Why does consumer surplus and producer surplus decrease when the elasticity of demand and elasticity of supply increase. The explanation given in the CFA text is that when the elsticity of demand and supply increases, the demand and supply curves becone more horizontal and the space between the curves to the left of the equilibrium quantity will become smaller. I still don’t get the logic behind. Can someone explain?
Sure. When demand becomes MORE elastic, that means that a change in price will lead to a larger change in quantity demanded. So a small price increase will lead to a large decrease in quantity demanded. If you’re looking at a demand and supply curve, the demand curve will become FLATTER (more elastic, remember, perfectly elastic curves are horizontal). The flat curve depicts the large change in quantity demanded (x axis) relative to price (y axis). Consumer surplus is the area beneath the demand curve that represents what consumers are willing to pay, in excess of what they do pay in equilibrium. If demand becomes more elastic, consumers are more sensitive to small changes in price, therefore they are less willing to pay in excess of market price. Really the best way to nail this concept is by memorizing the graph, and knowing the definition of each term… I hope this helped though!
Hi movingonup Thanks a lot! it did help me…will try & memorize the graph ASAP.