Price Elasticity of Supply

Price Elasticity of Supply AS economics revision presentation on price elasticity of supply

Price Elasticity of Supply • Price elasticity of supply (Pes) measures the relationship between change in quantity supplied and a change in price. • When supply is elastic, producers can increase production without a rise in cost or a time delay • When supply is inelastic, firms find it hard to change their production levels 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 • The co-efficient of elasticity of supply is positive, because an increase in price is likely to increase the quantity supplied to the market

% change in quantity supplied ES = % change in price Price Elasticity of Supply - Measurement ES > 1 price-elastic supply ES = 1 unit-elastic supply ES < 1 price-inelastic supply Es = 0 perfectly inelastic supply Es = infinity perfectly elastic supply

What Determines Supply Elasticity? • Factor substitution possibilities • Can labour/capital be switched easily when there is a change in demand • When factor substitution is possible, supply will tend to be elastic • When factors are highly specialized, substitution may be harder • Spare production capacity available • When there is spare capacity, businesses can expand output easily without upward pressure on costs

What Determines Supply Elasticity (2) • Stocks (inventories) available to meet demand • A low level of stocks makes supply inelastic in the short term • When stocks can be released onto the market, supply is elastic • The time frame allowed • Momentary period (fixed supply) • Short run (inelastic supply) • Long run (elastic supply) • Artificial limits on supply • E.g. the impact of patents that limit which firms can supply a product

Applying the Concept of Price Elasticity of Supply

Applying The Concept of Elasticity of Supply (1) • Seats in a football stadium / theatre / cinema • Short run capacity of any stadium is more or less fixed • Long run – expansion of stadium capacity / development of a new ground • An increase in demand for fresh salmon • Time lags in the production process – fixed supply available to the market in momentary period (i.e. the daily catch) • Longer term; change in the number of vessels, length of time at sea • World supply of oil following a large rise in world demand • Variable amount of spare capacity among the major oil producers • Can oil stocks be put onto the market to meet the rise in demand? • Oil supply might be inelastic if current output is close to capacity

Applying The Concept of Elasticity of Supply (1) • The supply of drugs required to treat Anthrax • Short term supply is dependent on stocks of product available • If stocks are low, supply cannot increase in the short term to meet demand • Debate over the use of patents and how this limits production in the long run • The supply of new housing • Planning permission + availability of land to develop + shortages of skilled labour • Time lags in the production process – new housing developments take months to complete

Momentary Supply – Price Elasticity = Zero Price (P) Quantity Supplied (Qs)

Momentary Supply – Price Elasticity = Zero Momentary Supply Price (P) Quantity Supplied (Qs) Q1

Momentary Supply – Price Elasticity = Zero Momentary Supply Price (P) P1 D1 Quantity Supplied (Qs) Q1

Momentary Supply – Price Elasticity = Zero Momentary Supply Price (P) P1 P1 D2 D1 Quantity Supplied (Qs) Q1

Momentary Supply – Price Elasticity = Zero Increase in price from P1 to P2 does not lead to a change in supply Momentary Supply Price (P) P1 P1 D2 D1 Quantity Supplied (Qs) Q1

Short Run Supply Momentary Supply Price (P) Short Run Supply P2 P1 D2 D1 Quantity Supplied (Qs) Q1

Short Run Supply Momentary Supply Price (P) Short Run Supply P2 P3 P1 D2 D1 Quantity Supplied (Qs) Q1 Q2

Short Run Supply Momentary Supply Price (P) Short Run Supply P2 Increase in price from P1 to P2 does lead to a short term expansion in supply P3 P1 D2 D1 Quantity Supplied (Qs) Q1 Q2

Long Run Supply Response Momentary Supply Price (P) Short Run Supply P2 P3 Long Run Supply P1 D2 D1 Quantity Supplied (Qs) Q1 Q2

Long Run Supply Response Momentary Supply Price (P) Short Run Supply P1 Long Run Supply P3 P1 D2 D1 Quantity Supplied (Qs) Q1 Q2 Q3

Long Term Response to an Increase in Demand Short Run Supply Price (P) P2 Long Run Supply P3 Longer time frame – supply is more elastic – larger rise in output if price P2 is sustained P1 D2 Demand Quantity Supplied (Qs) Q1 Q2 Q3

Values for price elasticity of supply • When supply is perfectly inelastic a change in price has no effect on the quantity supplied onto the market • When supply is perfectly elastic a firm can supply any quantity at the same market price. This occurs when the firm can produce output at a constant cost per unit and it has no capacity limits to its production • When supply is relatively inelastic a change in demand affects price more than quantity supplied • When supply is relatively elastic. A change in demand can be met without a change in market price

Differences in Price Elasticity of Supply Perfectly elastic supply An elastic supply curve Price Price Quantity Quantity Price Price Inelastic Supply Curve Perfectly inelastic supply Quantity Quantity

Relatively Elastic Supply Supply responds quickly to a change in demand Relatively Inelastic Supply Supply responds less than proportionately to a change in price Price Supply P2 Supply P1 P3 P2 P1 P3 D3 D2 D1 D3 D2 D1 Q2 Q1 Q3 Q1 Quantity Quantity Elasticity of supply and changes in market demand

The non-linear supply curve Price Supply P5 P4 P3 P2 P1 Q1 Q2 Q3 Quantity Q4 Q5

Price Elasticity of Supply