Determinants of Price Elasticity of Supply

Like price elasticity of demand, price elasticity of supply is also dependent on many factors. Some of these factors are within the control of the organization whereas others may be beyond their control. Regardless of the control, if the management has knowledge about these factors, it can manage its supply better.

Here is a list of determinants which generally affect the price elasticity of supply in the market:

Capacity Addition: The theoretical model stated in the law of supply simply assumes that supply will be able to adjust up and down as and when the price changes. In doing so, the law of supply ignores the ground realities that are related with supply.

Consider for instance the fact that most manufactured goods today are mass produced in massive factories and most of these factories are working to their optimum levels. Hence, if supply has to be increased new capacity needs to be added i.e. new factories need to be built.

This obviously means that supply will remain stagnant for a while when capacity is stagnant and may then increase by leaps and bounds when additional capacity is introduced. This is an important determinant of elasticity of supply. Products where capacity can be easily added and reduced have an elastic supply whereas products where it is difficult to increase or decrease capacity have inelastic demand.

Related Infrastructure Growth: Industry is usually an interconnected supply chain. If one part of the supply chain grows, whereas the rest of the supply chain remains stagnant, the growth will be lopsided. This affects the elasticity of supply as well.

Consider the case of agriculture. Let’s assume that farmers have got hold of a revolutionary technique with which they can increase productivity two fold. However, more production would mean more warehouses, more cold storages and even more transport vehicles. If this related infrastructure does not grow, producers may have to willfully cut down their production to avoid wastage. So, if the related infrastructure is easily scalable, then the supply of such a product will be highly elastic or else it will be inelastic.

Perishable vs. Non Perishable: Storage capacity is not the only issue. The supplier also needs to consider whether or not the goods that they hold are perishable or not. Perishable goods have a limited shelf life and the buyers know it.

The buyers can wait for some time and producers will have to lower the prices or take the losses that arise from wastage. The supply of perishable goods is therefore highly elastic since whatever has been produced has to be disposed off at the earliest. However, when it comes to non perishable goods it has been observed that the supply is usually inelastic since producers can hold on for as long as they have to. They are under no immediate compulsion to sell and hence the supply is inelastic.

Length of Production Period: The law of supply assumes that changes in price will produce an immediate effect in the quantity supplied. This may be theoretically correct. However, this is not possible in reality for many products.

Production is a time and resource consuming process. Hence, it cannot be scaled up or down with that much ease. In many cases, the time required for production stretches to many months or even years. Hence, there is a lagging effect on supply. This is another important determinant of the elasticity of supply. Products whose production times take longer have relatively inelastic supply compared to those products where the production time is less.

Marginal Cost of Production: The law of supply also assumes that the profitability of the supplier does not change with the number of units sold. That is not the case. In reality, we have something called the economies of scale and diseconomies of scale. This influences the marginal cost of production.

Hence, it may sometimes make economic sense to sell more whereas at other times, it may make more economic sense to sell less! Because producers consider marginal cost of production while making their decisions, it has become an important determinant in the elasticity of supply.

Long Run vs. Short Run: In the short run, the supply of all products is more or less inelastic. This is because there are many factors which producers cannot vary in the short run. However, in the long run, all the factors are variable and hence the supply of all products is completely elastic. Hence companies must be careful while making capital decisions.

The above mentioned list of factors is not exhaustive. However, using the reasoning behind these factors one can easily come up with more and more factors that may determine the price elasticity of supply.

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Managerial Economics