8 COURSE: AS LEVEL ECONOMICS (9708) CHAPTER: 2 – The Price System and the Microeconomy TOPIC: 2.3 – Price Elasticity of Supply Last edited: August 2022 Dr. Sylvain Hours econdoctor.com Outline 2.3 Price elasticity of supply 2.3.1 - Definition of price elasticity of supply (PES) 2.3.2 - Formula for and calculation of price elasticity of supply 2.3.3 - Significance of relative percentage changes, the size and sign of the coefficient of price elasticity of supply 2.3.4 - Factors affecting price elasticity of supply 2.3.5 - Implications for speed and ease with which firms react to changed market conditions Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply The Price Elasticity of Supply (PES) measures the proportionate response of quantity supplied to a proportionate change in the price of the good or service. Price Elasticity of Supply (PES): %∆𝑄𝑆 Δ𝑄𝑆 /𝑄𝑆𝑂 𝑃𝐸𝑆 = ⇔ 𝑃𝐸𝑆 = %∆𝑃 Δ𝑃/𝑃𝑂 Because of the Law of Supply (i.e. positive relationship between price and quantity supplied), the PES is positive (i.e. PES > 0). Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply PRICE QUANTITY Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply PRICE S QUANTITY Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply PRICE S O 𝑃𝑂 𝑄𝑆𝑂 QUANTITY Dr. Sylvain Hours econdoctor.com Price Elasticity of Supply PRICE S N 𝑃𝑁 ∆𝑃 = 𝑃𝑁 − 𝑃𝑂 O 𝑃𝑂 𝑄𝑆𝑂 𝑄𝑆𝑁 ∆𝑄𝑆 = 𝑄𝑆𝑁 − 𝑄𝑆𝑂 QUANTITY Dr. Sylvain Hours econdoctor.com Price-Elastic vs Price-Inelastic Supply If the PES is infinite, then supply is said to be perfectly price-elastic. A very small increase in price would lead to an infinite increase in quantity supplied, whilst a very small decrease in price would lead to the quantity supplied becoming zero. If the PES is larger than 1, then supply is said to be (relatively) price-elastic. A given percentage change in price will bring about a larger percentage change in quantity supplied. Dr. Sylvain Hours econdoctor.com Price-Elastic vs Price-Inelastic Supply If the PES is equal to 1, then supply is said to be unit (or unitary) price-elastic. If the PES is smaller than 1, then supply is said to be (relatively) price-inelastic. A given percentage change in price will lead to an equal percentage change in quantity supplied. A given percentage change in price will bring about a smaller percentage change in quantity supplied. If the PES is equal to 0, then supply is said to be perfectly price-inelastic. Price changes have no effect on the quantity supplied. Dr. Sylvain Hours econdoctor.com Price-Elastic vs Price-Inelastic Supply Dr. Sylvain Hours econdoctor.com Price-Elastic vs Price-Inelastic Supply 0 1 +∞ Dr. Sylvain Hours econdoctor.com Price-Elastic vs Price-Inelastic Supply PERFECTLY PRICE-INELASTIC 0 UNIT PRICE-ELASTIC PRICE-INELASTIC 1 PERFECTLY PRICE-ELASTIC PRICE-ELASTIC +∞ Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve A « quick-and-dirty » way to determine whether a linear supply is priceelastic or price-inelastic is to look at the shape of the supply curve: If it is relatively flat, then supply is (relatively) price-elastic. If it is relatively steep, then supply is (relatively) price-inelastic. If it is horizontal, then supply is perfectly price-elastic. If it is vertical, then supply is perfectly price-inelastic. However, as we shall see later, this method can be misleading because even a linear supply curve that looks steep can be price-elastic, while even a linear supply curve that looks flat can be price-inelastic. Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve PRICE QUANTITY Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve S2 PRICE S1 QUANTITY Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve S2 PRICE S1 A 8 10 QUANTITY Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve S2 PRICE C 10 B S1 A 8 10 11 16 QUANTITY Dr. Sylvain Hours econdoctor.com PES & Gradient of the Supply Curve S2 PRICE C 10 B S1 A 8 10 11 𝑃𝐸𝑆𝐴 → 𝐵 = 16 − 10 10 / 10 − 8 = 2.4 8 𝑃𝐸𝑆𝐴 → 𝐶 = 11 − 10 10 / 10 − 8 = 0.4 8 16 QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S A 𝑝1 QUANTITY 𝑞1 Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S 𝑝2 B 𝑝1 A QUANTITY 𝑞1 = 𝑞2 Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S A 𝑝1 QUANTITY 𝑞1 Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE S 𝑝1 A 𝑝2 B QUANTITY 𝑞1 = 𝑞2 Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply Dr. Sylvain Hours econdoctor.com Perfectly Price-Inelastic Supply PRICE QUANTITY SIMPLIFIED REPRESENTATION Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply PRICE S QUANTITY SIMPLIFIED REPRESENTATION Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER PRICE QUANTITY Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER PRICE 𝑝1 S QUANTITY +∞ Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER PRICE S 𝑝1 A QUANTITY 𝑞1 +∞ Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER PRICE C +𝜀 𝑝2 𝑝1 S A QUANTITY 𝑞1 +∞ Dr. Sylvain Hours econdoctor.com Perfectly Price-Elastic Supply ONE STEP FURTHER PRICE C +𝜀 −𝜀 𝑝2 𝑝1 𝑝3 S A B QUANTITY 𝑞3 𝑞1 +∞ Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve Assume supply is a linear function (i.e. represented by a straight line). 𝑃 = 𝑎𝑄𝑆 + 𝑏 ; 𝑎 > 0 The PES can be expressed as follows: 𝑃𝐸𝑆 = 𝑃𝑂 /𝑄𝑆𝑂 Gradient ⇔ 𝑃𝐸𝑆 = 𝑎𝑄𝑆𝑂 +𝑏 𝑎𝑄𝑆𝑂 ⇔ 𝑃𝐸𝑆 = 1 + 𝑏 𝑎𝑄𝑆𝑂 Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve If the supply curve passes through the origin (i.e. b = 0), then the PES is constant and equal to 1 (i.e. supply is unit price-elastic). If the supply curve has a positive vertical intercept (i.e. b > 0), then the PES is greater than 1 (i.e. supply is price-elastic), and it decreases as we move up along the supply curve. If the supply curve has a negative vertical intercept (i.e. b < 0), then the PES is smaller than 1 (i.e. supply is price-inelastic), and it increases as we move up along the supply curve. Nb: There is no economic intuition behind these statements. Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve PRICE QUANTITY Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve PRICE S1 QUANTITY b<0 Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve PRICE S2 S1 b=0 b<0 QUANTITY Dr. Sylvain Hours econdoctor.com PES & Linear Supply Curve S3 PRICE S2 S1 b>0 b=0 b<0 QUANTITY Dr. Sylvain Hours econdoctor.com Practice Time! P1 Q1 P2 Q2 5 40 3 24 5 40 3 40 5 40 3 16 5 40 3 36 %ΔP %ΔQ PES Dr. Sylvain Hours econdoctor.com Practice Time! P1 Q1 P2 Q2 %ΔP %ΔQ PES 5 40 3 24 -40% -40% 1 5 40 3 40 -40% 0% 0 5 40 3 16 -40% -60% 1.5 5 40 3 36 -40% -10% 0.25 Dr. Sylvain Hours econdoctor.com The Determinants of the PES Time The longer the time period considered, the more price-elastic the supply. In the short-run: Producers might find it difficult to switch from making one product to another. They may be unable to supply more output if the production process is lengthy. The number of firms operating in the market is usually taken as fixed. There could be capacity problems. In the long-run: Producers can adapt their output mix in response to price changes. They can supply more output, even if the production process is lengthy. Firms can enter or exit the market They can increase their production capacity Dr. Sylvain Hours econdoctor.com The Determinants of the PES The availability of stocks (for goods only) The larger the inventories, the more price-elastic the supply. Example: An increase in the price of frozen meat is likely to lead to a significant increase in the quantity supplied because producers can draw on stocks. The availability of inputs The more readily available the inputs, the more price-elastic the supply. Example: If the price of international education in China increases, then its supply is not likely to expand significantly because foreign teachers are quite difficult to find at the moment (June 2020). Dr. Sylvain Hours econdoctor.com The Determinants of the PES The availability of substitutes in production The more substitutes in production, the more price-elastic the supply. Example: If the price of strawberries falls, ceteris paribus, then farmers can reallocate their resources to produce less strawberries and more raspberries. The existence of barriers to entry or exit The easier or cheaper it is for sellers to enter or leave the market, the more price-elastic the supply. Example: The supply of aircrafts is likely to be price-inelastic because the high startup costs and the existence of substantial economies of scale make it very difficult for new firms to enter the market when the price rises. Dr. Sylvain Hours econdoctor.com Importance of the PES The value of the PES provides information about the extent to which firms can respond to price changes. Namely, the more price-elastic supply, the easier it is for firms to adjust their level of output when their product becomes either more or less valuable. Usually, firms benefit from having a price-elastic supply in the sense that they are more flexible and adaptable when market conditions change. They may attempt to increase the PES by raising their productive capacity, by building up their inventories, by improving their supply chain security, by producing goods and services with more substitutes in production, or shorter production processes, etc. Dr. Sylvain Hours econdoctor.com Importance of the PES The value of the PES also indicates the extent to which price changes will influence the total revenue received by firms from their sales. Namely, the more price-elastic the supply, the greater the impact of price changes on the total revenue received by firms from their sales. Finally, and as we shall see later (Topic 3.2), the value of the PES is a key determinant of the consequences of government intervention in markets (e.g. incidence and effectiveness of specific taxes and subsidies, size of a shortage or surplus caused by price ceilings and price floors, etc.). Dr. Sylvain Hours econdoctor.com
