What is Price Elasticity of Supply?
The Price elasticity of supply refers to the measure of the sensitivity of supply in response to the change in price and it is calculated by dividing the percentage change in quantity supplied (∆Qs/Qs) by the percentage change in price (∆P/P) which is mathematically represented as,
Further, the formula for price elasticity of supply can be elaborated to
where Q0S = Initial quantity supplied, Q1S = Final quantity supplied, P0 = Initial price and P1 = Final price
Explanation of the Price Elasticity of Supply
This can be determined in the following four steps:
- Step #1: Identify P0 and Q0S which are the initial price and initial quantity supplied respectively and then decide on the target quantity to be supplied and based on that the final price point which is termed as Q1S and P1 respectively.
- Step #2: Now, work out the numerator of the formula which represents the percentage change in quantity supplied. It is arrived at by dividing the difference of final and initial supply quantities (Q1S – Q0S) by summation of the final and initial supply quantities (Q1S + Q0S) which is represented as (Q1S – Q0S) / (Q1S + Q0S).
- Step #3: Now, work out the denominator of the formula which represents the percentage change in price. It is arrived at by dividing the difference of final and initial prices (P1 – P0) by summation of the final and initial prices (P1 + P0) i.e. (P1 – P0) / (P1 + P0).
- Step #4: Finally, the price elasticity of supply is calculated by dividing the expression in Step 2 by expression in Step 3 as shown below.
Example of Price Elasticity of Supply
Below we have taken some practical calculation examples of Price Elasticity of Supply to understand it better.
Price Elasticity of Supply Example #1
Let us take the simple example of pizza. Now let us assume that a surge of 40% in pizza price resulted in an increase in the supply of pizza by 25%. Using the above-mentioned formula the price elasticity of supply can be calculated as:
Price elasticity of supply formula = Percentage change in quantity supplied / Percentage change in price
Therefore, the pizza exhibited inelastic supply characteristics.
Price Elasticity of Supply Example #2
Let us assume that there is a company which has installed vending machines for supplying soft drinks. At present, the vending machines sell soft drinks at $3.50 per bottle. Now at this price, the manufacturer supplies 4,000 bottles per week. However, due to some governmental ban, the price has declined to $3.00 which has resulted in a lower supply of 3,000 bottles per week. Now, the price elasticity of supply can be calculated as below:
Given, Q0S = 4,000 bottles, Q1S = 3,000 bottles, P0 = $3.50 and P1 = $3.00
Price elasticity of supply formula = (Q1S – Q0S) / (Q1S + Q0S) ÷ (P1 – P0) / (P1 + P0)
- Price elasticity of supply formula = (3,000 – 4,000) / (3,000 + 4,000) ÷ ($3.00 – $3.50) / ($3.00 + $3.50)
- Price elasticity of supply = (-1/7) ÷ (-1/13)
- Price elasticity of supply = 13/7 or 1.857
Therefore, the soft drink supplier exhibited elastic supply characteristics.
Types of Price Elasticity of Supply
There are five cases of Price Elasticity of Supply which are discussed below:
#1 – Perfectly Inelastic Supply
The price elasticity of supply in such a case is zero which is indicative of the fact that the supply would remain the same irrespective of the price of the commodity.
#2 – Inelastic Supply
In the case of inelastic supply, the change in supply is relatively less than the change in price. As such, the price elasticity of supply, in this case, assumes a value which is less than 1.
#3 – Unitary Elastic Supply
In such a case, the change in supply quantity is exactly equal to the change in its price. As such, the price elasticity of supply, in this case, is equal to one.
#4 – Elastic Supply
In the case of elastic supply, the change in supply is relatively greater than the change in price. As such, the price elasticity of supply, in this case, assumes a value which is greater than 1.
#5 – Perfectly Elastic Supply
In such a case, the supply quantity becomes zero even with a slight fall in price and becomes infinite with a slight increase in price. This indicates that the suppliers are willing to supply an unlimited quantity of the commodity at a higher price.
Relevance and Uses
It is very important for a business to appreciate the concept and use of price elasticity of supply to understand the relationship between the price of a good and the corresponding quantity of the commodity that the supplier is willing to supply at that price. It can be used to decide on the batch production of various products.
In case the supply quantity fluctuates a lot when the price varies a little, then the product is said to be elastic. This often happens in the case of popular products or services that are in short supply for instance. In such a scenario when the price goes up the supplier increases the output immediately.
In case the quantity supplied changes by a very small margin despite a significant change in prices, then the product is said to be inelastic. This happens when there is a limited supply for the product or service and as such the supplier can’t supply despite higher prices.
This has been a guide to Price Elasticity of Supply and its definition. Here we discuss the formula to calculate Price Elasticity of Supply along with practical examples. You can learn more from the following articles-