Price Elasticity of Supply

Just like the law of demand, the law of supply also explains the qualitative relationship between price and supply. Qualitative relationships do not reveal the complete picture. For instance, it helps only up to a certain point to know that the quantity supplied as well as price move in the same direction. However, this is incomplete information. Economists and decision makers needed to know the magnitude of this movement. It is for this reason that they created this concept of price elasticity of supply.

In a way, the concept of price elasticity of supply is a mirror image of the concept of price elasticity of demand. There are however, some minor differences which will be discussed in this article. The elasticity of supply is based on the seller’s willingness to change the quantity supplied at different prices. In this article, we will look at this concept of elasticity of supply in a little bit more detail:

Concept: The definition of price elasticity of supply is as follows:

The measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as a percentage change in quantity supplied divided by the percentage change in price.

In simpler words, the idea is to look at how many percentage points does the supply change if the price changes by 1%. Based on the law of supply it is assumed that the change will always be in the same direction i.e. if price moves upwards, so does the quantity supplied and vice versa.

Calculation:

From the definition discussed above, we can derive the formula for price elasticity of demand as follows:

Price Elasticity of Supply = Percentage Change in Quantity Supplied / Percentage Change in Prices

= (Q2-Q1) / Q1 * 100 / (P2-P1) / P1 * 100

Let’s consider an example for better understanding. Let’s say that for a given product X, the price earlier was $2 and the units supplied were 400. Now, the price increased to $2.5 and the units supplied have changed to 600. In this case, the calculation will be as follows:

= (600 - 400) / 400 * 100 / ($2.5 - $2) / $2 * 100

= 50% / 25%

= 2

In this case the interpretation is that a 1% change in price will lead to a 2% change in the quantity supplied. As we can see here, that the elasticity of supply could range anywhere between negative infinity to positive infinity. However in 95% of the cases, it will be restricted from negative 10 to positive 10.

In many markets as well as well as industries, the idea that the elasticity of supply remains the same across the supply curve is not well received. There are economists who believe that suppliers react more to price changes when they first happen and when they happen in large magnitudes. Hence, in these cases elasticity may be computed at multiple points on the same curve to receive different elasticity numbers.

In fact, the concept of elasticity has a major correlation with the shape of the supply curve. However, discussing the same is beyond the scope of this article.

Only One Type: The price elasticity of supply looks at the market from the point of view of the supplier. Hence, in almost all cases it is only sensitive to prices. It is not affected by factors such as income levels of suppliers. Hence, we do not have such a concept as income elasticity of supply. Also, the supply of one product is less likely to interfere in the quantity supplied of another product. Hence, cross elasticity of supply is also not much of a consideration. Hence, unlike elasticity of demand where there are different types possible, the elasticity of supply is more or less based on a single type.


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Managerial Economics