Download Price Elasticity of Supply

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Price Elasticity of Supply
Price elasticity of supply (Pes) measures the relationship between
change in quantity supplied and a change in price.

If supply is elastic, producers can increase output
without a rise in cost or a time delay

If supply is inelastic, firms find it hard to change
production in a given time period.
The formula for price elasticity of supply is:
Percentage change in quantity supplied divided by the
percentage change in price
1. When Pes > 1, then supply is price elastic
Price Elasticity of Supply
2. When Pes < 1, then supply is price inelastic
The price elasticity of supply for most
goods is positive – a higher price is an
incentive and a signal to expand
production so that a business can
make higher profits
3. When Pes = 0, supply is perfectly inelastic
4. When Pes = infinity, supply is perfectly elastic following a
change in demand
What factors affect the elasticity of supply?
(1) Spare production capacity: If there is plenty of spare capacity then
a business can increase output without a rise in costs and supply will
be elastic in response to a change in demand. The supply of goods
and services is most elastic during a recession, when there is plenty of
spare labour and capital resources.
(2) Stocks of finished products and components: If stocks of raw
materials and finished products are at a high level then a firm is able to respond to a change in
demand - supply will be elastic. Conversely when stocks are low, dwindling supplies force prices
higher because of scarcity
(3) The ease and cost of factor substitution/mobility: If both capital and labour are occupationally
mobile then the elasticity of supply for a product is higher than if capital and labour cannot easily be
switched. E.g. a printing press which can switch easily between printing magazines and greetings
cards. Or falling prices of cocoa encourage farmers to switch into rubber production
(4) Time period and production speed: Supply is more price elastic the longer the time period that a
firm is allowed to adjust its production levels. In some agricultural markets the momentary supply is
fixed and is determined mainly by planting decisions made months before, and also climatic
conditions, which affect the production yield. In contrast the supply of milk is price elastic because of
a short time span from cows producing milk and products reaching the market place.
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An empty restaurant – plenty of spare capacity to meet any
rise in demand!
When networks get congested at peak times, elasticity of
supply becomes low
Businesses with plentiful stocks can supply quickly and
easily onto the market when demand changes
For many agricultural products, time lags in the production
process means that elasticity of supply is low in the
momentary time period
If Pes is inelastic: it will be difficult for suppliers to react swiftly to changes in price
If Pes is elastic – supply can react quickly to changes in price
Price
Perfectly elastic supply
Price
An elastic supply curve
S
S
P1
D1
Q1
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Q2
D2
D1
Quantity
Q1
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D2
Q2 Quantity
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Perfectly inelastic supply: Pes = zero (supply cannot respond to a change in demand / price) –
often associated with the momentary period with agricultural products
Price
Price
Perfectly inelastic supply
Inelastic Supply Curve
P2
P1
D1
D2
D2
D1
Q1
Q1
Quantity
Q2
Quantity
The non-linear supply curve
In the diagram below, the price elasticity of supply is high at low levels of demand (e.g. D1 and D2) but when
demand is high, elasticity of supply is much lower (e.g. D4 and D5) – the main reason would be that at peak
periods, suppliers reach capacity limits and find it hard to increase output in the short run.
Price
Supply
P5
Pes < 1
P4
D5
D4
P3
P2
D3
P1
Pes > 1
D2
D1
Q1
Q2
Q3
Q4 Q5
Quantity
Elasticity of demand and supply and price changes – a quick summary
Elasticity determines how much a shift changes quantity versus price.

If D increases and S is perfectly inelastic, then price rises and quantity doesn't change.

If S increases and D is perfectly inelastic, then price falls and quantity doesn't change.

If D increases and S is perfectly elastic, then price stays the same and quantity rises.

If S increases and D is perfectly elastic, then price stays the same and quantity rises
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