Economics | Elasticity of supply

Welcome to the Elasticity of Supply Toolkit!

Hello future economists! In this chapter, we pivot from consumer responsiveness (Elasticity of Demand) to producer responsiveness. We are going to explore Elasticity of Supply (Es), which tells us how quickly and easily producers can change the amount they produce when the market price changes.

Why is this important? Understanding Es is vital for businesses deciding whether to invest in new equipment and for governments trying to manage supply shocks (like a sudden shortage). It helps explain market volatility and the time it takes for markets to adjust.

---

Section 1: Defining Price Elasticity of Supply (Es)

What is Elasticity of Supply?

The Price Elasticity of Supply (Es) measures the degree of responsiveness of the quantity supplied of a product to a change in its price.

Think of it like flexibility. When the price of your product goes up, how flexible are you, as a producer, to increase production immediately?

• If you are very flexible (can ramp up production fast), your supply is elastic.
• If you are inflexible (stuck at your current production level), your supply is inelastic.

Key Term:

Price Elasticity of Supply (Es): The measure of how much the quantity supplied of a good responds to a change in the price of that good.

Key Takeaway: Es is about a producer's ability to react to price signals. Unlike elasticity of demand (which is usually negative), Es is almost always a positive value because price and quantity supplied move in the same direction (due to the Law of Supply).

---

Section 2: Calculating Es and Interpreting the Value

The Es Formula (The only math you need!)

To calculate Es, we use the percentage method, which is identical in structure to the formula for Price Elasticity of Demand (PED), but we replace 'Quantity Demanded' with 'Quantity Supplied'.

$$ E_s = \frac{\% \text{ Change in Quantity Supplied}}{\% \text{ Change in Price}} $$

Where the percentage changes are calculated as:
\( \% \text{ Change in Quantity Supplied} = \frac{\text{Change in } Q_s}{\text{Original } Q_s} \times 100 \)
\( \% \text{ Change in Price} = \frac{\text{Change in } P}{\text{Original } P} \times 100 \)

Interpreting the Coefficient

The magnitude (size) of the Es coefficient tells us exactly how responsive the producers are:

Es Value	Definition	Meaning (The Response)
\( E_s > 1 \)	Relatively Elastic	Percentage change in Qs is greater than percentage change in P. Producers are very responsive.
\( E_s < 1 \)	Relatively Inelastic	Percentage change in Qs is less than percentage change in P. Producers are not very responsive.
\( E_s = 1 \)	Unitary Elastic	Percentage changes are equal.

Key Takeaway: A high Es value (e.g., 5) means producers can easily increase output when prices rise. A low Es value (e.g., 0.2) means they struggle to boost production.

---

Section 3: Extreme Cases of Elasticity of Supply

We need to understand two important extreme cases, which relate directly to the slope of the supply curve when graphed:

1. Perfectly Inelastic Supply \( (E_s = 0) \)

In this case, the quantity supplied never changes, regardless of how much the price rises or falls. Supply is fixed.

• Diagram: The supply curve is vertical.
• Real-World Example: The immediate supply of fresh fish caught that morning; the number of seats available at a specific theatre performance; the supply of ancient artifacts. Once the item exists, no amount of price increase can produce more immediately.

2. Perfectly Elastic Supply \( (E_s = \infty) \)

In this rare theoretical case, producers are willing to supply any amount at a certain price (the market price), but if the price drops even slightly below that level, supply falls to zero.

• Diagram: The supply curve is horizontal.
• Context: This is often seen in models of perfect competition where firms are "price takers."

Did You Know? The supply curve for most goods starts off relatively inelastic (in the short run) and becomes elastic as time passes and firms can adjust their production capacity.

---

Section 4: The Determinants of Elasticity of Supply

What determines whether a producer is flexible or inflexible? These factors are crucial for evaluating market reactions.

1. Time Period (The Most Important Factor)

The amount of time a producer has to react to a price change is the single most critical determinant.

• Momentary Run (Immediate Market Period): Supply is often perfectly inelastic \( (E_s = 0) \). Producers cannot change output at all. Example: Once the strawberries are picked today, that’s the fixed supply for today.
• Short Run: Producers can vary some inputs (like labour and raw materials) but cannot change their fixed capital (factory size, machinery). Supply is generally inelastic \( (E_s < 1) \), but not perfectly so.
• Long Run: Producers can change all factors of production. They can build new factories, train new workers, and invent new processes. Supply is usually elastic \( (E_s > 1) \).

2. Mobility of Factors of Production

How easily and quickly can a firm shift resources (land, labour, capital) from producing one good to another?

• If factors are highly mobile (e.g., a factory can switch from making blue shirts to red shirts easily), supply will be elastic.
• If factors are immobile (e.g., farming land cannot easily become a semiconductor factory), supply will be inelastic.

3. Spare Capacity

Does the firm have machinery sitting idle or working only one shift?

• If a firm has lots of spare capacity, it can immediately use those idle resources when price increases. Supply is elastic.
• If a firm is running at full capacity (or near 100%), it cannot produce any more unless it invests heavily. Supply is inelastic.

4. Ability to Store Stocks (Inventories)

If a good can be easily and cheaply stored (put into inventory), the firm can respond quickly to a price rise by drawing down its stock rather than needing to increase production immediately.

• Storable Goods: Supply is more elastic (e.g., canned goods, electronics).
• Perishable or Difficult-to-Store Goods: Supply is more inelastic (e.g., fresh milk, large, customized items).

5. Nature of the Product and Production Process

This relates specifically to how production happens:

• Simple/Quick Manufacturing: Goods that use few, easily sourced raw materials and take little time to produce (like simple toys) are more elastic.
• Complex/Long Lead Times: Goods that require years of growing (like specialty coffee beans) or complex engineering (like commercial jets) have a highly inelastic supply, even in the short to medium run.

Key Takeaway: Elasticity of Supply fundamentally depends on how constrained the producer is. The fewer constraints (more time, more spare capacity, more mobile resources), the more elastic the supply.