Source: Sample Midterm 1, Q2
Difficulty: Introductory to Intermediate | Prerequisites: Basic supply and demand model, understanding of equilibrium price and quantity.
This topic ties together two building blocks: how changes in production costs shift the supply curve, and how the price elasticity of demand determines what happens to total spending when price changes. It sits squarely in the supply-and-demand toolkit section of the course. You need to be comfortable drawing supply and demand diagrams, finding equilibrium, and understanding what "shifts" versus "movements along" a curve mean.
When the marginal cost of producing a good falls, the supply curve shifts down (rightward), lowering the equilibrium price and raising the quantity. If demand is elastic (elasticity > 1 in absolute value), the percentage increase in quantity outweighs the percentage fall in price, so total consumer spending on the good rises.
Price elasticity of demand
The percentage change in quantity demanded divided by the percentage change in price. In simple terms, it measures how sensitive buyers are to a price change. An elasticity greater than 1 (in absolute value) means demand is elastic.
Elastic demand
Demand where the percentage change in quantity exceeds the percentage change in price (elasticity > 1 in absolute value). On a graph, elastic demand is represented by a relatively flat demand curve.
Inelastic demand
Demand where the percentage change in quantity is smaller than the percentage change in price (elasticity < 1 in absolute value). A relatively steep demand curve.
Supply shift (downward/rightward)
When the cost of production falls, each unit can be produced more cheaply, so firms are willing to supply more at every price. The supply curve shifts down (equivalently, rightward).
Total spending / total revenue
Price multiplied by quantity (P x Q). Whether this rises or falls after a price change depends on the elasticity of demand.
The market supply curve is the industry marginal cost curve. If the marginal cost of producing blueberries (or any good) falls, firms can produce each unit more cheaply.
This means at every price, firms are willing to supply more. Graphically, the supply curve shifts from S₁ to S₂ (downward and to the right).
Result: equilibrium price falls (P₁ to P₂) and equilibrium quantity rises (Q₁ to Q₂).
Price elasticity of demand = %ΔQ / %ΔP (in absolute value).
If elasticity > 1 (elastic demand): the percentage rise in quantity is larger than the percentage fall in price. Since total spending = P x Q, spending goes up.
If elasticity < 1 (inelastic demand): the percentage rise in quantity is smaller than the percentage fall in price. Total spending falls.
If elasticity = 1 (unit elastic): the two percentage changes exactly offset. Total spending stays the same.
Draw a relatively flat demand curve to represent elastic demand.
Initial spending is the area of the rectangle P₁ x Q₁ (shaded red in the source diagram). New spending is P₂ x Q₂ (shaded blue).
Because the demand curve is flat (elastic), the quantity increase is large relative to the price decrease, so the blue rectangle is bigger than the red one. Total spending has risen.
Price elasticity of demand:
E_d = \frac{\%\Delta Q_d}{\%\Delta P}Total spending (total revenue from the consumer side):
\text{Total Spending} = P \times QRule of thumb: when price falls and demand is elastic (|E_d| > 1), total spending rises. When demand is inelastic (|E_d| < 1), total spending falls.
Diagram: S₁ shifts down to S₂. Flat D₁ curve. Compare the rectangles P₁ x Q₁ and P₂ x Q₂ to see the spending change.
When improved farming technology reduces the cost of growing blueberries, the supply curve shifts out. If consumers are very responsive to blueberry prices (elastic demand), total spending on blueberries rises despite the lower price, because people buy so many more. This same logic applies to consumer electronics: as manufacturing costs fall, prices drop, quantities surge, and total spending in the category often grows.
Students often confuse a shift of the supply curve with a movement along it. A fall in production cost shifts supply. A change in the good's own price causes a movement along supply.
Some students forget to explain why the supply curve shifts. The supply curve is the industry marginal cost curve, so lower marginal costs shift it down.
Elastic demand does not mean the demand curve is perfectly flat. A flat curve is a convenient approximation, but elasticity varies along a linear demand curve.
Students sometimes think total spending always rises when quantity rises. Whether spending rises or falls depends on elasticity, not just the direction of the quantity change.
⚠️ The diagram and a discussion of elasticity are essential. You cannot get full marks without both.
⚠️ Explaining why lower marginal costs shift the supply curve is required for full credit. Do not just assert the shift.
⚠️ You can discuss things in terms of a "relatively big change in Q and a relatively small change in P" with the rectangle areas, even without explicitly mentioning percentage changes, and still earn nearly full marks (up to about 14 out of 15).
⚠️ You do not need to show that elasticity changes along the demand curve. A flat demand curve as an approximation for elastic demand is fine.
True or false: A fall in the cost of producing a good shifts the demand curve to the right. (False, it shifts the supply curve down/right.)
Fill in the blank: Price elasticity of demand = %ΔQ / ______. (%ΔP)
True or false: If demand is elastic, a fall in price increases total spending. (True.)
Fill in the blank: Total spending equals ______ times ______. (Price, Quantity)
True or false: A steep demand curve represents elastic demand. (False, a flat curve does.)
Q: Suppose the marginal cost of producing blueberries falls and the demand for blueberries is highly elastic. Using a diagram, explain what happens to the price, quantity, and total consumer spending on blueberries.
A: Draw a supply-and-demand diagram with a relatively flat demand curve (elastic demand). The fall in marginal cost shifts the supply curve from S₁ down to S₂. The new equilibrium has a lower price (P₂ < P₁) and a higher quantity (Q₂ > Q₁). Because demand is elastic, the percentage increase in Q exceeds the percentage decrease in P, so total spending (P x Q) rises. You can see this by comparing the rectangles: P₂ x Q₂ > P₁ x Q₁.
Q: If demand were inelastic instead of elastic, would total spending on blueberries rise or fall after the supply shift? Explain.
A: Total spending would fall. With inelastic demand, the percentage increase in quantity is smaller than the percentage decrease in price, so the price effect dominates and P x Q declines.
This connects to tax incidence and welfare analysis: the elasticity of demand and supply determines who bears the burden of a tax and how large the deadweight loss is. It also links to the monopoly topic, where the monopolist's pricing decision depends on the shape of the demand curve it faces.
Price elasticity of demand, elastic demand, inelastic demand, unit elastic, supply shift, marginal cost reduction, total spending, total revenue, P times Q, supply and demand diagram, percentage change, flat demand curve, steep demand curve, ECON 2, intro microeconomics, NYU Economics 2, blueberries example