A) Understanding of price elasticity of supply:
Price elasticity (PES) measures the responsiveness of quantity supplied to a change in price.
B) Use formula to calculate price elasticity of supply
PES = % Change in quantity supplied / % Change in price (%∆ in QS / %∆ in P)
∆ = change
P =Price
QS = Quantity supplied
C) Interpret numerical values of price elasticity of supply:
| PES | |
| 0 | Perfectly inelastic |
| 0 to +1 | Relatively inelastic |
| +1 to ∞ | Relatively elastic |
| ∞ | Perfectly elastic |
The steeper the supply curve the more price inelastic the product is. For example, a steep supply curve would indicate that despite a big increase in the price of the product the supply would increase at a disproportionate rate. This can be shown by the following diagram:
On the other hand, a flat supply curve would indicate that the product is price elastic. As a result of this, an increase in price would lead to a more than proportionate increase in supply. This can be useful when implementing tax policies in order to reduce the supply of a de-merit good as only a small increase in tax is needed in order to reduce supply by a large amount.
D) Factors that influence price elasticity of supply
Production lag – The product that a firm makes is a big influence on the elasticity of supply. For example, in the agriculture industry crops such as wheat take a relatively long time to produce. As a result of this, despite an increase in price the supply of wheat may take a relatively long time to adjust to this and reach market equilibrium. This is because although the firm may want to produce more wheat straight away it takes time to do so resulting in wheat having a more inelastic price elasticity of supply.
Substitutability of factors of production – A firms factors of production are directed towards different products that the firm produces. For example, the majority of factors of production may be directed towards making vans rather than cars. However, if the price of vans starts to increase then a rational firm would want to direct more resources towards vans rather than cars. If the firms factors of production are easily substitutable then the firm will be able to direct shift some of the factors of production that were making cars towards making vans assuming they were operating at Pareto efficiency. This would result in the price elasticity of supply for vans being relatively elastic. However, if a firms factors of production were not substitutable then they wouldn’t be able to shift some of their factors of production away from cars and direct them towards vans meaning the price elasticity of supply for vans would be price inelastic.
Stocks – An example of this is in the retail industry. If there is an increase in the price of chocolate then the supermarket will be incentivised to increase its supply of chocolate. If the supermarket has lots of chocolate stock in the warehouse then all they have to do is move this from the warehouse onto the shelves. This would make the supply of chocolate relatively price elastic. However, if there was no stock in the warehouse then it would mean that the supermarket would have to call the wholesaler to order more chocolate. This chocolate would then take time to be shipped to the supermarket meaning that although the price of chocolate has increased, they may only be able to increase their supply of it after a few weeks. Therefore in this scenario the supply of chocolate would be relatively price inelastic.
Spare capacity – If a firm is working at full capacity then regardless of an increase in the price of the product that they are producing, they are unable to increase supply. This is due to the fact that their existing factors of production such as capital are already working at maximum. This would result in the supply of the product being price inelastic. On the other hand, a firm that has capital working at 50% or labour working part time rather than full time will be able to adjust to this increase in price by increasing their supply of the product. For example, they can increase the time at which the machines are producing goods for, they can hire full time employees rather than part time etc. Therefore the supply of the product in this case would be price elastic.
Complexity of product – The more complex the product, the longer that it will take for the firm to react to an increase in price. For example, if the price of a toy car increased then it would take a relatively short amount of time to increase its supply. However, if the price of cruise ships increased then the increase of supply that is likely to follow will take much longer. This is because cruise ships undergo large amounts of testing, planning etc. As a result of this the supply of toy cars will be much more price elastic than the supply of cruise ships.