Price Elasticity of Supply

Introduction

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

• When Pes > 1, then supply is price elastic
• When Pes < 1, then supply is price inelastic
• When Pes = 0, supply is perfectly inelastic
• When Pes = infinity, supply is perfectly elastic following a change in demand

What factors affect the elasticity of supply?

• 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.
• 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 in the market.
• The ease and cost of factor substitution: 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. A good example might be a printing press which can switch easily between printing magazines and greetings cards.
• 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.

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 he short run.

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.