Price Elasticity Of Supply

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Price Elasticity Of Supply?

Price elasticity of supply is used to identify how the supply of a particular product and service reacts with the change in the price of the same. Higher price elasticity will denote that the producers and sellers of particular goods and services are highly sensitive to even the slightest of changes or fluctuations concerning their prices.

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It shows how the supply of goods responds to the price change. However, many factors affect the responsiveness of supply. It also depends a lot on whether the study is done on a short-term or long-term basis. It is expressed in a numerical form.  

Key Takeaways

  • Price elasticity of supply recognizes how the particular product or service supply behaves when the price change. The higher price elasticity shows that the producers and sellers of specific goods and services are highly sensitive to small changes or price shifts.
  • Perfectly inelastic supply, inelastic supply, unitary elastic supply, elastic supply, and perfectly elastic supply are the five types of price elasticity of supply.
  • If the supply quantity varies a lot or if the price differs slightly, then it is considered that the product is elastic. In addition, when the amount supplied varies by a minimal margin, although there is a remarkable price change, it is inelastic. 

Price Elasticity Of Supply Explained

The price elasticity of supply shows the responsiveness of supply of goods and services to change in the price of the same. We calculate price elasticity of supply calculated by dividing the percentage change in quantity that is supplied by the change in price calculated as a percentage.

It can be less than one, more than one or equal to one. However, it is important to understand the supply curve dynamics in order to understand the concept. The firm will have to regulate its supply as per the price of its products in the market.

When there is a rise in  price, the producer will prefer to raise production to take advantage of the price rise and earn revenue. The price elasticity will measure by how much the producer will raise this supply.

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Formula

Let us understand how to calculate price elasticity of supply.

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,

Price Elasticity of Supply = (∆QS/QS) ÷ (∆P/P)

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Further, the formula for price elasticityFormula For Price ElasticityPrice elasticity is calculated by dividing the percentage change in quantity by percentage change in price. Price elasticity typically refers to price elasticity of demand that measures the response of demand of a particular item to the change in its price. read more of supply can be elaborated to

Price Elasticity of Supply = (Q1S – Q0S) / (Q1S + Q0S) ÷ (P1 – P0) / (P1 + P0),

where Q0S = Initial quantity supplied, Q1S = Final quantity supplied, P0 = Initial price, and P1 = Final price

Thus the above price elasticity of supply equation explains the concept.

How To Calculate?

In the above-given formula, the symbol Q0 in the above formula depicts the initial quantity that is demandedQuantity That Is DemandedQuantity demanded is the quantity of a particular commodity at a particular price. It changes with change in price and does not rely on market equilibrium.read more which exists when the Price equals P0. When the quantity supplied changes to Q1, it will be because of P1, which symbolizes the new price.

In the above formula, the Price Elasticity of Supply will be a positive number because of the relationship between the Quantity supplied and the price. As the prices go up, the quantity supplied shall also go up. On the flip side, when the Prices go down, the quantity supplied shall also decrease. In this way the firms work on the degrees of price elasticity of supply.

Types

There are five cases of the degrees 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 indicates that the supply would remain the same irrespective of the commodity’s price.

#2 – Inelastic Supply

In the case of inelastic supply, the change in supply is relatively less than the price change. In this case, it assumes a value that is less than 1.

#3 – Unitary Elastic Supply

In such a case, the change in supply quantity is equal to the change in its price. As such, in this case, it is equal to one.

#4 – Elastic Supply

In the case of elastic supply, the change in supply is relatively greater than the price change. As such, in this case, it assumes a value greater than 1.

#5 – Perfectly Elastic Supply

In such a case, the supply quantity becomes zero even with a slight fall in price and infinite with a slight price increase. It indicates that the suppliers are willing to supply an unlimited quantity of the commodity at a higher price.

Examples

Below we have taken some practical calculation examples of the Price Elasticity of Supply formulaPrice Elasticity Of Supply FormulaPrice elasticity of supply is a measure to identify how the supply of a particular product and service reacts with the change in the price. A higher price elasticity denotes that the producers and sellers of specific goods are highly sensitive to even the slightest changes or price fluctuations.read more to understand it better.

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 formula as mentioned above, the price elasticity of supply can be calculated as:

Price elasticity of supply formula = Percentage change in quantity supplied / Percentage change in price

price elasticiyty 1

Therefore, the pizza exhibited inelastic supply characteristics.

Example #2

Let us assume that a company has installed vending machines for supplying soft drinks. 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, resulting 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

Therefore,

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)

= (-1/7) ÷ (-1/13)

= 13/7 or 1.857

Therefore, the soft drink supplier exhibited elastic supply characteristics.

The above examples explain the price elasticity of supply equation in details.

Determinants

There are various factors affecting price elasticity of supply or the degree to which the firm will change its supply to change in price. They are as follows:

  • Production complexity – The producer can easily change the supply with response to price is the production process is less complicated, requires less of skilled labor or can be done in any kind or environment, etc.
  • Capacity expansion – If there is the possibility of expansion in the production process, then it is possible to change the supply. If the production is already in its full capacity, then it is not possible.
  • Inventory management – There should be proper system for inventory management. If the raw materials can be preserved or stored for a longer time, it is possible to store higher quantity of them and increase or supply. Similarly is they can be bought whenever needed and are easily available, then supply can be reduced during price fall.
  • Production flexibility – If the firm has the latest technology and raw materials are easily available to then the manufacturer can also alter the supply.
  • Market entry – If the entry is difficult, then supply elasticity will be low, whereas if entry barrier is low, elasticity will be high.
  • Time period – If the time period is more the firm will have enough time to change its production process, arrange more factors like labor, capital, better technology and influence the supply. This is difficult in the short term.

Thus, the above factors affecting price elasticity of supply or by how much the manufacturer will alter the supply with change in price.  

Importance

A business needs to appreciate the concept and use of this 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 use it to decide on the batch production of various products.

If the supply quantity fluctuates a lot when the price varies a little, then the product is said to be elastic. It often happens in the case of popular products or services in short supply, for instance. In such a scenario, when the price goes up, the supplier increases the output immediately.

If the quantity supplied changes by a very small margin despite a significant change in prices, then the product is inelastic. It happens when there is a limited supply for the product or service, and as such, the supplier can’t supply despite higher prices.

Price Elasticity Of Supply Vs Price Elasticity Of Demand

Let us understand the differences between the price elasticity of supply and demand.

  • The former shows the change in supply with change in price whereas the latter shows the change in demand due to change in price.
  • When price rises, supply rises and demand falls, whereas when price falls, supply falls and demand rises.
  • The former has an upward sloing curve whereas the latter has a downward sloping curve.

Frequently Asked Questions (FAQs)

Is the price elasticity of supply always positive?

The price and the supplied quantity move in a similar direction. Consequently, the price elasticity of supply is positive. In addition, the larger the price elasticity of supply, the more the supply firms of the good or service react to price movements.

Can the price elasticity of supply be negative?

Generally, during labor supply, the price elasticity of supply is positive but can be negative.

What are the five determinants of price elasticity of supply?

The five determinants of price elasticity of supply are marginal cost, number of firms, factors of production mobility, capacity, and time.

How does the price elasticity of supply affect total revenue?

The price elasticity of supply determines the percentage change in supply quantity. It compares to the percentage change in the price. Above all, this theory estimates the change in total revenue.

This has been a guide to what is Price Elasticity of Supply. We explain its formula, how to calculate, determinants, example, types & importance. You can learn more from the following articles-

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