Price elasticity of supply is a measure of the sensitivity (responsiveness) of the quantity supplied of a good or service to a change in the price of that good or service.
|% Change in Quantity Supplied|
|Price Elasticity of Supply||=||
|% Change in Price|
If the price of a good or service increases in the market, the suppliers/producers will naturally tried to increase their supply, so that they can make more profit. However, there will be limits by which they can increase the output. Price elasticity of supply measures this ability of them to increase the output.
Calculation of price elasticity of Supply
Suppose that the price of a good increases from $10 to $12, and in response to this increase in price, the firms increase the quantity supplied from 2000 units to 2200 units. let us calculate the price elasticity of supply.
% Change in Quantity Supplied = 100 X 200/2000 = 10%.
% Change in Price = 100 X 2/10 = 20%
Price Elasticity of Supply = 10/20 = 0.5.
If the calculation of this formula shows a number which is greater than 1, then the supply is price elastic.
If it is less than 1, then the supply is price inelastic.
Unit elasticity occurs where PES = 1.
The interpretation of the elasticity is straight forward. If the PES is 0.7, an increase in price of 10% will lead to an increase in the quantity supplied of 7%, which means it is inelastic.
If the PES is 1, an increase in price of 10% will lead to an increase in the quantity supplied of 10%.
Elasticity of Supply – Demand & Supply diagrams
Factors affecting elasticity of supply
– Time:Firms may not be able to respond quickly to a sudden change in price. However, as time goes, they will be able to increase production. It is feasible for firms to change their supply decision in the long run than in the short run. In the short-run there will be fixed costs, and the firm can increase production only by increasing variable inputs like labour. However, in the long-run the firm can invest in machinery and other factor inputs, which give them more capacity, and thus supply tends to be more price elastic in the long-run.
– Availability of resources / Spare Capacity: If the economy is already using most of its scarce resources, then firms will find it difficult to employ more (i.e. workers) and so the firms will not be able to increase output. In such a situation, the supply of most goods and services will be price inelastic, and vice versa.
– Number of producers: If there are more producers in the economy, the possibility of increasing the aggregate output is higher. Therefore, supply tends to be price elastic when the number of producers are high.
– Ease of storing stocks: The type of good that a producer supplies will affect elasticity. If goods can be stocked with ease and have a long shelf life, then supply will be elastic. Otherwise the goods will be inelastic. For example, perishable goods such as fresh flowers, vegetables have comparatively inelastic supply because it is difficult to store them for longer periods.
– Increase in cost of production as compared to output (marginal cost): In cases where there is a significant increase in cost of production when output is increased, supply is inelastic. As the marginal cost keeps on rising at higher production levels, the producers will be hesitant to increase output, especially if the marginal cost is higher than the price levels (marginal revenue).
– Improvements in Technology: Some industries will have improvements in technology that affects the price elasticity of supply. Improvements lead to goods being more elastic (i.e. firms are more efficient in production- better machinery. so output can be easily increased when there is an increase in price.
– Stock availability of finished goods: In some industries where there are higher inventory or stock of finished goods, the suppliers can supply more as the price rises. Thus, the price elasticity of supply for these goods will be elastic.