Chapter 12: Price elasticity of supply (1.2)

  • Definition of price elasticity of supply

Compare the three goods in figure 12.1. Why would a supply curve be ‘steep’ or ‘shallow’? Try to fit the correct good to each diagram; blank DVDs, the Olympic boxing finals and the supply of IB economics hours in a public school (answer in footnote).[1] It is rather self-evident that the supply curves indicate the willingness/ability of firms to increase output of a good within a given period of time.

The diagram series above pretty much says it all. The price has increased by 50% in all three cases (from $100 to $150) but the percentage increase in quantity supplied varies from 100% to zero. We have just defined price elasticity of supply (PES); it is the relative increase in quantity supplieddue to a relative increase in price. The price elasticity of supply (PES) for Good a is 100/50; PES = 2:Good b is 50/50; PES = 1.0.Good c is 0/50; PES = 0.

  • Formula

PES =

  • Range of values
  • Diagrammatical illustration

Any linear supply curve which starts on the P-axis will have a PES of more than one. A linear curve starting at the origin will have a PES equal to 1 and in full logical consequence; a straight-line supply curve originating from the Q-axis will have a PES of less than 1. Note that this rule is valid no matter what the slope of a (linear) supply curve is. This is illustrated in figure 12.3, where the changes in quantity and price have been marked out along the axis for comparison.

(Smaller heading) A few extreme cases of PES

There are two extreme cases of price elasticity of supply. One is where the quantity supplied remains the same no matter what the price, i.e. perfectly inelastic supply. The other case is when quantity supplied is infinite at one specific price, i.e. perfectly elastic supply. In both cases, there is actually no correlation between price and quantity supplied. Figure 12.4illustrates this.

  • Determinants of price elasticity of supply

The ability for producers to increase output is intimately hinged on the time span in question; the shorter the time period, the lower the price elasticity of supply. The quantity supplied of fresh tomatoes is difficult to increase in a two week period while a period of six months gives entirely different supply elasticity.

In a similar vein, time is an issue for producers who are at the limits of output capacity. The availability of excess capacity, say available machines, labour and factory space, will have a major impact on the ability to increase supply within a given time frame. In the short run it can be difficult to get hold of scarce factors and to expand the size of production plants. Over longer time-periods it is easier to plan and target output by increasing bulk-buying of material and increasing the amount of capital used.

The ease or difficulty any given supplier experiences in moving productive resources from one good to another will be a major factor in determining supply elasticity. A common classroom example is whiteboard pens and permanent markers being very close producer substitutes. Switching from whiteboard pens to permanent markers[2] would involve very little in the way of tool readjustment, machine modifications, new material and knowledge and so forth. Supply would be very elastic. Switching from compact cars to mid-sized cars is also fairly supply elastic.

Manyprimary goods such as iron ore, teak wood and agricultural goods will be highly inelastic, as the ability to switch to such goods in the short run is very limited. The basic premise here is that once suppliers have a large amount of resources sunk in a certain sector, the re-applicability of these resources is the key to increasing supply of other goods. Justconsider commodities such as iron and copper; if you have a copper mine and demand for iron increases it’s going to be a bit difficult to switch production to iron. I mean, you have a copper mine…

  • Applications of price elasticity of supply

Many primary goods such as iron ore, teak wood and agricultural goods will be highly inelastic, as the ability to switch to such goods in the short run is very limited. The basic premise here is that once suppliers have a large amount of resources sunk in a certain sector, the re-applicability of these resources is the key to increasing supply of other goods. Just consider commodities such as iron and copper; if you have a copper mine and demand for iron increases it’s going to be a bit difficult to switch production to iron.[3]

Secondary goods tend to have higher price elasticity of supply than primary goods. The reasons are simply that secondary goods can be stored, are often produced in industries with a degree of excess capacity, are subject to technological advances in production and are increasingly global in span so that production is close to relevant markets.

[1]The answers are: Figure a = blank DVDs, figure b = supply of IB economics, figure c = supply of tickets to the Olympic boxing finals. You may still send me $5.

[2]A favourite classroom prank known to all my people, incidentally.

[3] I mean, you have a copper mine…