Price Elasticity of Supply
Tale of content
- Mobility of factors
- Time to respond
- Price elasticity
- Supply could be inelastic
- Elastic supply
- Example 2
- Short & long terms
Price Elasticity of Supply Price elasticity of supply (PES or Es) is a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price or cost. The elasticity is represented in numerical form, and is defined as the percentage change in the quantity supplied divided by the percentage change in price. When the coefficient is less than one, the said good can be described as inelastic; when the coefficient is greater than one, the supply can be described as elastic. An elasticity of zero indicates that the quantity supplied does not respond to a price change: it is “fixed” in supply. Such goods often have no labor component or are not produced, limiting the short-run prospects of expansion. If the coefficient is exactly one, the good is said to be unitary elastic. The number of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks that they can build up or run down.
Determinants Availability of raw materials, for example, availability may cap the amount of gold that can be produced in a country regardless of price. Likewise, the price of Van Gogh’s paintings is unlikely to affect their supply. The length and complexity of production depend on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings – no special structures are needed. Thus, the PES for textiles is elastic. On the other hand, the PES for specific types of motor vehicles is relatively inelastic. Auto manufacturing is a multi-stage process that requires specialized equipment, skilled labor, a large supplier network, and large R&D costs. Mobility of factors If the factors of production are easily available and if a producer producing one good can switch their resources and put it towards the creation of a product in demand, then it can be said that the PES is relatively elastic. The inverse applies to this, to make it relatively inelastic.
Availability of raw materials
For example, availability may cap the amount of gold that can be produced in a country regardless of price. Likewise, the price of Van Gogh’s paintings is unlikely to affect their supply.
Length and complexity of production
Much depends on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings – no special structures are needed. Thus, the PES for textiles is elastic.
Mobility of factors
If the factors of production are easily available and if a producer producing one good can switch their resources and put it towards the creation of a product in demand, then it can be said that the PES is relatively elastic. The inverse applies to this, to make it relatively inelastic.
Time to respond
The more time a producer has to respond to price changes the more elastic the supply. Supply is normally more elastic in the long run than in the short run for produced goods, since it is generally assumed that in the long run all factors of production can be utilized to increase supply, whereas in the short run only labor can be increased, and even then, changes may be prohibitively costly. For example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price of soybeans because of the time it would take to procure the necessary land.
A producer who has a supply of goods or available storage capacity can quickly increase supply to the market.
Spare or excess production capacity
A producer who has unused capacity can (and will) quickly respond to price changes in his market assuming that variable factors are readily available. The existence of spare capacity within a firm would be indicative of a more proportionate response in quantity supplied to changes in price (hence suggesting price elasticity). It indicates that the producer would be able to utilize spare factor markets (factors of production) at its disposal and hence respond to changes in demand to match with supply. The greater the extent of spare production capacity, the quicker suppliers can respond to price changes and hence the more price elastic the good/service would be.
Price Elasticity of Supply
Price elasticity of supply measures the responsiveness of quantity supplied to a change in price.
The price elasticity of supply (PES) is measured by the % change in Q.S divided by the % change in price.
- If the price of a cappuccino increase by 10%, and the supply increases by 20%. We say the PES is 2.0.
- If the price of bananas falls 12% and the quantity supplied falls 2%. We say the PES = 2/12 = 0.16
- Inelastic supply – a change in price causes a smaller proportional change in quantity supply
- Elastic supply – a change in price causes a bigger proportional change in supply
This means that an increase in price leads to a smaller % change in supply. Therefore PES <1
In this case the PES =
- % change in Q.S. = (64-60)/60 = 0.06666
- % change in price = (106-80)/80 = 0.325
- PES = 0.2
Supply could be inelastic for the following reasons
- Firms operating close to full capacity.
- Firms have low levels of stocks, therefore there are no surplus goods to sell.
- In the short term, capital is fixed in the short run e.g. firms do not have time to build a bigger factory.
- If it is difficult to employ factors of production, e.g. if highly skilled labor is needed
- With agricultural products, supply is inelastic in the short run, because it takes at least six months to grow new crops. In September the farmer cannot suddenly produce more potatoes if the price goes up.
Examples of goods with inelastic supply
- Nuclear reactors – It takes considerable time and expertise to build a new reactor. If there is high demand, few firms would be able to increase output in quick time
- Grapes – Harvest is once a year, so in the short-term, supply would be very inelastic.
- Flood defenses – If there is heavy rainfall and flooding, there would be high demand for flood defenses. But, supply barriers against floods cannot occur overnight. It will take many months of construction to build.
- During an economic boom when demand for goods is very high and firm is running out.
This occurs when an increase in price leads to a bigger % increase in supply, therefore PES >1
- % change in Q.S. = 110-60/60 = 0.8333
- % change in Price = 106-80/80 = 0.325
- PES = 2.56
Supply could be elastic for the following reasons
- If there is spare capacity in the factory.
- If there are stocks available.
- In the long run, supply will be more elastic because capital can be varied.
- If it is easy to employ more factors of production.
- If a product can be sold on the internet it increases the scope of international competition and increases options for supply.
Examples of goods with elastic supply
- Fidget spinners. These goods are relatively easy to make, requiring only basic raw materials of plastic. Many manufacturing firms could easily adapt production to increase supply.
- Taxi services. It is relatively easy for people to work as taxi drivers. People can work part-time and only need a qualified driving license. With mobile apps like Uber, it has also become easier to fit consumers with a broader range of options. If the price rises, Uber can offer higher wages and encourage more people to come out to work. There are still some supply constraints on very popular days. But, mostly, supply is quite elastic.
- During the recession and excess supply. In a recession with a fall in demand, the firm will have unsold goods and a large stock.
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The elasticity of a good provides a measure of how sensitive one variable is to changes in another variable. In this case, the price elasticity of supply determines how sensitive the quantity supplied is to the price of the good.
Calculating the PES
When calculating the price elasticity of supply, economists determine whether the quantity supplied of a good is elastic or inelastic. The percentage of change in supply is divided by the percentage of change in price. The results are analyzed using the following range of values:
- PES > 1: Supply is elastic.
- PES < 1: Supply is inelastic.
- PES = 0: Supply is perfectly inelastic. There is no change in quantity if prices change.
- PES = infinity: Supply is perfectly elastic. A decrease in prices will lead to zero units produced.
Factors that Influence the PES
There are numerous factors that impact the price elasticity of supply including the number of producers, spare capacity, ease of switching, ease of storage, length of the production period, time period of training, factor mobility, and how costs react.
The price elasticity of supply is calculated and can be graphed on a demand curve to illustrate the relationship between the supply and price of the good.
Supply and Demand Curves: A demand curve is used to graph the impact that a change in price has on the supply and demand of a good.
Short run and long run
Since firms typically have a limited capacity for production, the elasticity of supply tends to be high at low levels of quantity supplied and low at high levels of quantity supplied. At low levels of quantity supplied, firms typically have substantial capacity available for use, so small increases in price make it profitable for firms to begin to use this idle capacity. Thus, the responsiveness of quantity supplied to changes in price is high in this region of the supply curve. However, as capacity becomes fully utilized, increasing production requires additional investment in capital (for example, plant, and equipment). Since the price must rise substantially to cover this additional expense, supply becomes less elastic at high levels of output.