12.

Price Elasticity of Supply

Objectives:
● Define and calculate​ price elasticity of supply (PES).
● Draw and interpret ​supply curve diagrams to show different PES.
● Understand ​the determinants of PES.
● Demonstrate​ the significance of PES for decision makers.

We know that supply extends as prices rise and supply will contract as prices fall. This is because price
changes signal to a firm that more or less profit can be made from supply a particular good or service over
time. Nevertheless, it is important for firms to know ​by how much they can adjust their supply in response
to a price change.

Price elasticity of supply​ measures​ ​the responsiveness of quantity supplied to a change in price.
To measure price elasticity of supply we use the following formula:

PES = % change in quantity supplied / % change in price

● If the percentage change in price is proportionally ​greater ​than the percentage change in quantity
supplied, supply is said to be ​price inelastic ​and the value of price elasticity of supply will be ​less than
one​.

● If the percentage change in price causes a proportionally ​larger​ percentage change in quantity
supplied, supply is said to be ​price elastic​. Price elasticity of supply will therefore be ​greater than one​.

Task:​ Look at the supply schedule for fresh flowers and calculate the PES for flowers.

Price per flower Quantity supplied per month

$1 10, 000

$2 15, 000

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These are the steps to follow:

50%
1. Calculate the % change in quantity supplied = ____________________________________________

100%
2. Calculate the % change in price = _______________________________________________________

0.5
3. PES = % change in quantity supplied / % change in price = ___________________________________

4. Are fresh flowers price elastic or price inelastic in supply? Why do you think that is the case?

I think the fresh flowers price is inelastic in supply, as the elasticity is smaller than 1. When the price
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changes, the quantity supplied changes with a smaller amount.

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Factors which affect Price Elasticity of Supply ​(FAST)

1. Factor mobility​ (F)

If it is easy to transfer resources away from supplying goods whose prices are falling towards goods whose
prices are rising, supply will be more price elastic. What do you think the PES for wheat would be like in the
immediate term, short run and long run for wheat if a farmer was currently using his land to grow barley?

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2. The availability of resources ​(A)

If a firm wishes to expand production it will need more factors of production (land, labour and capital). If the
economy is already using most of its limited resources then firms will find it difficult to employ more and so
output will not be able to rise. If this is the case what will supply be? Price elastic or inelastic? Why?

In this case, supply will be price elastic, as the quantity supplied is already a large proportion of the resources of a
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firm. Therefore, if the price increases, the quantity supplied will decrease with great sensitivity.
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If resources are not being fully used then firms will be able to use them when they want to raise output and
supply will be more price elastic.

3. Storage possibilities: Ability to store stocks/inventories ​(S)

If a firm is able to store its products easily (and they will not ‘go off’ or perish), then they can more quickly
respond to price changes. For example, if the price of tinned soup is rising, firms can quickly taken tins out of
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storage and put them into to the market to sell. Or if prices drop, they can stockpile them until prices begin to
rise again, if they wish.

4. Time ​(T)

The flower example shows us how the price elasticity of supply can change over time. Supply of most goods
and services, including flowers, will be fixed at any one moment in time. It will take time for a shop to get more
stock to sell, so for the very short term the supply of its products is fixed.

This means that the supply curve will be shown as a vertical line as price changes cannot affect quantity
supplied immediately. In the short run, firms can produce some more goods for sale, but only by using more
labour and/or machinery. More flowers could be picked and sent to the shops as the price rises. Supply can
only rise by a little bit though. Why is this?

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In the long run, firms can get more labour, land and capital to expand the scale of production, so ​in the long
run​ supply becomes more ​price elastic​.

Task: ​Look at the supply schedule for chairs and answer the questions.

Price of chairs ($) Quantity supplied per week

40 100,000

60 250,000

Calculate the price elasticity of supply. (Use $40 as your original price)

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Are chairs price elastic or inelastic in supply? Why do you think that is the case?

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Task: Calculate​ the PES values for the following products and ​explain​ your answers. (Use * as your original
price and quantity)

Price per car Quantity supplied per month

*10,000 *240,000

22,000 620,000

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Price per chocolate bar (SGD) Quantity supplied per month

*$1 *140,000

$2 180,000

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Price per bag of sugar (SGD) Quantity supplied per month

*$1.50 *120,000

$2.25 210,000

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Now let’s illustrate this using diagrams. In the boxes below, draw one steep supply curve on the left and one
flatter supply curve on the right. Show a 10% fall in prices and label what happens to the quantity supplied in
both cases on the X axis.

Price Inelastic Supply (fresh flowers) Price Elastic Supply (chairs)

Which supply curve would represent the market for fresh flowers and which would represent the market for
chairs? Why?

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Some special supply curves

If the quantity supplied of a good remains the same whatever its price, supply is ​perfectly price inelastic​.
That is, price elasticity of supply is 0. What goods do you think may have a perfectly price inelastic supply
curve? Why?

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If producers are willing to supply as much as they can at one particular price and supply nothing at any other
price then supply is said to be​ infinitely price elastic​. What goods do you think may have an infinitely price
elastic supply curve? Why?

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If price elasticity of supply is 1 then supply is said to be ​unit elastic​. This means that the % change in price will
be matched with the same % change in quantity supplied. If the price goes up by 50%, then the supply will rise
by 50% Es = 1.

Task:​ Draw and explain these three special shaped supply curves below for goods of your choice.

Perfectly price inelastic supply Perfectly price elastic supply Unit elastic supply

Why is PES important & for who?

It’s preferable for producers to have a high PES - that is, to be highly responsive to changes in price (and other
market conditions). This can help to make firms more competitive and therefore generate more profits!

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Key Question:

a. How might knowledge of PES be useful to producers (firms)?

b. How might knowledge of PES be useful to the government?

Notes:

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