This App will help you to avoid any unwanted slip-ups in the exam. Although most of the reminders are common sense, but from the evidence students still need reminding of them. Read through the tips and take note of the most relevant ones before tackling your exam.
Price Elasticity of Supply
These terms are used in exactly the same way as with demand elasticities. I will summarise their meanings with respect to supply in the following table:
|Value of the elasticity||Price rise or cut?||What will happen to the quantity supplied?|
|Es = 0||Price rise||The supply curve is vertical, so supply remains the same but with a higher price.|
|(Perfectly inelastic)||Price cut||The supply curve is vertical, so supply remains the same but with a lower price.|
|0 < Es < 1||Price rise||For a given rise in price, the rise in supply will be proportionately smaller than the rise in price.|
|(Relatively inelastic)||Price cut||For a given fall in price, the fall in supply will be proportionately smaller than the rise in price.|
|Price rise or a price cut||For a given change in price (up or down) the change in supply will be proportionately the same as the change in price.|
|1 < Es < ∞||Price rise||For a given rise in price, the rise in supply will be proportionately larger than the rise in price.|
|(Relatively elastic)||Price cut||For a given fall in price, the fall in supply will be proportionately larger than the fall in price.|
Again, I have missed out the case where the elasticity is infinite. As with demand, the curve is horizontal, implying that firms can supply as much as they want at a given price. Another way of looking at it is that if there is a change in price then the quantity supplied will fall to zero.
When we looked at the diagrams illustrating the elasticity of demand curves, the key point was how steep or flat the curve was (although it must be appreciated that the elasticity did change as one moved along the demand curve). With supply curves, the issue is not so much the gradient of the curve but whether it cuts the x-axis, the y-axis or the origin.
In the diagram above, S1 is quite a flat curve but S2 is fairly steep. But the gradient is not the issue. Both curves have an elasticity of less than one because they both cut the x-axis. The percentage change in quantity supplied has to be higher than the percentage change in price because one is working out the percentage change in quantity supplied from a higher initial figure.
You might expect the flatter curve to be relatively elastic. Looking at the move from point A to point B in the diagram, if the price rises from 1 to 2 (a 100% increase) this causes quantity supplied to rise from 10 to 12 (a 20% rise). This gives an elasticity of +0.2 (20 divided by 100), which is very inelastic.
The vertical curve S3 is perfectly inelastic in the same way that a vertical demand curve is perfectly inelastic.
In the diagram above, S5 is quite a flat curve but S4 is fairly steep. Again, the gradient is not the issue. Both curves have an elasticity of more than one because they both cut the y-axis. The percentage change in price has to be higher than the percentage change in quantity demanded because one is working out the percentage change in price from a higher initial figure.
You might expect the steeper curve to be relatively inelastic. Looking at the move from point C to point D in the diagram, if the price rises from 10 to 12 (a 20% increase) this causes quantity supplied to rise from 2 to 4 (a 100% rise). This gives an elasticity of +2.5 (50 divided by 20), which is very elastic.
The vertical curve S6 is perfectly elastic in the same way that a horizontal demand curve is perfectly elastic.
In the diagram above, all three curves go through the origin. Again, the gradient is not the issue. Whether the curve is steep, flattish or at an angle of 45 degrees, the percentage change in the quantity supplied will be exactly the same as the percentage change in price.
Look at the moves from point E to F and from point G to H. In both cases the price increases from 20 to 24 (a 20% increase). When moving from E to F, the quantity supplied rises from 10 to 12 (a 20% rise). When moving from G to H the quantity supplied rises from 20 to 24 (a 20% rise. In both cases the percentage change in quantity supplied is exactly the same as the percentage change in price. As with demand elasticities, this is known as unitary elasticity.
As with demand, there are numerous factors that will affect the value of the price elasticity of supply. Many of them are similar in nature to those used to explain the value of the price elasticity of demand.
Does the industry have spare capacity? During a recession, there tends to be more spare capacity in firms and industries. This means that firms have the ability to increase output; perhaps some of their machines are currently unused. In these situations, firms will be able to respond quickly to a rise in the price of their product and so supply will be relatively elastic. If the economy, or the firm in question, is close to full capacity, then they will not be able to respond so quickly to a price rise so the supply curve will be relatively inelastic.
Can the product be stored? Some goods can be kept as stock very easily. You have probably seen the pictures of the huge areas of parked new cars on TV whenever there is a feature about the declining car industry on the news. If a firm has the ability to stockpile the product in question, then it can respond quickly to a rise or a fall in price by simply running down or piling up its stocks. In this case supply would be relatively elastic. Firms that sell perishables, for example (like greengrocers), cannot store old produce, and so their ability to respond to changes in the price level is reduced. Their supply will be relatively inelastic on this count.
How long is the production process? Factories make cars very quickly nowadays with the production lines filled with robots. On the other hand, the length of time from the planting of the seed to the harvesting of the crop for most agricultural products is very long, relatively. The shorter the production period the more elastic supply will be as, again, the firm in question can respond more quickly to a change in the price level.
Can the firm produce substitutes easily? This is similar to the 'substitutes' factor in the 'determinant of the value of the elasticity of demand' section. The difference is that we are now dealing with substitute products that a firm can produce given the materials to hand, rather than substitute choices for the consumer to buy. Again, the magnitude of the elasticity of supply depends on the ability to respond quickly to price changes. If a firm is making cars, but the price of cars is falling relative to the price of motorbikes, then the firm may be tempted to stop making cars and start making motorbikes. The machines, workers and materials they have will be similar(ish!) to those required for motorbike making, so they should be able to respond quite quickly. If a farmer wanted to transfer to the production of motorbikes, he might find it a little bit more difficult!
What is the time period under consideration? We have touched on this before. The elasticity of supply will depend on whether the time period involved is immediate (or 'momentary'), relatively short (the 'short run') or relatively long (the 'long run'). The diagram below should help to explain:
S1 is a vertical, perfectly inelastic, supply curve. This represents 'momentary' supply. In most industries, if a firm was asked to produce a large order immediately, it simply would not be able to do it, regardless of the price offered for the order. Supply is perfectly inelastic in the very short run.
S2 is a fairly inelastic curve representing the short run. In the short run, a firm is able to vary some of its inputs (like labour and raw materials), but some of them will remain fixed (capital, in particular). The firm will be able to respond to a price change, but not to any great extent.
S3 is a relatively elastic supply curve representing the long run. In the long run, all factors of production are variable, so the firm can respond easily to a price change.
In all of the factors above, I have kept referring to a firm's ability to respond to a change in price. It is worth asking the question at this stage: 'what would cause the price to change if one assumes that the supply curve is given and fixed?' In the topic on 'supply and demand' we looked at shifts in demand and supply. If we have a fixed supply curve and the price has changed, the only explanation is that the demand curve has shifted. What I am trying to say, I suppose, is that whenever I refer to the firm's ability to respond to a change in price, I am, effectively, also referring to the firm's ability to respond to a change in demand.