Price Elasticity of Supply

Price Elasticity of Supply (PES)

• Definition: Price elasticity of supply measures the responsiveness of the quantity supplied of a product to a change in its price.

Key Concepts

• Price Elastic Supply: Supply is price elastic when producers can increase supply easily in response to price increases.

  • Competitive advantage for firms with price elastic supply as they can respond quickly to market changes.

• Price Inelastic Supply: Supply is price inelastic when firms have difficulty changing production in response to price changes.

Calculating PES

• Formula: PES is calculated as: PES = \frac{%\Delta QS}{%\Delta P}

  • Where:

  • %ΔQS= Percentage change in quantity supplied

  • %ΔP = Percentage change in price

• Example Calculation:

  • For an increase in market price of beans from $2 to $2.20 (10% increase),

  • Quantity supplied rises from 10,000 to 10,500 (5% increase).

  • Calculation:

  • Percentage change in quantity supplied:
    %\Delta QS = \frac{10,500 - 10,000}{10,000} = 0.05 \text{ or } 5\%

  • Percentage change in price:
    %\Delta P = \frac{2.20 - 2.00}{2.00} = 0.10 \text{ or } 10\%

  • Therefore:
    PES = \frac{5\%}{10\%} = 0.5

• Interpretation: A PES less than 1 indicates that supply is inelastic (less responsive to price changes).

Interpreting PES Values

• If PES > 1: Supply is price elastic; quantity supplied is responsive to price changes.

• If PES < 1: Supply is price inelastic; quantity supplied is relatively unresponsive.

• Perfectly Inelastic Supply (PES = 0): No change in quantity supplied regardless of price changes.

• Perfectly Elastic Supply (PES = ∞): Supply changes without any change in price.

• Unitary Elasticity (PES = 1): Proportional change in quantity supplied equals the proportional change in price.

Supply Curve Diagrams

• Price Elastic Supply Diagram:

  • More spare capacity allows for greater proportional increases in supply relative to price increases.

• Price Inelastic Supply Diagram:

  • Limited spare capacity results in smaller proportional increases in supply for large price changes.

Determinants of PES

1. Degree of Spare Capacity:

   • High spare capacity enables easy increase in supply (price elastic).

   • Example: Coca-Cola can quickly adjust production levels.

2. Level of Stocks/Inventories:

   • Higher stocks allow quicker response to price changes.

   • Easier to increase supply of storable goods (e.g., non-perishable items).

3. Number of Producers:

   • More firms lead to greater supply responsiveness (price elastic).

   • Less competition leads to inelastic supply.

4. Time Period:

   • Short run constraints limit responsiveness; long run allows for adjustments to production.

5. Ease and Cost of Factor Substitution:

   • Occupational mobility of resources increases elasticity.

   • Example: Publishing firms can rapidly shift production focus.

Significance of PES for Decision Makers

• For Firms:

  • High PES allows firms to capitalize on price increases, generating greater revenue.

  • Firms can respond by creating more capacity or improving inventory management.

• For Governments:

  • Understanding PES can inform policy decisions, particularly in housing markets and labor markets.

  • Governments may need to intervene in situations of inelastic supply to promote equitable access.

Revision Checklist

• PES measures quantity supplied response to price changes.

• PES Formula: PES = \frac{%\Delta QS}{%\Delta P}

• PES value interpretations and conditions.

• Key determinants affecting PES.

• Significance of PES for firms and government policy.