Price elasticity of supply

Not to be confused with Price elasticity of demand.

Price elasticity of supply (PES or Es) is a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price.

The elasticity is represented in numerical form, and is defined as the percentage change in the quantity supplied divided by the percentage change in price.

When the coefficient is less than one, the said good can be described as inelastic; when the coefficient is greater than one, the supply can be described as elastic.[1] An elasticity of zero indicates that quantity supplied does not respond to a price change: it is "fixed" in supply. Such goods often have no labor component or are not produced, limiting the short run prospects of expansion. If the coefficient is exactly one, the good is said to be unitary elastic.

The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down.

Determinants

Availability of raw materials
For example, availability may cap the amount of gold that can be produced in a country regardless of price. Likewise, the price of Van Gogh paintings is unlikely to affect their supply.[2]
Length and complexity of production
Much depends on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings – no special structures are needed. Thus the PES for textiles is elastic. On the other hand, the PES for specific types of motor vehicles is relatively inelastic. Auto manufacture is a multi-stage process that requires specialized equipment, skilled labor, a large suppliers network and large R&D costs.[3]
Mobility of factors
If the factors of production are easily available and if a producer producing one good can switch their resources and put it towards the creation of a product in demand, then it can be said that the PES is relatively elastic. The inverse applies to this, to make it relatively inelastic.
Time to respond
The more time a producer has to respond to price changes the more elastic the supply.[2][3] Supply is normally more elastic in the long run than in the short run for produced goods, since it is generally assumed that in the long run all factors of production can be utilised to increase supply, whereas in the short run only labor can be increased, and even then, changes may be prohibitively costly.[1] For example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price of soybeans because of the time it would take to procure the necessary land.
Inventories
A producer who has a supply of goods or available storage capacity can quickly increase supply to market.
Spare/Excess Production Capacity
A producer who has unused capacity can (and will) quickly respond to price changes in his market assuming that variable factors are readily available.[1] The existence of spare capacity within a firm, would be indicative of more proportionate response in quantity supplied to changes in price (hence suggesting price elasticity). It indicates that the producer would be able to utilise spare factor markets (factors of production) at its disposal and hence respond to changes in demand to match with supply. The greater the extent of spare production capacity, the quicker suppliers can respond to price changes and hence the more price elastic the good/service would be.

Various research methods are used to calculate price elasticities in real life, including analysis of historic sales data, both public and private, and use of present-day surveys of customers' preferences to build up test markets capable of modelling elasticity such changes. Alternatively, conjoint analysis (a ranking of users' preferences which can then be statistically analysed) may be used.[4]

Graphical representation

It is important to note that elasticity and slope are, for the most part, unrelated. Thus, when supply is represented linearly, regardless of the slope of the supply line, the coefficient of elasticity of any linear supply curve that passes through the origin is 1 (unit elastic).[5] The coefficient of elasticity of any linear supply curve that cuts the y-axis is greater than 1 (elastic), and the coefficient of elasticity of any linear supply curve that cuts the x-axis is less than 1 (inelastic). Likewise, for any given supply curve, it is likely that PES will vary along the curve.[1]

Selected supply elasticities

See also

Notes

  1. ↑ 1.0 1.1 1.2 1.3 Png, Ivan (1999). pp. 129–32.
  2. ↑ 2.0 2.1 Parkin; Powell; Matthews (2002). p.84.
  3. ↑ 3.0 3.1 Samuelson; Nordhaus (2001).
  4. ↑ Png, Ivan (1999). pp. 79–80.
  5. ↑ Research and Education Association (1995). pp. 595–97.
  6. ↑ 6.0 6.1 6.2 6.3 Png (1999), p.110
  7. ↑ 7.0 7.1 Suits, Daniel B. in Adams (1990), p. 19, 23. Based on 1966 USDA estimates of cotton production costs among US growers.
  8. ↑ Barnett and Crandall in Duetsch (1993), p.152

References

  • Adams, Walter (1990). The Structure of American Industry (8th ed.). MacMillan Publishing Company. ISBN 0-02-300771-0.
  • Case, K; Fair, R (1999). Principles of Economics (5th ed.).
  • Duetsch, Larry L. (1993). Industry Studies. Englewood Cliffs, NJ: Prentice Hall. ISBN 0-13-454778-0.
  • Parkin, Michael; Powell, Melanie; Matthews, Kent (2002). Economics. Harlow: Addison–Wesley. ISBN 0-273-65813-1.
  • Png, Ivan (1999). Managerial Economics. Blackwell. ISBN 978-0-631-22516-4. Retrieved 28 February 2010.
  • Research and Education Association, The Economics Problem Solver. REA 1995.
  • Samuelson; Nordhaus (2001). Microeconomics (17th ed.). McGraw–Hill.
  • Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 104. ISBN 0-13-063085-3.