Price Elasticity of Supply PES

PES Learning Outcomes: Concept of Price Elasticity of Supply Calculate PES Explain using diagrams and PES values Determinants of PES Explain why the PES for primary commodities is relatively low and the PES for manufactured products is relatively high

Price Elasticity of Supply (PES) A measure of how much the supply of a product changes when there is a change in the price of the product “How much does the quantity supplied change when the price changes?”

Price Elasticity of Supply (PES) % D Quantity Supplied FORMULA = % D Price Percent change in quantity supplied / Percent change in price

PES Example A publishing firm realizes that they can now sell their monthly magazine for $5.50 instead of $5.00. In light of this, they increase their supply from 200,000 to 230,000 magazines per month. Calculate the price elasticity of supply. PES = 15% / 10% = 1.5

Range of PES Values INELASTIC SUPPLY: Price elasticity of supply of less than 1 and greater than zero UNIT ELASTIC: Price elasticity of supply equal to 1 ELASTIC: Price elasticity of supply greater than 1 and less than infinity

Range of PES Values PERFECTLY INELASTIC: Price elasticity of supply is equal to zero PERFECTLY ELASTIC: Price elasticity of supply value of infinity

Supply curves with different price elasticity of supply PES = <1 Any straight-line supply curve starting from the x-axis has a PES value of less than one P0 O Q0 Q

Supply curves with different price elasticity of supply PES = >1 S2 P0 Any straight-line supply curve starting from the y-axis has a PES value greater than one O Q0 Q

Supply curves with different price elasticity of supply PES = 1 S1 S2 Any straight-line supply curve, passing through the origin, has an elasticity of supply of one O Q

Determinants of PES The amount of time following a change in price The mobility of factors of production The ability to store stocks The amount of unused capacity

Determinants of PES Time following a change in price The shorter the time period the lower the PES Market Period: the period immediately following a change in price (supply would be highly inelastic) Short Run: period of time over which land & capital are fixed, but labor is variable (supply would be more elastic than the market period) Long Run: period of time over which all factors of production are variable (supply is highly elastic)

Determinants of PES Mobility of Factors of Production The more mobile the factors of production (land, labor and capital) the more responsive a firm can be to changes in price Relatively elastic supply: manufactured goods & low-skilled services Relatively inelastic supply: primary commodities & heavy industrial goods Manufactured goods – clothes, toys, simple electronics Low skilled services – haircuts, laundry services, housekeeping Primary commodities- land intensive: coffee, rice, corn, wheat Heavy industrial goods – airplanes, automobiles, high tech goods

Determinants of PES The ability to store stocks If large inventories of a good can easily be stored in warehouses or kept on hand by producers, then supply of the good can be highly responsive to changes in the price

Determinants of PES The amount of unused capacity Excess capacity refers to the amount a firm is able to produce in the short run without having to expand its plant size and the amount of capital and land employed in production If an industry is operating at or near full capacity, supply will be highly inelastic If an industry is operating under capacity, supply will be highly elastic

PES Exercise

Exercise A firm producing stuffed toys experiences an increase in the demand for its main product, a cuddly dog, because of an increase in its popularity. The price of the toy rises from $15 to $18. In response, the firm increases its output of the toy from 5,000 per week to 5,500 per week. Using a demand and supply diagram, explain why the price of the toy dog has increased. Calculate the elasticity of supply for the toy dog.

Effect of a shift in the demand curve P S i 18 PES = 10% / 20% = .5 g 15 D2 D1 O 5000 5500 Q