2.8 - Price Elasticity of Supply
The definition and calculation of price elasticity of supply
Price elasticity of supply (PES) measures the responsiveness of the quantity supplied of a product to a change in its price. It indicates how much the amount producers are willing to supply adjusts when the price alters.
PES is typically positive because an increase in price usually encourages greater supply, as firms seek to maximise profits.
Formula for calculating PES
PES does not have units and is expressed as a numerical value rather than a percentage.
Worked example - Calculating price elasticity of supply
A firm's supply of a product rises from 300 units to 360 units when the price increases from £15 to £18. Calculate the PES.
Step 1: Identify the values
- Original quantity supplied = 300 units
- New quantity supplied = 360 units
- Original price = £15
- New price = £18
Step 2: Calculate percentage changes
Percentage change in quantity supplied =
Percentage change in price =
Step 3: Apply the PES formula
Step 4: Interpretation
A PES of 1 indicates unit elasticity, where the percentage change in supply matches the percentage change in price.
Types of price elasticity of supply
PES can vary in degree, reflecting how sensitive supply is to price changes. The value determines whether supply is elastic, inelastic, or somewhere in between.
Categories of PES
- Elastic supply (PES > 1) - A change in price leads to a proportionally larger change in quantity supplied. The supply curve is relatively flat, showing high responsiveness.
- Inelastic supply (0 < PES < 1) - A change in price results in a proportionally smaller change in quantity supplied. The supply curve is steep, indicating low responsiveness.
- Unit elastic supply (PES = 1) - The percentage change in quantity supplied equals the percentage change in price.
- Perfectly elastic supply (PES = ∞) - Supply is infinite at a certain price; any price drop reduces supply to zero. The supply curve is horizontal.
- Perfectly inelastic supply (PES = 0) - Quantity supplied remains constant regardless of price changes. The supply curve is vertical.
Time periods and their impact on PES
The elasticity of supply often depends on the timeframe considered, as firms need time to adjust production levels. Supply tends to be less flexible in shorter periods.
Short run and PES
In the short run, at least one factor of production, such as capital (e.g., factories or machinery), is fixed. This limits a firm's ability to expand output quickly, making supply inelastic. For example, a manufacturer can hire more staff or buy extra materials, but building new facilities takes time.
Long run and PES
In the long run, all factors of production are variable, allowing firms to increase capacity fully. This makes supply more elastic, as businesses can respond more effectively to price changes.
Variations across industries
The length of the short run and long run differs by sector. Agricultural products, like crops or livestock, have more inelastic supply in the short run due to growth cycles, while manufactured items, such as electronics, can adjust faster.
Importance of PES to firms
Understanding PES is vital for firms as it affects their ability to adapt to market changes and maintain competitiveness and profitability.
Benefits of high PES to firms
Firms benefit from elastic supply as it allows them to capitalise on price increases by boosting output without delays. This responsiveness helps meet rising demand and maximise revenue.
Measures to improve elasticity of supply
- Flexible working patterns - Allowing variable shifts or temporary staff to scale production rapidly.
- Latest technology - Adopting efficient tools to speed up manufacturing processes.
- Spare production capacity - Maintaining unused resources, like extra factory space, to increase output without new investments.
Factors affecting PES
Several elements influence how elastic or inelastic supply is for a good or service. These factors determine a firm's ability to adjust output in response to price changes.
Key influences on PES
- Unemployment levels - High unemployment makes supply more elastic, as firms can easily hire additional workers to expand production.
- Perishability of goods - Items that spoil quickly, such as fresh produce or flowers, have inelastic supply because they cannot be stored long-term.
- Stock levels - Businesses with substantial inventories can increase supply quickly, leading to more elastic PES.
- Mobility of factors of production - Industries where labour, capital, or resources can be reallocated easily (e.g., without heavy machinery that is hard to move) tend to have elastic supply.
- Production time - Products requiring long cultivation periods, such as certain agricultural commodities, exhibit inelastic supply, while goods manufactured quickly, like microchips, tend to have more elastic supply.
- Spare capacity - Firms with unused production facilities can ramp up supply without extra costs, enhancing elasticity.