economicsblog: Price Elasticity of Supply

Yesterday I discussed what effect price changes have on demand. But, price changes also have an effect on the quantity supplied. That’s what I will be talking about today.

Price Elasticity of Supply (PES) measures the relationship between the change in quantity supplied and change in price.
The formula for PES = %change quantity supplied / %change price

There can be 4 outcomes for this formula:
1)PES = 0, supply is perfectly inelastic.
2)PES is bigger than 1, the supply is price elastic. Producers can increase output without a rise in cost or a time delay.
3)PES is less than 1, the supply is price inelastic. Firms find it hard to change production in a given time period.
4)PES = infinity. Supply is perfectly elastic following a change in demand.

There are four main factors that influence the PES, those are:
1)Spare production capacity.
If there is spare production capacity the business is able to increase the output without a rise in costs and therefore supply will be elastic in response to demand. This happens mostly during recession because there is plenty of spare labour and capital resources available.
2) Stocks of finished products and components.
If stocks are on a high level, businesses are more able to respond to a change in demand quickly. Therefore the businesses with big stocks will be elastic in response to demand, and businesses with small stocks will be inelastic in response to change in demand.
3) The ease and cost of factor substitution.
If labour and capital can easily be switched businesses are more able to respond to a changing demand, those business are elastic in response to change in demand.
4) Time period involved in the production process.
For many agricultural products there are time lags in the production process which means that elasticity of supply is very low.

Yesterday I stated companies that have a relatively elastic demand would be able to increase their total revenues by lowering their price. However, knowing this, there is just one thing to mention. To be able to respond to the higher demand companies will have to be elastic in response to demand. Companies are able to influence this and become more elastic by increasing stocks and increasing production capacity. However, companies won’t be able to fully influence this. That’s why the most companies have a non-linear supply curve. (See picture below)