3.4 Price elasticity of supply – Essay
Frequently asked topics
Explain elastic/inelastic PES (value of PES)
Explain factors affecting PES (producing period, level of stock, capacity, mobility of
resources, time period)
Discuss how business could increase PES (investment, labour training)
Discuss how government could increase PES (buffer stock scheme)
Essay lists
15S1 Explain two factors that are likely to make the supply of a product relatively
price inelastic. [8]
16S2 Discuss the policies that a government might adopt to increase the price
elasticity of supply of agricultural goods in an economy and consider which policy is
likely to be most effective. [12]
15S1 Explain two factors that are likely to make the supply of a product relatively
price inelastic. [8]
Plan
P1 Explain inelastic PES
P2 Factor 1: producing period
P3 Factor 2: Spare production capacity
P4 Factor 3: level of finished stock
Sample
The price elasticity of supply is the responsiveness of a
change inquantity supplied to a change in price. The formula is PES = % change in
quantity supplied / % change in price. The value of PES is always positive, because
price and quantity supply are positively correlated.
If PES‹1, percentage change in quantity supplied is smaller than percentage change
in price, PES is inelastic. The supply curve has a positive x-intercept.
If a product takes a long time to produce, then producers will not be able to quickly
increase its supply. Thus, supply will be relatively price inelastic. For instance, a fruit
producer may not be able to immediately increase the supply of the fruits he sells if
they take a full year and the appropriate season to grow. Comparatively, a chef can
increase the amount of food they produce even on the same day that they notice an
increase in demand. This makes the supply of fruits relatively price inelastic, and the
supply of restaurant food relatively price elastic.
If a producer wants to increase supply, they need additional resources. If these
resources are unavailable, they will find it difficult to increase production. This
resource constraint may be in land (lack of raw materials), capital (lack of machinery),
or labour (lack of workers with necessary skills); they all limit productive capacity,
thus making supply relatively price inelastic.
If a firm has stocks of goods available or stocks can be obtained very quickly,
producers could immediately increase quantity supply by running down stocks to
meet increased demand when price changes. In this case, supply is likely to be
relatively elastic. However, if there is a low level of stock, PES will be inelastic. There
are two reasons why producers may not have stocks of a product. Firstly, if it is so
costly to store the good that storage costs exceed the potential revenue gain from
having elastic supply; then maintaining stocks is unprofitable. Secondly, if the good is
perishable such as apple, maintaining stocks may not be feasible.
(338 words, 1 diagram)
16S2 Discuss the policies that a government might adopt to increase the price
elasticity of supply of agricultural goods in an economy and consider which policy
is likely to be most effective. [12]
Plan
P1 Method 1: Financial support
P2 Evaluation
P3 Method 2: Buffer stock
P4 Evaluation
P5 Method 3: Supply-side policy
P6 Evaluation
P7 Conclusion
Sample
Agricultural goods constitute the necessary consumption for the economy. If there is
an increase in demand, then its price will increase to provide a profit incentive for
producers to increase supply. However, if PES is inelastic, the increase in quantity
supply will be limited and the prices for such necessities may become prohibitively
high. Thus, government wants to make the supply of product more price-elastic.
Firstly, government could give financial support to fund research and development
to shorten production time. The improvement in productivity could enable
producers to respond more quickly to changes in demand. With financial support,
producers could also purchase more warehouses, this could improve the ability to
stock finished goods. Hence, PES becomes more price-elastic.
However, such attempts are likely to succeed, but only to a certain degree. It is
probable that agricultural production times can be shortened, they are unlikely to
fall dramatically. In addition, the cost of research and development is often high, the
returns are not always certain. Finally, agriculture goods are perishable, even though
producers have spaces to keep stocks, they will not be kept long.
Secondly, government could introduce buffer stock scheme. If there is surplus in the
market, government could purchase the surplus and put in stock. When there is
shortage in the market, government could release these stocks. As the level of
finished stocks increases, PES will be more elastic.
However, agricultural goods are perishable, they cannot be kept for a long time.
Moreover, government agencies may have poor information about which products
to buy and actually it can be difficult to know whether there is a surplus until later in
the year. As a result, government could remove trade barriers to encourage imports,
this will broaden the supply base of agricultural goods. An important advantage of
doing this is that foreign producers will not be affected if there is a bad local weather
condition. The openness of international trade will promote competition, it will also
improve productivity of local producers.
Finally, supply-side policy is a useful method. Government might provide training
schemes to increase the quantity of labourers.After a long-time training, more
workers are able to be employed, this increase the total number of labor force. In
addition, education and training also increases the mobility of labor as workers may
now have multiple skills. Finally, better education can improve labour productivity,
producing period will be shortened. As a result, PES becomes more elastic.
However, supply-side policy is only useful in the long run. In addition, if the economy
is operating at full employment, the government may find it difficult to increase the
supply of labour. Furthermore, there are natural constraints such as the available
area of land suitable for agriculture, this is difficult to overcome with supply-side
policies.
To conclude, government could use financial support, buffer stock scheme and
supply-side policy to increase the price elasticity of supply of agricultural goods. As
agricultural goods are perishable and have a relative long producing period, it is
difficult to increased PES in the short-run. Hence, the most effective method is
supply-side policy, which is more useful in the long run, or encourage international
trade, which is very effective when there is poor weather condition.
(534 words)