Understanding Price Elasticity of Supply

Oct 23, 2024

Price Elasticity of Supply (PS)

Introduction

  • PS measures the responsiveness of quantity supplied to changes in price.
  • Equation: Similar to Price Elasticity of Demand (PD), but focuses on supply:
    • PS = (% change in quantity supplied) / (% change in price)
  • Remember: "Cube before you P" - Calculate quantity change before price change.

Calculating Percentage Change

  • Formula: (Difference between two numbers / Original number) × 100

Law of Supply

  • PS will always result in a positive number due to the law of supply:
    • Price increase leads to quantity supplied increase (both positive).
    • Price decrease leads to quantity supplied decrease (both negative).
  • Positive sign is irrelevant; focus on the magnitude.

Interpretation of Elasticity

  • PS > 1: Supply is price elastic (quantity supplied changes more than price).
  • PS < 1: Supply is price inelastic (quantity supplied changes less than price).
  • PS = 0: Perfectly price inelastic (quantity supplied does not change).
  • PS = ∞: Perfectly price elastic (quantity supplied changes infinitely).
  • PS = 1: Unit price elastic.

Example Calculation

  • Example: Oil price increases from £40 to £60.
    • Price change: (20/40) × 100 = 50%
    • Quantity change: (30/150) × 100 = 20%
    • PS = 0.4 (price inelastic)
    • Interpretation: Quantity supplied increases less than price.

Supply Curves

  • Price Inelastic Supply: Steep curve (small change in quantity supplied).
  • Price Elastic Supply: Shallow curve (large change in quantity supplied).
  • Perfectly Inelastic: Vertical line.
  • Perfectly Elastic: Horizontal line.

Determinants of Price Elasticity of Supply

  • Production Lag: Longer lag = more inelastic.
  • Stock Levels: Higher stocks = more elastic.
  • Spare Capacity: More capacity = more elastic.
  • Substitutability of Factors: More substitutable = more elastic.
  • Time Period: Short-run = inelastic; long-run = elastic.

Remembering Determinants

  • Memory aid: Sound of opening a can of Coke/Pepsi (3 S's).
    • P: Production Lag
    • S: Stocks
    • S: Spare Capacity
    • S: Substitutability of Factors
    • T: Time Period

Conclusion

  • Understanding PS involves grasping both the concept and calculation.
  • It is crucial to use appropriate terminology and interpretations when discussing PS.