
afford the steep prices due to inelasticity, could get very seriously
hurt, which is why when po licy deba tes rage over the price of
energy, it’s so useful to know the economics behind the problem.

[End of Audio]

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