Price Elasticity of Supply (PES)

Lesson ObjectivesBy the end of this lesson you will:

Understand the concept of price elasticity of supply

Know the formula for calculating PES and be able to use this formula

Be able to describe the determinants of PES

PES: a definitionPrice Elasticity of Supply (PES) may be defined as:

the relationship between the proportionate changes in price and the proportionate change in quantity supplied

Calculating Price Elasticity of Supply (PES)PES =

% Change in quantity supplied% change in price

Working out the % change% change =Absolute changeOriginal valueX 100

Price Elasticity of SupplyMost products have either elastic or inelastic supply.

Elastic supply is when a % change in price causes a greater % change in supply.

Inelastic supply is when a given % change in price causes a smaller % change in supply.

Elastic SupplyPrice Elastic: Elasticity between 1 and meaning that the % change in supply is greater than % change in price.

Inelastic SupplyPrice Inelastic: Elasticity between 0 and 1meaning that the % change in supply is less than % change in price.

Perfectly Elastic Supply CurvePerfectly Elastic: Elasticity = Producer are prepared to supply all they can obtain at some given price but none at all at a higher price

Perfectly Inelastic Supply CurvePerfectly Inelastic: Elasticity = 0The quantity supplied does not change at all as the price changes

Unitary Elasticity of SupplyUnitary elasticity: Elasticity = 1The quantity supplied changes at exactly the same % as does the price

Determinants of the degree of PESThe extent to which supply is elastic depends upon the flexibility and mobility of the factors of production.

If production can be expanded easily and quickly and/or products can easily be bought out of storage supply will be elastic. If not it will be inelastic.

Availability of substitutesThis does not mean consumer substitutes but producer substitutes.

These are defined as goods which a producer can produce as alternatives.E.g. Cadburys can easily switch its production lines between producing various chocolate bars

If a product has many substitutes then producers can quickly and easily alter the pattern of production as prices rise/fall. Hence price elasticity of supply will be high.

The level of spare capacity in the industryIn an industry which is operating below full capacity there will be unemployed resources. In such a situation supply will be elastic.

The industry will be able to expand production fairly easily and take advantage of the previously idle fixed assets.

The level of unemploymentLinked to spare capacity (see previous slide).

When there is full employment the supply of most goods and services will be inelastic.

Supply could be increased by improved productivity but in the short run no significant increases in output will be possible.

In a domestic market supply ma be more elastic if it is possible to import supplies from other countries.

Ability to store the productSupply will be elastic if the product can be stored.

A rise in price will see a rapid increase in the supply due to drawing on stocks.

If price falls supply can be reduced by adding to stocks.

Whether the products are agricultural or manufactured onesFor agricultural products supply in the short run is inelastic. This is because supply in one year is governed by what was planted in the previous year.

Some products (such as coffee take several years for newly planted trees to reach maturity)

A similar argument applies for beef and milk.

Whether the products are agricultural or manufactured onesThe supply of manufactured products tend to be more elastic.

The production process is usually shorter so supply can be increased far quicker.

Of course some products have much longer production periods than others (it takes far longer to produce a Boeing 747 than it does to turn out a washing machine)

The time it takes to increase capacityIn some industries expanding capacity takes a very long time. These industries will have inelastic supply.

Examples would include mining and oil or mineral extraction (due to the time needed to sink new mines)

PES and timeTime is a particularly important influence on PES.

When considering time economists tend to focus on three periodsThe momentary periodThe short runThe long run

The momentary periodThis is the period of time during which supply is restricted to the quantities actually available in the market at the moment.

At this period supply is fixed (perfectly inelastic)

Normally this period will be very short (e.g. the supply of newspapers to an area on a day)

The short runThe short run is the interval which must elapse before more can be supplied with the existing capacity.

There will be at least one fixed factor of production

The short run in some industries will be very short (such as clothing) but in others (such as house building) it will be many months.

The long runThe long run is defined as the time interval which is long enough to change the quantity of all of the factors of production employed.

This would include building an extension to a factory, installing an expensive new machine and so on.

It would also include new firms entering an industry.