The model of demand and supply predicts the direction of changes in
equilibrium price and quantity in response to various shifts in demand
and supply curves. For many purposes, however, it is not enough to know
merely whether price and quantity rise or fall; it is also important to know
by how much each changes.
For example, during the 2011 civil war in Libya, that country’s oil
production was sharply reduced for over six months. As a result, global
oil production fell by over 1.5 million barrels per day, a decline of just
under 2 percent. This drop in the world supply of oil led to an immediate
20 percent increase in the world price, which persisted until Libya’s
production returned to more normal levels after the end of the civil war.
How can we explain why the increase in the price of oil in this situation
was 20 percent rather than 50 percent or only 5 percent? As we will see in
this chapter, the shapes of the demand and supply curves determine the
sensitivity of prices and quantities to various economic shocks. Precise
measures of these sensitivities are provided by what are called the
elasticity of demand and supply.
6. measure cross elasticity of demand and distinguish between
substitute and complement goods.