2.8 - Price Elasticity of Supply
The meaning and calculation of price elasticity of supply
Price elasticity of supply (PES) shows how much the quantity supplied of a good changes in response to a shift in its price. PES is always positive because supply curves slope upwards, meaning higher prices generally lead to more supply.
Formula for PES
Where:
- Percentage change in quantity supplied = The proportional change in the amount producers are willing to supply
- Percentage change in price = The proportional change in the good's price
Worked example - Calculating PES
Two clothing manufacturers produce shirts at £15 each, making 50 shirts per day. After a rise in demand, both increase prices to £18. Firm X can now supply 53 shirts, while Firm Y can supply 65 shirts. Calculate the PES for each firm.
Step 1: Identify the values
- Original price = £15
- New price = £18
- For Firm X: Original quantity supplied = 50 shirts, New quantity supplied = 53 shirts
- For Firm Y: Original quantity supplied = 50 shirts, New quantity supplied = 65 shirts
Step 2: Calculate percentage changes
Percentage change in price = ((£18 - £15) / £15) × 100 = 20%
For Firm X: Percentage change in quantity supplied = ((53 - 50) / 50) × 100 = 6%
For Firm Y: Percentage change in quantity supplied = ((65 - 50) / 50) × 100 = 30%
Step 3: Apply the PES formula
For Firm X: PES = 6% / 20% = 0.3 (inelastic supply)
For Firm Y: PES = 30% / 20% = 1.5 (elastic supply)
Types of price elasticity of supply
PES can vary depending on how responsive supply is to price changes.
Categories of PES
- Elastic supply (PES > 1) - Quantity supplied changes by a larger proportion than the price. The supply curve is relatively flat.
- Inelastic supply (PES < 1) - Quantity supplied changes by a smaller proportion than the price. The supply curve is steep.
- Perfectly elastic supply (PES = ∞) - Producers supply any amount at one specific price but nothing above or below it. The supply curve is horizontal.
- Perfectly inelastic supply (PES = 0) - Supply stays fixed regardless of price changes. The supply curve is vertical.
Factors that influence PES
PES depends on how flexible producers are in adjusting their output. Greater flexibility leads to more elastic supply.
Key influences on PES
- Availability of stocks - Businesses that can easily build up or draw down inventories have more elastic supply. For example, service providers like cinemas cannot 'stock' unsold seats, making their supply inelastic.
- Time period - In the short run, supply is often inelastic due to limits like fixed machinery or labour. Over longer periods, firms can invest in new equipment or hire more staff, making supply more elastic.
- Productive capacity - Firms with spare resources or the ability to expand quickly have higher PES. Shortages of key inputs, like skilled workers or raw materials, make supply inelastic.
The impact of PES on markets and businesses
PES affects how markets respond to changes in demand, influencing prices, revenues, and business strategies.
Differences between sectors
- Agricultural goods - Supply is often inelastic, especially in the short run, because changing crops takes time. Factors like weather, disasters, or policies can make supply unstable, leading to big price swings when demand changes.
- Manufactured goods - Supply tends to be more elastic due to easier adjustments in production, like scaling up factories or holding stocks.
Effects on prices and business decisions
- In inelastic markets (e.g., farming), demand shifts cause large price changes but small supply adjustments.
- In elastic markets (e.g., consumer electronics), businesses can quickly ramp up supply to meet demand without major price hikes.
- Businesses with elastic supply can adapt to demand surges by releasing stocks, maintaining stable prices.