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1.2.4 Elasticity of Supply What is the relationship between price and supply? State 2 factors that would shift a supply curve to the left. What is meant by price elasticity of demand? AQA E CON 1: M ARKETS AND MARKET FAILURE 1.2.4 W HAT YOU NEED TO KNOW Candidates should be able to calculate price elasticity of supply and understand the factors that influence price elasticity of supply P RICE ELASTICITY OF S UPPLY If a product is price inelastic i.e. less than 1: i) an increase in P will lead to an increase in S less than the increase in P ii) A decrease in P will lead to a decrease in S less than the decrease in P If a product is price elastic i.e. greater than 1: i) an increase in P will lead to an increase in S greater than the increase in P ii) A decrease in P will lead to a decrease in S greater than the decrease in P Price elasticity of supply (PES) is a measure of the responsiveness of supply to a change in price Calculated by the formula: % change in quantity supplied = PES % change in price Or: % Δ qs = PES %Δp Title answer mean? What does the PED coefficient Relevance to business 0 Perfectly inelastic The business does not change S in response to a change in P. It is fixed. 0<1 Price inelastic If P rises, S will increase, BUT at a lesser proportion to the increase in price. 1 Unitary (constant) elasticity Increasing or decreasing price will lead to a proportional change in supply. 1>∞ (infinity) Price elastic If P rises, S will increase, BUT at a greater proportion to the increase in price. ∞ Perfectly elastic Producers will supply any amount above a certain P. P RICE ELASTICITY OF SUPPLY The formula for PED can be rearranged to make it easier to work out an answer: a) Δ𝑄 Q ÷ ∆𝑃 𝑃 Example: A firm supplies 100 units at a price of £10.00 per unit. The market price increases to £15.00 so the firm supplies 10 more units. Work out the price elasticity of supply. =? Step 1: b) Δ𝑄 𝑃 x Q Δ𝑃 =? Step 2: P Change in supply Original supply Change in price Original price x 100 = 10/100 x 100 = 10% x 100 = 5/10 x 100 = 50% ∆𝑄 c) Q x Δ𝑃 = ? Complete the equations a-c to prove that PES is the same using all three formulas. Step 3: %Δ qs p %Δ = 10/50 = +0.2 Q UICK TEST To calculate the percentage change in the quantity supplied of a good following a change in price, the price elasticity of supply should be a) Multiplied by the percentage change in price b) Multiplied by the percentage change in quantity c) Divided by the percentage change in price d) Divided by the percentage change in quantity Can you explain your answer? P RICE ELASTICITY OF SUPPLY – RELEVANCE TO BUSINESS Unlike PED, the PES coefficient is likely to have a positive figure. As price increases firms find it more profitable to increase supply. Price inelastic Perfectly inelastic S S Price Price Quantity Quantity A perfectly inelastic supply curve will have a PES coefficient of 0. A price inelastic supply curve will have a PES coefficient between 0 and 1. If price was to change the quantity supplied would not be affected. If price was to change the quantity supplied would change by a lesser amount. In theory, the firm would supply the same amount at any given price. This may be because of difficulties in increasing supply or that the incentive to increase supply is not great enough for some firms. P RICE ELASTICITY OF SUPPLY – RELEVANCE TO BUSINESS Perfectly elastic Price elastic Price Price S S Quantity Quantity A price elastic product will have a PES coefficient between 1 and ∞. A perfectly elastic product will have a PES coefficient of ∞. If price was to change the quantity supplied would change by a greater amount. If price was to stay the same or increase the quantity supplied would be infinite. Firms find it easy to increase supply or the incentive to increase supply has become greater. If price was to decrease the quantity supplied would fall to zero. D ETERMINANTS OF PRICE ELASTICITY OF SUPPLY Firms will try to increase their PES. A more elastic PES coefficient suggests that the firm is more flexible in changing the supply of its products, thereby making it more competitive. This contrasts to PED where firms will wish to have a more inelastic PED coefficient. Price elasticity of supply is determined by: Agricultural markets are often used to illustrate price elasticity of supply. What trends are driving the PES of food in global markets? Price Increases in price act as an incentive for firms to increase supply At higher price levels a firm is more profitable as the contribution per unit (selling price – variable cost) is higher Substitutes The number and closeness of producer substitutes will help to determine PES If it is easy for a firm to change production of its products e.g. from tables to chairs then PES is likely to be very price elastic and vice versa The easier it is to switch production the higher the PES Time In the short run products are likely to be more price inelastic as producers find it difficult to increase production In the long run products are likely to be more price elastic as producers adjust to changing market conditions by buying more machinery, building new factories etc Therefore, it is easier to increase capacity T EST YOURSELF Define the term price elasticity of supply. Always make use of relevant calculations when doing elasticity questions. The following table shows estimated annual changes in the price and supply of organic tomatoes: Year % change in price % change in quantity supplied 2010 4 2 2011 15 10 2013 25 30 Using the information in the table comment on the business relevance for organic tomato growers of the changes in PES between 2010 and 2013. E LASTICITIES Take it in turns to pick a term and explain it to the rest of the group. After each explanation one member of the group should ask a question to clarify any points made or to stretch to add an additional point e.g. what would that look like in a diagram? Price elasticity of demand Giffen goods PED coefficient Cross elasticity of demand Price elastic demand XED coefficient Price inelastic demand Substitutes Perfectly price elastic demand Complementary goods Perfectly price inelastic demand Price elasticity of supply Income elasticity of demand PES coefficient YED coefficient Price elastic supply Income elastic demand Price inelastic supply Income inelastic demand Perfectly price elastic supply Inferior goods Perfectly price inelastic supply
