Welcome to the World of Price Elasticity of Supply!
Hello future economist! This chapter is all about how suppliers (the businesses that make and sell goods) react when the price of their product changes. We’ve already seen how prices are determined by supply and demand, but now we need to ask: How quickly and easily can a company boost its production if the price goes up?
Understanding Price Elasticity of Supply (PES) is crucial because it tells us whether a market can respond smoothly to changes in demand, or if it will struggle, leading to large price swings. Don't worry if this sounds complicated—we will break it down piece by piece!
Key Takeaway from the Introduction:
PES measures the responsiveness of quantity supplied to a change in price.
Section 1: Defining Price Elasticity of Supply (PES)
Think of PES as a measure of a firm’s flexibility.
What is PES?
Price Elasticity of Supply (PES) is the degree to which the quantity supplied of a good changes in response to a change in its price.
- If the price of chocolate bars goes up by 10%, can the chocolate factory immediately ramp up production by 20%? If so, its supply is very responsive, or elastic.
- If the price of oil goes up by 10%, but the oil company can only increase production by 1% because it takes years to drill new wells? Its supply is very unresponsive, or inelastic.
Analogy Alert!
Imagine you are a baker. The price of your bread suddenly doubles!
Scenario A (Elastic Supply): You have plenty of flour, yeast, and a second oven sitting idle in your back room. You can easily hire an extra worker and double your production by tomorrow. Your supply is elastic.
Scenario B (Inelastic Supply): Your kitchen is tiny. You are already using your one small oven 24 hours a day, and you can’t buy a new oven for months. You can barely increase production. Your supply is inelastic.
Remember this: Elastic means flexible and easy to change. Inelastic means rigid and difficult to change.
Section 2: The PES Formula and Calculation
Like Price Elasticity of Demand (PED), PES is calculated using percentage changes. This allows us to compare the responsiveness of totally different products (like apples and aircraft carriers).
The Formula
The PES formula is:
$$ \text{PES} = \frac{\%\text{ Change in Quantity Supplied}}{\%\text{ Change in Price}} $$
Important Note: Since suppliers usually want to sell more when prices are higher, the relationship between price and quantity supplied is always positive (the supply curve slopes upward). Therefore, the PES result will always be a positive number (or zero). We don't worry about negative signs here!
Step-by-Step Example Calculation
Let’s say the price of a game console increases by 15%, and the quantity the manufacturer is willing to supply increases by 30%.
- Identify the percentage changes:
% Change in Quantity Supplied = 30%
% Change in Price = 15% - Apply the formula:
\( \text{PES} = \frac{30\%}{15\%} \) - The result:
\( \text{PES} = 2 \)
A PES of 2 means that for every 1% change in price, the quantity supplied changes by 2%. This is highly elastic.
Section 3: Interpreting the PES Result (The Categories)
The number you calculate for PES tells you exactly how elastic or inelastic the supply is. There are five main categories you must understand:
Case 1: Elastic Supply (PES > 1)
- Meaning: Quantity supplied changes by a larger percentage than the change in price.
- Example: If P goes up 10%, QS goes up 25%. (PES = 2.5)
- Key Feature: Suppliers are very responsive. This is common for goods that are easy and cheap to produce more of.
Case 2: Inelastic Supply (PES < 1)
- Meaning: Quantity supplied changes by a smaller percentage than the change in price.
- Example: If P goes up 10%, QS only goes up 4%. (PES = 0.4)
- Key Feature: Suppliers are unresponsive or "stuck." This is common for goods that take a long time to produce or require scarce resources.
Case 3: Unitary Elasticity (PES = 1)
- Meaning: Quantity supplied changes by the exact same percentage as the change in price.
- Example: If P goes up 10%, QS goes up 10%. (PES = 1)
Case 4 & 5: Extreme Cases
These two cases are less common but vital for exam success:
a) Perfectly Inelastic Supply (PES = 0)
Definition: Quantity supplied never changes, regardless of the price change.
Example: A single, rare painting by a dead artist. No matter how high the price goes, the supply cannot increase.
b) Perfectly Elastic Supply (PES = \(\infty\))
Definition: Suppliers can supply any amount at a given price, but nothing at a lower price. If price changes even slightly, supply falls to zero or rockets up instantly. (This is mostly theoretical for real-world application).
PES > 1: Elastic (Flexible)
PES < 1: Inelastic (Rigid)
PES = 1: Unitary
Section 4: The Determinants of Price Elasticity of Supply
Why is the supply of some goods elastic while others are inelastic? It all comes down to the factors that make it easy or hard for a firm to increase production.
1. The Availability of Factors of Production (Inputs)
This is about how easily the firm can get the resources (land, labour, capital, enterprise) needed to produce more.
- Easy Access = Elastic: If a firm can easily find and hire more skilled workers, buy more raw materials, or get more machinery, supply will be elastic. (e.g., producing fast-food burgers where ingredients and low-skilled labour are plentiful).
- Scarce Resources = Inelastic: If the inputs are scarce or specialized, supply will be inelastic. (e.g., finding highly specialized engineers or rare earth minerals).
2. Time Period of Production
This is often the most important determinant. It is much easier to increase supply in the long run than in the short run.
- Short Run (Inelastic): In the short run, a firm cannot change the size of its factory or buy brand new complex machinery. It can only work existing machines harder or add a few shifts. Therefore, supply is usually inelastic.
- Long Run (Elastic): In the long run, the firm has time to build a new factory, train new staff, or develop new technology. All factors of production can be varied, making supply much more elastic.
Did You Know? Agricultural products (like fresh fruit) often have inelastic supply in the short run because once the crop is planted, you cannot magically grow more until the next season, no matter how high the price goes!
3. Spare Capacity
Spare capacity refers to how much of a firm’s production potential is currently unused.
- Lots of Spare Capacity = Elastic: If a factory is only running its machines half the time (50% capacity), it can easily increase output when prices rise simply by switching the machines on for longer. This is elastic supply.
- No Spare Capacity = Inelastic: If the factory is already running 24 hours a day (100% capacity), it cannot easily produce more. Supply is inelastic.
4. Stock Levels (Inventories)
This refers to the number of finished goods a firm has sitting in its warehouse, ready to be sold.
- High Stock Levels = Elastic: If a firm has large inventories, it can immediately respond to a price increase by shipping out existing goods. This makes supply highly elastic in the immediate term.
- Low Stock Levels = Inelastic: For perishable goods (like fresh seafood) or services (you can't "stockpile" a haircut), stock levels are low or zero. The firm must produce the good or service when demanded, making supply inelastic.
Summary: Why PES Matters to Economists
Understanding PES is vital because it helps predict how quickly prices will stabilize after a shock to the market (a sudden change in demand).
- If supply is highly elastic, a sudden rise in demand will cause only a small, temporary rise in price because suppliers can quickly increase production.
- If supply is highly inelastic, a sudden rise in demand will cause a massive price hike because suppliers simply cannot increase output quickly enough to meet the demand. (Think of housing prices in a crowded city – the supply is highly inelastic!).
You've done a fantastic job covering this essential topic. Keep practising the interpretation of the PES number, and remember the four key determinants!