Elasticity of Supply

This section explains elasticity of supply, covering the price elasticity of supply formula and how to use it, how to interpret numerical values of price elasticity of supply, the factors that influence price elasticity of supply and the distinction between short run and long run in economics and Its significance for elasticity of supply. 

Understanding Price Elasticity of Supply (PES)

Definition: Price elasticity of supply (PES) measures the responsiveness of the quantity supplied of a good or service to a change in its price. It shows how much the quantity supplied changes when the price of the good changes.

Formula:

$$\text{Price Elasticity of Supply (PES)} = \frac{\% \text{ Change in Quantity Supplied}}{\% \text{ Change in Price}}$$

• If PES > 1, the supply is elastic (producers can increase supply significantly when prices rise).
• If PES = 1, the supply is unitary elastic (the percentage change in quantity supplied equals the percentage change in price).
• If PES < 1, the supply is inelastic (producers cannot significantly change the quantity supplied in response to a price change).

How to Use Formula to Calculate Price Elasticity of Supply

To calculate the price elasticity of supply, we use the formula:

$$PES = \frac{\text{Percentage Change in Quantity Supplied}}{\text{Percentage Change in Price}}$$ 

Step 1: Calculate the percentage change in quantity supplied:

$\Delta Q = \frac{Q_2 - Q_1}{Q_1} \times 100%$ 

Where:

$Q_1$​ is the initial quantity supplied

$Q_2$ is the new quantity supplied

Step 2: Calculate the percentage change in price:

$\Delta P = \frac{P_2 - P_1}{P_1} \times 100%$ 

Where:

$P_1$​ is the initial price

$P_2$ is the new price

Step 3: Plug these values into the PES formula to calculate the price elasticity of supply.

Interpret Numerical Values of Price Elasticity of Supply

Perfectly Inelastic Supply (PES = 0): A change in price has no effect on the quantity supplied. The supply curve is vertical.

• Example: The supply of land is perfectly inelastic, as the quantity of land cannot change regardless of price.

Relatively Inelastic Supply (0 < PES < 1): The quantity supplied is not very responsive to price changes. A large change in price results in a relatively smaller change in quantity supplied.

• Example: If the price of cigarettes rises, manufacturers may not significantly increase production, as there are limits to their production capacity.

Unitary Elastic Supply (PES = 1): A proportional change in price leads to an equal proportionate change in quantity supplied.

• Example: A 10% increase in price leads to a 10% increase in quantity supplied.

Relatively Elastic Supply (PES > 1): The quantity supplied is highly responsive to price changes. A small change in price leads to a relatively large change in quantity supplied.

• Example: In the case of a manufactured good, a small increase in price may lead to a large increase in the quantity supplied due to flexibility in production.

Perfectly Elastic Supply (PES = ∞): Any small change in price leads to an infinite change in quantity supplied. The supply curve is horizontal.

• Example: In a perfectly competitive market, where all firms offer identical products, any price increase could lead to a massive increase in supply.

Factors That Influence Price Elasticity of Supply

Several factors determine the price elasticity of supply for a good or service:

Time Period:

• In the short run, supply is often inelastic because producers may not be able to increase output quickly due to fixed factors of production (e.g., capital and labour).
• In the long run, supply is more elastic as producers can adjust all factors of production, such as building new factories or acquiring more resources.

Spare Capacity:

• If a firm has spare capacity, it can increase production more easily in response to a price rise, making supply more elastic.
• If a firm is already operating at full capacity, supply is more inelastic because they cannot increase production without significant investment.

Mobility of Factors of Production:

• If factors of production (such as labour and capital) can easily move between industries, supply will tend to be more elastic.
• If factors are specialised and difficult to reallocate, supply is more inelastic.

Storage Ability:

• Goods that can be easily stored (e.g., manufactured goods) tend to have a more elastic supply, as producers can increase supply when prices rise by drawing from existing stock.
• Goods that are perishable (e.g., fruit and vegetables) have a more inelastic supply because they cannot be stored.

Flexibility of Production:

• If producers can quickly change the amount of a good they produce in response to price changes, the supply will be more elastic.
• If production processes are highly specific and inflexible, supply is more inelastic.

The Distinction Between Short Run and Long Run in Economics and Its Significance for Elasticity of Supply

The distinction between the short run and long run plays a key role in determining the price elasticity of supply:

Short Run:

• In the short run, some factors of production are fixed (e.g., the size of factories or machinery). As a result, producers may find it difficult to increase supply in response to price changes.
• In this period, the supply of goods is generally inelastic because firms have limited capacity to adjust production in the short term.
• Example: If the price of oil rises, oil extraction may not increase significantly in the short run because oil fields and drilling rigs cannot be quickly expanded.

Long Run:

• In the long run, all factors of production are variable, and firms can adjust their capacity to produce more goods. Thus, the supply curve tends to be more elastic in the long run.
• Example: Over time, firms in the oil industry can invest in new drilling technology, open new oil fields, and increase supply in response to a price increase. This flexibility makes supply more elastic in the long run.

Summary of Key Points

Summary

Price elasticity of supply is an essential concept for understanding how producers respond to price changes. It is influenced by factors such as the time period, spare capacity, the mobility of factors of production, the ability to store goods, and the flexibility of production processes. In the short run, supply tends to be more inelastic due to fixed factors, while in the long run, supply becomes more elastic as firms can adjust their production capacity. Understanding these dynamics allows firms and policymakers to predict how supply will respond to changes in price, enabling more informed decision-making in both market and policy contexts.