Supply and PES

Definition and Fundamental Principles of Supply

Supply represents the total quantity of a good or service that producers are willing and able to offer at a specific price level. A central characteristic of all supply curves is that they slope upwards, moving from the bottom left to the top right of a graph. This upward trajectory is due to the direct relationship between price and quantity supplied: as the price of a good rises, the quantity supplied also increases. This occurs because higher prices lead to higher profit margins for producers, creating a greater incentive for them to increase their output. This behavior rests on the fundamental economic assumption that firms operate with the goal of maximizing their profit.

Changes in the quantity supplied that result from changes in the price of the good itself are represented by movements along the supply curve. When the price increases, it results in an extension in supply. Conversely, when the price decreases, it results in a contraction in supply. These movements occur specifically when all other factors outside of price remain constant.

Price Elasticity of Supply (PES)

Price Elasticity of Supply, or PES, is a metric used to measure the responsiveness of the quantity supplied of a good to a change in its price. The formula for calculating PES is defined as the percentage change in quantity supplied divided by the percentage change in price:

$\text{PES} = \frac{\% \text{ change in QS}}{\% \text{ change in price}}$

To determine the percentage change for either variable, the standard formula used is:

$\frac{\text{New Value} - \text{Original Value}}{\text{Original Value}} \times 100$

In economic theory, PES values are always positive because price and quantity supplied move in the same direction; if price rises, quantity supplied rises, and if price falls, quantity supplied falls. A supply is considered elastic when the PES value is greater than $1$, meaning producers are highly responsive to price changes and the percentage change in quantity supplied is larger than the percentage change in price. Supply is inelastic when the PES value is less than $1$, indicating that producers are less responsive and quantity supplied changes by a smaller percentage than the price. Unitary elastic supply occurs when the PES is exactly $1$, meaning the percentage change in quantity supplied is exactly proportional to the percentage change in price.

Numerical and Graphical Demonstrations of Elasticity

To demonstrate an elastic supply curve, consider a scenario where the price of a good is $£10$ and the quantity supplied is $500$ units. If the price rises by $10\%$, increasing by $£1$ to a new price of $£11$, and the producers respond with a $40\%$ increase in quantity ($200$ additional units), the new quantity supplied becomes $700$ units. This significant response (40\% \text{ change in QS} > 10\% \text{ change in P}) illustrates that even a small change in price causes a large change in the quantity supplied.

In contrast, an inelastic supply curve can be demonstrated by a scenario where the initial price is $£2$ and the quantity supplied is $1000$ units. If the price increases by $80\%$, which is an increase of $£1.60$ leading to a new price of $£3.60$, but the quantity supplied only increases by $10\%$ ($100$ units) to a total of $1100$ units, the PES is low. This shows that despite a massive change in price, the change in quantity supplied is relatively small because producers remain unresponsive. For a unitary elastic supply curve, the line on a graph must start from the origin ($0,0$).

Determinants of Price Elasticity of Supply

Several factors influence the level of responsiveness in production. One primary factor is spare capacity. If Factory 1 has very little spare capacity, it lacks the physical space or machinery to increase output significantly if prices rise, resulting in inelastic supply. However, if Factory 2 has significant spare capacity, it can easily utilize idle machinery and space to increase output and capitalize on higher prices, making its supply elastic.

Another factor is the availability of factors of production. If the inputs required for a good are readily available, such as the ingredients for a cucumber sandwich, producers can easily find more resources to increase supply if prices rise, leading to elastic supply. Conversely, if factors of production are scarce, such as the resources needed to produce a diamond ring, producers will find it difficult to increase supply even if they wish to, resulting in inelastic supply. The state of the economy also plays a role. In a poor economic state where workers are unemployed and shops are vacant, a producer like Dolly can easily find land and labor to expand a coffee shop business, leading to elastic supply. In a good economy where resources are already fully occupied or employed, it is much harder for Dolly to increase production, making the supply inelastic.

Perishability, Stockpiles, and Time Periods

Stockpiles and perishability are critical in determining PES. Goods like pencil sharpeners are durable and can be easily stockpiled. If prices rise, producers can quickly sell existing stock from storage, increasing the quantity supplied by a large percentage and creating elastic supply. Perishable goods like cheese cannot be easily stored long-term as they spoil. Therefore, if the price of cheese rises, producers cannot rely on stockpiles and must produce more from scratch, which takes significant time. This makes the supply of cheese inelastic.

Time itself is a major determinant. In the short run, at least one factor of production is fixed. For example, a race car producer might have a fixed amount of factory space or a specific number of machines. Even if prices rise massively, they cannot increase production beyond these physical limits, making supply more inelastic. In the long run, all factors of production can be changed, allowing firms to expand factories and purchase more equipment, making supply more elastic as they can respond more fully to price changes.

Extreme Elasticity Values and Supply Shifts

There are two extreme cases of elasticity. Perfectly inelastic supply is represented by a vertical supply curve, where the PES is $0$. This means the quantity supplied is completely unresponsive to price changes. This is common in the short run for agricultural goods like wheat, strawberries, or beef, where it is impossible to increase supply immediately regardless of price because of the time required to grow crops or raise animals. Perfectly elastic supply is represented by a horizontal supply curve, where producers will respond to a price change by an infinite or huge amount.

While price changes cause movements along the curve, other factors cause the entire supply curve to shift. These are known as the conditions of supply. A shift to the right indicates an increase in supply, while a shift to the left indicates a decrease. Factors that cause these shifts include changes in technology or weather. Costs of production also trigger shifts; for instance, if the price of pizza dough rises, producers make less profit from pizza, leading them to supply less pizza and perhaps switch to supplying pasta instead. If they cannot afford the dough, the supply curve shifts left. Finally, the number of suppliers and productivity levels influence shifts. Productivity can be increased through specialization and the division of labor, making workers more efficient and shifting supply right. However, if repetitive tasks lead to worker demotivation, productivity may fall, resulting in a leftwards shift of the supply curve.