The Quantity Index and the Elasticity of Demand for Output

Abstract

Classification according to elasticities is particularly important in constructing supply and demand functions relating aggregates of output, sales, purchases or consumption to price levels of these aggregates. If these aggregates consist of commodities with widely different individual demand or supply elasticities the aggregate supply or demand curve may be almost meaningless, for consistent with a given price level of the aggregate there may be a wide range of possible values of the quantity level, depending on the composition of the price level. Thus suppose that we have an aggregate consisting of commodity A, which has an elastic demand, and commodity B, which has an inelastic demand. A rise in the price of A coupled with a fall in the price of B may leave the price level unchanged: it will, however, diminish the purchases of A very substantially and increase the purchases of B very little, because of the differing elasticities of demand, and hence the index of quantities purchased may decline even though the price level remains unchanged. Exactly similar considerations apply to supply. It is possible to draw aggregate supply and demand curves, therefore, only when the commodities aggregated have approximately the same elasticities of demand and supply. For this reason aggregate demand and supply curves which include very large groups of commodities, and even more, aggregate demand and supply curves which attempt to cover the whole of output are very unreliable and dangerous weapons of analysis.