Lisa Borga

Price elasticity of supply is a way of identifying how the supply of a specific good or service will respond to changes in the market price of the good or service.

Economic theory states that if the price of a product or service rises, the supply of the product or service will increase.

Whereas if the price decreases, the supply will decrease as well.

If the price elasticity of supply is high, the producers will quickly change the quantity they produce with even a small change in price.

In contrast, if the price elasticity is low, producers will not be quick to change their level of production due to a change in price.

## The Law of Supply

Producers compete with other producers in order to obtain a profit in a free economy.

Because profits do not stay the same over time or for different products, it is necessary for businesspeople to move the labor and resources they have away from less profitable products and services to products or services that produce more profit.

As this happens,  there is a greater supply of products that are highly valued and a decline in the supply of products that are not as valued.

This relationship between prices and quantity supplied is what economists call the law of supply.

As an example, suppose consumers start to demand more muffins than croissants.

Once bakers notice the change in demand, they will start baking more muffins than croissants in order to increase their profits.

## The Formula for the Price Elasticity of Supply

The price elasticity of supply is computed by dividing the percentage change in quantity supplied by the percentage change in price.

If the price elasticity of supply is greater than one, the supply is relatively elastic.

Whereas if the price elasticity of supply is less than one, it is inelastic.

Price elasticity of 1 indicates a fixed supply.

Here is the mathematical formula for price elasticity of supply.

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

Or when the formula is expanded:

[(New Quantity Supplied – Old Quantity Supplied)/(Old Quantity Supplied)] / [(New Price – Old Price)/(Old Price)]

In this formula, the price elasticity of supply will turn out to be positive due to the positive relationship that exists between price and the quantity that is supplied.

This means that when prices increase, the quantity supplied will also increase.

Conversely, when prices decrease, the quantity supplied also decreases.

## Price Elasticity of Supply Examples

Here are some examples that show how to use the formula for Price Elasticity of Supply.

### Example One

As an example, we will look at doughnuts.

Suppose that the price of doughnuts increases by 35%, and this causes the supply of doughnuts to increase by 25%.

We can use this information along with the formula above to compute the price elasticity of supply.

Price Elasticity of Supply = (∆QS/QS) ÷ (∆P/P) = .35/.25

Price Elasticity of Supply = 1.4

This would indicate that the supply of doughnuts is elastic.

### Example Two

For example, two, suppose the minimum ticket price to attend local minor league baseball games has increased from \$22 to \$25.

When the tickets were \$25, the number of tickets supplied was 500. Now that the price is \$27, the number of tickets supplied is 600.

The formula to calculate the price elasticity of supply is:

[Quantity Supplied (New) –Quantity Supplied (Old)] /Quantity Supplied (Old))

The new quantity supplied is 600, and the old quantity supplied was 500.

The new price is \$27, and the old price is \$25.

With this information, it will be necessary to calculate the percentage change in the number of tickets supplied and the percentage change in the price.

#### Computing the Percentage Change in Quantity Supplied

In order to calculate the percentage change in quantity supplied, the old quantity supplied is subtracted from the new quantity supplied, and this figure is divided by the old quantity supplied, as shown below.

[(600-500) / 500] = .20

Percentage change in quantity = 20%

#### Computing the Percentage Change in Price

Now, the percentage change in price needs to be determined.

This is done by subtracting the old price from the new price and dividing this figure by the old price, as follows.

[(\$27 – \$25) / \$25] = .08

Percentage change in price = 8%

Now that both the percentage change in quantity and the percentage change in price has been obtained, the price elasticity of supply can be calculated.

#### Price Elasticity of Supply

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

Price Elasticity of Supply = .20/.08 = 2.5

The price elasticity of supply for these minor league baseball tickets is elastic and is quite sensitive to changes in price.

## Different Types of Price Elasticity

There are five different types of price elasticity.

Here is an explanation of each of these types.

### Perfect Inelastic Supply

When the price elasticity of supply is zero, this indicates there is perfect inelasticity of supply.

The supply will remain the same at any price level.

### Relatively Inelastic Supply

If the supply of a good is relatively inelastic, the supply will change in response to a change in price, but by a smaller amount.

So, the price elasticity of supply will be less than one.

### Unitary Elastic Supply

Unitary elasticity of supply exists if the change in supply and the change in price are equal.

Therefore, the price elasticity, in this case, is one.

### Elastic

An elastic supply indicates that the change in supply is greater than the change in price.

So, the price elasticity of supply is greater than one.

### Perfectly Elastic Supply

When supply is perfectly elastic, a small decline in price will cause the quantity supplied to drop to zero, whereas a small increase in price will cause suppliers to be willing to supply unlimited quantities of a good.

## The Determinants of Price Elasticity of Supply

The price elasticity of supply measures the response of a producer in terms of supply to a change in price.

There are a number of factors that can affect this response, and here are some of these factors.

### Time Period

This is the amount of time it takes companies to adjust their production inputs as a result of changes in price.

This is not easy to do in a short period of time due to fixed inputs, such as capital.

Companies need to rely on variable inputs that are easier to adjust. Therefore, the price elasticity of supply is less elastic in the short run.

However, in the long run, companies can hire and train additional labor and obtain new capital, so the price elasticity of supply becomes more elastic.

### Mobility of Production Factors

The mobility of the factors of production refers to the ability to transfer resources between distinct production functions.

In other words, this generally means the ability to use a resource that is used in producing one product to produce another.

When factors of production are mobile, the production elasticity of supply is generally more elastic.

If these factors of production are mobile, it indicates that inputs, such as labor or other manufacturing inputs, can be easily moved from one production function to another.

This means that should demand for a company’s products sharply increase, it may be able to rapidly increase supply by transferring resources from the production of its other products.

### Barriers to Entry

In many markets, there are barriers to entry that can make it difficult for a new firm to enter.

These include high capital requirements, technological barriers, and legal factors, all of which can make it difficult or impossible for new firms to enter a market. When there are few barriers to entry, demand is typically more elastic because companies can enter and leave as prices fluctuate.

However, when barriers to entry are high, supply will generally be more inelastic because new businesses will have difficulty entering the market regardless of the change in price.

### The Type of Goods

The type of goods in question has a major impact on the elasticity of supply.

For example, durable goods generally have an inherently more elastic supply due to the ability to store them when prices fall.

In contrast, perishable goods cannot be stored for a significant time, meaning that their supply is relatively inelastic.

The level of difficulty in adding and removing production capacity has a major impact on the elasticity of supply.

The majority of manufactured products in the modern day are mass-produced, which means that they are produced in factories that, under most conditions, can be assumed to be operating at an optimum capacity.

This means that in order to add capacity in response to an increase in price, a new factory would need to be built.

This means that adjustments in supply in response to a change in price for these products are likely to be relatively slow.

This means that difficulty in adding capacity can have a major impact on the elasticity of supply for a product.

If it is relatively easy to add capacity for a product, the supply is more elastic, and for products where it is difficult to add capacity, it is less elastic.

## Significance of Elasticity of Supply

For businesses, it is important to have an understanding of the price elasticity of supply in order to ensure they are able to respond to increases and decreases in demand.

Suppliers of goods will try and make their supply more elastic in order to optimize their supply. In order to do this, they may consider:

• Paying workers overtime during periods of high demand
• Working with a temporary staffing agency during busy periods.
• Outsourcing production to other companies

However, it is important to balance the cost of these strategies against the potential benefits.

In some cases, it may cost more to increase the elasticity of supply than it is worth.

## FAQ

### What is price elasticity?

Elasticity of price refers to the responsiveness of the supply or demand for a good to a change in price. The more elastic a good is, the more supply and demand will respond to changes in price.

### Why does supply increase when price increases?

An increase in price acts as a signal for existing suppliers that the market wants more of a given product, which means that suppliers can spend more on production and sell more of the product for higher prices. In addition, a price increase will incentivize additional suppliers to enter the market in order to take advantage of the higher prices.

### What does perfectly inelastic mean?

A product has a perfectly inelastic supply or demand when a change in price does not have any impact on the quantity demanded or supplied. Perfect inelasticity primarily just exists in theory because few goods have a truly inelastic demand or supply; however, goods such as lifesaving medicines or raw materials are often used as examples of goods that are nearly perfectly inelastic.

## Conclusion

Higher prices act as a signal to suppliers to increase the supply of a given good or service.

These higher prices mean that more can be spent on scaling up production in order to sell more and earn higher profits.

However, supply for a given good or service may be more or less elastic, meaning that suppliers may not always be equally able to scale supply to changing prices.

This is what the price elasticity of supply measures, and it is a crucial concept for businesses to understand in order to maximize their ability to optimize their supply to take advantage of changes in the marketplace.

## Key Takeaways

• According to economic theory, if the price of a good increases, producers will increase their production of the good so as to sell more of the good at a higher price.
• Price elasticity of supply measures the responsiveness of the quantity a producer supplies of a good in response to a change in the price of the good.
• If producers do not keep up with increases in demand, prices might continue to increase if the quantity supplied does not meet demand.

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1. University of Minnesota "5.3 Price Elasticity of Supply" Page 1 . September 26, 2022

2. Fullerton College "PRICE ELASTICITY OF SUPPLY" Page 1 . September 26, 2022