Price Elasticity of Supply

Introduction

The price elasticity of supply is a determinant of the flexibility of organizations in production in the case of a price rise of their products in the market. The price elastic supply is responsive to price increases and it is an ideal status for organizations that compete for profit in the free market.

What is Price Elasticity of Supply?

Price elasticity of supply refers to the responsiveness to the supply of a good due to the changes in its market price. According to the law of supply, the supply of a commodity increases with the increase in its price. Therefore, the price elasticity of a commodity refers to the percentage change in the responsiveness in supply when a given percentage change is applied to the price.

A commodity is elastic when its supply responsiveness is quick and palpable. In contrast, the commodity which does not respond palpably in terms of supply due to a price change is termed to be inelastic. Depending on the amount of responsiveness in supply, commodities can be divided into various segments from perfectly elastic to perfectly inelastic.

$$\mathrm{The\: Price\: Elasticity\: is\: calculated\: as\:=\:\frac{Percentage\: change\: in \:supply}{percentage\: change \:in\: price}}$$

In other words, price elasticity measures the producer’s ability to change production parameters depending on the price changes in the market. If a producer is quick enough to increase production and supply when the price of a commodity it produces or sells goes up, it is said to be quite a price elastic.

On the other hand, if the producer responds to a price rise of a commodity slowly, it is termed less price elastic. If no action is taken by producers even when there is a price rise in the product it produces, then the producer is termed price inelastic.

Price Elasticity of Supply Formula

It is simple to calculate the price elasticity of supply. As mentioned above,

$$\mathrm{Price\: Elasticity\:=\:\frac{Percentage\: change\: in \:supply}{percentage\: change \:in\: price}}$$

For example, let's consider a farmer who grows wheat. If the demand for wheat goes up in the market by 50% and the farmer increases production by 50%, then the price elasticity of the farmer is 1. However, if the price of wheat goes up by 50% and the farmer increases the supply by 25%, the price elasticity will be (25/50) = 0.5

So, we can infer that in the case of inelastic supply the change in price causes a smaller change in the supply of a product. In the case of elastic supply, the increment in prices leads to a larger proportional change in the supply of the product. In simpler terms, the more production increase a producer makes in proportion to a given price change, the more is its price elasticity.

The Law of Supply

Like many other concepts in microeconomics, the concept of price elasticity is related to the law of supply. The law states that when all other factors are kept constant, the products the price of which increases in the market, the supply of that product is also increased by the producers.

Producers and entrepreneurs in a free market usually fight for profitability. The more profit a product tends to bring, the more is its production by the producers.

For example, if the prices of oranges grow more than bananas, the producers of bananas will shift their focus from bananas to oranges and produce more oranges than bananas.

Price elasticity is, therefore, directly associated with the law of supply. As the percentage change in supply is proportional to the percentage change in the price of a good or commodity, we can infer from the law of supply that products will be elastic or inelastic depending on their choice to respond to the price changes in the market of a commodity.

Types of Price Elasticity of Supply

Depending on the responsiveness of production and supply for an increase in prices of a commodity in the market, there are five types of price elasticity of supply.

These are the following −

Perfectly Inelastic

When the value of Price Elasticity is zero, the supply is termed to be perfectly inelastic. Here, there is no change in supply even when there is an increase in the price of the product.

Examples of perfectly inelastic supply include artworks from deceased artists and the number of bitcoins. Both of these cannot exceed a certain limit. The deceased artist cannot produce art and no more bitcoins can be generated after it reaches its limits even if there is a price rise of these products in the market.

Relatively Inelastic

When the value of Price Elasticity is between zero and one, the elasticity is termed to be relatively inelastic. In such cases, the supply of products is slower in comparison to the price rise of the product.

One example of a relatively inelastic supply is the construction of nuclear power plants which takes enough time in comparison to the energy demands.

Unitary Elastic Supply− In the case of unitary elastic supply, the change in supply is directly proportional to the change in price. In other words, the PE value for unitary elastic supply is one.

The example of the farmer who grows cotton and increases the supply by 10% when there is a rise in the price of cotton by 10% is an example of a unitary elastic supply.

Relatively Elastic Supply

In this case, the price elasticity of supply is more than one. This means that producing and supplying the products, in this case, is relatively easier and more prompt than usual.

An example of a relatively elastic supply would include the production of toys. The manufacturers can increase the production of toys within a short span of time when the price rises in the market.

Perfectly Elastic Supply

In perfectly elastic supply the supply of products for a given price rise is infinite but it cannot be applied to any other price rise. It is practically impossible to cite an example of a perfectly elastic supply where even a small price rise would negate the possibility of increasing the supply from the end of the producer.

Conclusion

As production must coincide with supply for profitability and growth, the price elasticity of supply concept helps economists to classify the organizations in terms of their ability to respond to price changes. More flexible organizations are usually more profitable in the long run.

Price elasticity also makes organizations ready for the future. As organizations make themselves more flexible, they organize their organizational framework to suit the needs of the times yet to come. Therefore, when the price of the product rises, it can respond readily and more flexibly to earn more profit and revenue.

FAQs

Qns 1. On which law is the price elasticity of supply based?

Ans. The price elasticity of supply is based on the law of supply which states that with an increase in price, the supply of products increases proportionally too.

Qns 2. Which type of price elastic supply is impossible to get in practice?

Ans. The perfectly elastic price elasticity is impossible to obtain because it proposes that even a small increase in price would lead to an infinite increase in production.

Qns 3. Why is the price elasticity of supply always a positive number?

Ans. The positive number means that there is a direct and proportional relationship between the supply and the price of a good or service.