Price elasticity of supply (PES) is the responsiveness of the supply of a good to a change in price. The formula to calcular PES is:
In most cases a positive answer is obtained, indicating that the two variables of price and quantity move in the same direction. There is a positive gradient.
If PES is greater than 1, the good is price elastic: that is , the percentage change in supply is greater than the percentage change in price.
If PES is less than 1, the good is price elastic: that is , the percentage change in supply is less than the percentage change in price.
If PES is equal to 1, the good is unit elastic: that is the percentage change in supply is equal to the percentage change in price.
If PES is equal to 0, the good is perfectly inelastic: that is the percentage change in price has no effect on the quantity supplied. The supply curve is vertical.
If PES is infinite, the good is perfectly elastic. A change in price would cause supply to drop to 0. The supply curve is horizontal.
[diagram on page 27]
Determinants of price elasticity of supply
- Level of spare capacity. A high level of spare capacity in a form means that it can raise production quickly, so supply tends to be elastic. A form or industry operating at fill capacity is unable to raise output quickly and so supply tends to be inelastic.
- The state of the economy. In a recession there are many unemployed resources and so there is a high level of spare capacity. Firms find it relatively easy to raise capacity if needed.
- Level of stock of finished goods in a firm. A high level of stocks means that the firm can increase supply quickly, so supply is elastic: for example, US motor vehicle manufacturers often have stockpiles of cars waiting to sell. Alternatively, a firm or industry operating with low stocks ii unable to raise output quickly so supply tends to be inelastic. This is more likely to be the case for a form making designer wedding dresses.
- Perishability of the product. Some goods cannot be stockpiled: for example, some agricultural good such as fresh fruit, vegetables and flowers are highly perishable. These goods are typically inelastic in supply. On the other hand, manufactured goods tend to be non-perishable and so can be stockpiled by forms in order to meet anticipated increased in demand. Examples are household electrical goods such as fridges, freezers and washing machines.
- The ease of entry into the industry. If there are high entry barriers to an industry then it will be difficult for new forms to enter, even with the attraction of high prices and profits. Sometimes existing producers deliberately create entry barriers, so that supply can be restricted and inelastic.
- The time period under consideration. This is perhaps the most important determinant of elasticity of supply. The short run is the period of time in which a firm is able to increase supply with its existing capacity. A least one factor input is likely to be fixed in quantity in the short run, which makes it difficult for a form to raise production. Supply tends to be relatively inelastic. The long run is the period of time in which a form is able to increase supply by adding to its production capacity. All factor inputs are variable in the long run, making it easier for a firm to raise production. Supply tends to be relatively inelastic.
For many agricultural products, supply is inelastic in the short run because the output for the summer and autumn harvests depends on the amount of seeds planted at the start of the year. It takes an even longer period of time to raise the supply of dairy products such as milk or beef, because these depend on the nurturing of animals over several years.
The supply of mineral may also be inelastic in the short tun due to the length of time required to explore and discover new deposits and then extract them. The costs and technical complexities involved could be phenomenal: for example, developing a new iron ore mine in Western Australia to cater for increasing demand from China. This will require heavy machinery and construction of new rail and road links.