Economics (9708) | Price elasticity of supply

1. Defining Price Elasticity of Supply (PES)

Don't worry if this seems tricky at first. It’s just like PED, but focusing on quantity supplied instead of quantity demanded!

What is PES?

The Price Elasticity of Supply (PES) measures the responsiveness of the quantity supplied of a good or service to a change in its price.

• If a price goes up by 10%, does the amount supplied go up a lot (Elastic) or only a little (Inelastic)?
• If producers can react quickly and cheaply to a price change, supply is likely to be elastic.
• If production is constrained, and they can’t change output easily, supply is inelastic.

---

Quick Review Box: The Sign of PES

Unlike PED (which is negative), the coefficient for PES is always positive.
Why? Because of the Law of Supply: price (P) and quantity supplied (Qs) move in the same direction. If P goes up, Qs goes up, so the ratio is positive (+/+).

---

2. The Formula and Calculation of PES

We calculate PES using the same percentage change method we used for PED.

The PES Formula:

The formal definition is:

\( \text{PES} = \frac{\text{Percentage change in Quantity Supplied (\%\Delta Qs)}}{\text{Percentage change in Price (\%\Delta P)}} \)

Where:

• \(\%\Delta Qs\) = \(\frac{\text{Change in Quantity Supplied}}{\text{Original Quantity Supplied}} \times 100\)
• \(\%\Delta P\) = \(\frac{\text{Change in Price}}{\text{Original Price}} \times 100\)

Example Calculation:

Imagine the price of wheat increases from \$5 per bushel to \$7 per bushel (a 40% rise). Consequently, the quantity supplied by farmers rises from 100 tonnes to 120 tonnes (a 20% rise).

\(\text{PES} = \frac{+20\%}{+40\%} = 0.5\)

In this case, the PES is 0.5. Since 0.5 is less than 1, supply is price inelastic.

Key Takeaway: PES measures the proportional relationship between the percentage change in quantity supplied and the percentage change in price.

3. Interpreting the PES Coefficient (Elasticity Values)

The numerical value of the coefficient tells us exactly how responsive supply is.

1. PES = 0 (Perfectly Inelastic Supply)

   The quantity supplied does not change at all, regardless of price changes.
   Analogy: A single, irreplaceable vintage painting. No matter how high the price goes, only one exists.

2. 0 < PES < 1 (Price Inelastic Supply)

   The percentage change in quantity supplied is less than the percentage change in price.
   A large price change leads to only a small change in supply. Firms struggle to respond quickly.
   Example: Agricultural crops or limited resources like oil fields.

3. PES = 1 (Unitary Elastic Supply)

   The percentage change in quantity supplied is equal to the percentage change in price.
   (e.g., 10% price rise leads to a 10% supply rise).

4. PES > 1 (Price Elastic Supply)

   The percentage change in quantity supplied is greater than the percentage change in price.
   A small price change leads to a large change in supply. Firms can respond easily and quickly.
   Example: Mass-produced goods like cheap clothing or software licenses.

5. PES = ∞ (Perfectly Elastic Supply)

   An infinite amount can be supplied at a given price, but nothing can be supplied below that price. This is a purely theoretical concept, usually represented by a horizontal supply curve.

Memory Aid: Think of the letter 'S' for Supply.
If the supply curve is steep (closer to a vertical 'I'), it is Inelastic.
If the supply curve is shallow (closer to a horizontal line), it is Elastic.

4. Factors Affecting Price Elasticity of Supply (Determinants)

What determines whether a producer can respond quickly to a price signal? Several key factors influence the size of the PES coefficient.

A. Time Period of Production (The Most Important Factor)

This is often the greatest influence on PES. Firms can adjust supply more over longer time horizons.

• Immediate/Momentary Run: PES is often perfectly inelastic (PES=0). Supply is fixed instantly. Example: Once fish are caught and brought to market, no more can be supplied today regardless of the price.
• Short Run: Producers can only change variable factors (like labour or raw materials), but not fixed factors (like factory size). PES is usually inelastic (PES < 1) because expansion capacity is limited.
• Long Run: Producers can vary all factors of production (building new factories, installing new machinery). PES is generally much more elastic (PES > 1) as output can be significantly altered.

B. Availability of Spare Capacity

If a firm is operating below its maximum potential output, it has spare capacity.

• If a factory is only running 5 days a week, it can easily increase production by running 6 or 7 days if the price rises. This makes supply more elastic.
• If a factory is already operating 24/7 (full capacity), increasing supply requires building a new plant, which takes time. Supply is more inelastic in the short run.

C. Mobility of Factors of Production

This refers to how easily and quickly resources (Land, Labour, Capital) can be switched from producing one good to another.

• If inputs can be moved easily (e.g., a baker can easily switch from making bread to making cakes using the same oven and flour), supply is elastic.
• If inputs are highly specialized (e.g., building a nuclear power plant requires highly specific, trained engineers and infrastructure), supply is inelastic.

D. Ability to Hold Stock (Inventories)

If goods can be stored easily without perishing or becoming obsolete, firms can respond quickly to price rises by selling existing stock.

• If goods are durable and cheap to store (e.g., canned goods, electronics), supply is more elastic.
• If goods are perishable (e.g., fresh fruit) or bulky/expensive to store, firms cannot use inventories to react quickly. Supply is more inelastic.

E. Ease of Switching Production

In a multi-product firm, how easy is it to switch resources between different goods?

• A company that makes different types of soft drinks can easily switch bottling lines from Cola A to Cola B if the price of Cola B rises. Supply is elastic.
• A dedicated car manufacturer cannot easily switch production to making airplanes. Supply is inelastic.

5. Implications of PES for Firms and Markets

Section 2.3.5 requires us to understand the implications of PES for the speed and ease with which firms react to changed market conditions.

A. Market Stability

Markets where supply is elastic (PES > 1) are generally more stable and adaptable.

• If demand suddenly increases, an elastic supply can meet that demand quickly, preventing extreme price spikes. The firm reacts quickly and easily.
• If supply is inelastic, a sudden rise in demand will cause a massive price increase because producers cannot easily increase output. The firm reacts slowly and with difficulty.

B. Impact on Price Volatility (Fluctuations)

Goods with inelastic supply tend to have highly volatile prices. This is especially true for primary commodities (like cocoa or coffee) because the time lag for planting and harvesting makes immediate supply changes impossible (inelastic in the short run).

Example: If there is a drought, the supply of corn is perfectly inelastic until the next harvest. If demand remains constant, the price will skyrocket because farmers cannot easily react until the long run.

C. Decision-Making for Firms

Firms need to know their PES:

• If a firm knows its supply is elastic, it can confidently invest in expanding output quickly when it sees a profitable price rise.
• If a firm's supply is inelastic, it may be limited to short-term price adjustments and must focus on long-term investment (like R&D or factory construction) to improve its responsiveness over time.

Key Takeaway: PES dictates how effective the price mechanism is at bringing a market back to equilibrium after a shock. High PES means fast, smooth adjustment; low PES means slow, volatile adjustment.