Price elasticity of supply (PES)

Definition Measures the responsiveness of supply for a good or service after a change on the price of the good or service.

The use of PES PES is often used to predict or explain why prices rise of fall dramatically when there are changes in demand.

Market disequilibrium A positive change in the factors of demand and consequences for equilibrium demand, supply and market price. An elastic response to the excess demand (supply is responsive) An inelastic response to the excess demand (supply is not responsive) P S1 P P2 S1 E2 P2 P1 E1 P1 D2 D2 D1 D1 QDS QDS1 QDS2 QDS1 QDS2 QDS

Factors that determine the PES for a good or service PES is essentially determined by the ability and/or willingness to respond to a change in demand

The PES of a good or service is calculated as follows:- PES formula The PES of a good or service is calculated as follows:- Percentage change in the quantity supplied of the good or service Percentage change in the price of the good or service The PES will be positive (+). Plotting supply against price provides a positive gradient.

PES calculations PES Elasticity e.g. Description Perfectly inelastic Perfectly inelastic Supply does not respond at all to a change in price < 1 Inelastic 0.6 Supply is not responsive to the change in price 1 Unitary > 1 Elastic 1.3 Supply is responsive to the change in price 8 Perfectly elastic Supply is very responsive to a change in price. Excess demand is completely eliminated with no increase in price

Factors that determine the PES for a good or service 1.The time taken produce extra output . Where extra output may take time to produce or extract , the PES for that good, commodity or service is likely to be low (inelastic). This means a rise in the price of the good , commodity or service will see a proportionally smaller change (extension) in supply (an inelastic response). The consequence for price is to see an rapid increase in the price of the good or service. Hand made jewellery Agriculture Precious metals

Factors that determine the PES for a good or service 1.The degree of spare capacity in the production process. There a business is producing at or close to full capacity, it may not be able to respond to an increase in demand. The response to the increasing prices caused by excess demand is likely to be low (inelastic). This may be the case when a business experiences a sudden or unexpected increase in demand. Alternatively it may happen over a period of time such as in times of strong economic growth (this will be taken further in unit 2)

Factors that determine the PES for a good or service 2.The ability of a firm or industry to stockpile. Stockpiling involves the or extraction or production and storage of surplus commodities, semi finished or finished goods. These can then be released onto the market in times of increased demand. This means a rise in the price of the good or commodity may see a change (extension) in supply. The consequence for price is to see them stabilised. Excess demand may be partially or completely eliminated depending on the PES adopted by the firm/industry. The oil industry is a an example of a sector that may engage in stockpiling. By doing so firms can respond to sudden increases in demand and capitalise on rising prices With an inelastic PED for petrol, their total revenue will rise.

Factors that determine the PES for a good or service 3.The ability to alter or switch between methods of production. Where a business can alter or switch to alternative methods of production, the PES for that good, commodity or service is likely to be high (elastic). This means a rise in the price of the good , commodity or service may see a proportionally larger change (extension) in supply (an elastic response). The consequence for price is to see them stabilised or even fall following a rise in demand. This approach to supply may often be adopted by businesses in competitive markets when demand increases, but the business cannot capitalise on this through higher prices (due to the XPED between firms). Instead supply is increased which will allow the firm to increase its total revenue. This can be witnessed during Christmas with the price of everyday goods such a chocolate and snacks and soft drinks. This may be achieved by stopping the production of less popular lines for those in greater demand.

Factors that determine the PES for a good or service 4.The ease with which firms can enter (and exit). Where firms find it difficult to enter the market in response to higher prices (profit signalling), the PES for that good, commodity or service is likely to be low(inelastic). This means a rise in the price of the good , commodity or service may see a proportionally smaller change (extension) in supply (an inelastic response). The consequence for price is to see them rise following an increase in demand. This may be found in markets that are less competitive and where barriers to entry exist. It will almost certainly be the case in monopoly situations (one firm controlling market supply). This practice was evident in the diamond mining industry where De Beers controlled the supply of diamonds to the secondary sector through the acquisition of new mining firms.

(supply is not responsive at all, PES =0) Market disequilibrium A positive change in the factors of demand and consequences for equilibrium demand, supply and market price. A perfectly inelastic response to the excess demand (supply is not responsive at all, PES =0) Where a business cannot or will not respond to an increase in demand by increasing supply, the PES is said to be perfectly inelastic. The excess demand is not eliminated by an increased in supply, but rationed through ‘rocketeting’ prices. This is typical of markets where supply is fixed by the supplier (monopoly) or fixed due to a lack of spare capacity (all seater stadia) S1 P E2 P2 E1 P1 D2 D1 QDS1/2 QDS

Example 2 The following are price and corresponding supply figures for Soneji’s Super Cinema Shows. P1 = £200 QS1 = 1,000 units P2 = £220 QS2 = 1,000 units Commentary on the PES

(supply is infinitely responsive, PES=  ) Market disequilibrium A positive change in the factors of demand and consequences for equilibrium demand, supply and market price. A perfectly elastic response to the excess demand (supply is infinitely responsive, PES=  ) Where a business will respond to an increase in demand by increasing supply, but there is no incentive of rising prices in order to do so. The PES is said to be perfectly elastic. The excess demand is eliminated completely by an increased in supply, and no recourse to higher prices. This is typical of markets that are competitive and a high XPED between firms is likely to exist. P S1 E1 E2 P1 D2 D1 QDS1 QDS2 QDS

Example 2 P1 = £20p QS1 = 1,000 units P2 = £20p QS2 = 1,200 units The following are price and corresponding supply figures for Soneji’s (not so)Super sweets at Christmas time P1 = £20p QS1 = 1,000 units P2 = £20p QS2 = 1,200 units Commentary on the PES