Lesson 3.4: Price Elasticity of Supply

Introduction

Welcome to Lesson 3.4 of Foundation Economics! In today’s lesson, we are going to dive into the concept of Price Elasticity of Supply (PES). By the end of this lesson, you should be able to understand and apply the ideas surrounding PES to real-world scenarios.

Learning Objectives

By the end of this lesson, you will be able to:

Define price elasticity of supply (PES) and use its formula.
Interpret elastic, inelastic, perfectly elastic, and perfectly inelastic supply.
Identify the determinants of PES, including spare capacity, stocks, mobility of factors, and especially time.
Understand why supply is usually more elastic in the long run compared to the short run.
Read PES from supply curves and apply it to markets with long production lags.

What is Price Elasticity of Supply?

Price Elasticity of Supply (PES) measures how responsive the quantity supplied of a good is to a change in its price. PES is calculated by using the following formula:

$$ PES = \frac{\%\ \text{change in quantity supplied}}{\%\ \text{change in price}} $$

Example 1: Calculating PES

Suppose the price of strawberries increases from $5 to $7 per box, and the quantity supplied increases from 100 boxes to 150 boxes.

First, calculate the percentage change in quantity supplied:

$\%\ \text{change in quantity supplied} = \frac{(150 - 100)}{100} \times 100 = 50\%$

Next, calculate the percentage change in price:

$\%\ \text{change in price} = \frac{(7 - 5)}{5} \times 100 = 40\%$

Now plug those numbers into the PES formula:

$$ PES = \frac{50\%}{40\%} = 1.25 $$

This means that the supply of strawberries is elastic, as PES > 1.

Types of Price Elasticity of Supply

Understanding different types of PES is crucial in interpreting how supply responds to price changes:

Elastic Supply

An elastic supply occurs when the quantity supplied changes by a larger percentage than the change in price. For instance, if PES > 1, supply is considered elastic, meaning producers can easily increase production when prices rise.

Inelastic Supply

An inelastic supply occurs when the quantity supplied changes by a smaller percentage than the change in price, indicating that producers cannot easily change production levels. If PES < 1, supply is inelastic.

Perfectly Elastic Supply

Perfectly elastic supply means that any small change in price will cause an infinite change in quantity supplied. This is rare in real-world markets, but it can occur in perfectly competitive markets.

Perfectly Inelastic Supply

Perfectly inelastic supply means that quantity supplied does not change at all when the price changes. This is represented by a vertical supply curve, typically seen in the case of unique items like art or collectibles where supply is fixed.

Determinants of Price Elasticity of Supply

Several factors affect the PES of a product:

1. Spare Capacity

Firms with spare capacity can easily increase production without incurring higher costs. For example, a factory that isn't running at full capacity can quickly respond to price increases by producing more.

2. Stocks

If a firm has significant stocks of a product, it can supply more readily in response to price changes.

3. Mobility of Factors of Production

How easily resources can be moved to different uses greatly impacts PES. If labor and capital can be easily shifted from one product to another, the supply becomes more elastic.

4. Time

Time is a crucial determinant of PES. In the short run, firms may not be able to adjust their resources quickly to meet changes in price. However, in the long run, firms can adjust production levels more efficiently, leading to more elastic supply.

Elasticity Over Time

Why is supply generally more elastic in the long run? The answer lies in the ability of companies to adapt:

Short Run: Companies may face limitations in quickly changing their level of production due to fixed resources, leading to inelastic supply.
Long Run: Firms can invest in new technology, hire more workers, and alter production processes to respond to price changes, increasing elasticity.

Example 2: Long-Term vs. Short-Term Supply

Let’s consider the market for cars. In the short run, if the price of cars increases, manufacturers might not be able to produce significantly more cars because of existing contracts, labor agreements, and assembly line limits.

However, if the price remains high over several years, firms can build new factories, make new hires, and invest in technology, which makes the supply much more elastic in the long run.

Reading PES From the Supply Curve

You can visually interpret PES from the supply curve:

A steeper supply curve indicates inelastic supply, as it changes little with price changes.
A flatter supply curve indicates elastic supply, as it responds more significantly to price changes.

Application in Markets with Long Production Lags

In industries like agriculture, where production takes a long time (like crops), the PES tends to be inelastic in the short run but can become elastic as farmers have time to respond to price signals in subsequent seasons.

Conclusion

Understanding Price Elasticity of Supply is vital for analyzing how suppliers react to price changes. It helps us better assess market dynamics and predict how changes in prices can affect overall supply levels. Mastery of PES allows businesses and policymakers to make informed decisions that can impact the economy significantly.

Study Notes

Price Elasticity of Supply (PES) measures supply responsiveness to price changes: $ PES = \frac{\%\ \text{change in quantity supplied}}{\%\ \text{change in price}} $.
PES can be classified as elastic ($ PES > 1 $), inelastic ($ PES < 1 $), perfectly elastic, or perfectly inelastic.
Key determinants of PES include spare capacity, stocks, mobility of factors, and time.
Supply is generally more elastic in the long run due to flexibility in production adjustments.
The shape of the supply curve helps indicate PES levels: steeper is inelastic, flatter is elastic.
Long production lags affect elasticity in industries like agriculture.