Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in price. It is necessary for a firm to know how quickly, and effectively, it can respond to changing market conditions, especially to price changes. The following equation can be used to calculate PES.
= ((New Quantity Supplied – Old Quantity Supplied)/(Old Quantity Supplied)) / ((New Price – Old Price)/(Old Price))
Determinants of Price Elasticity of Supply
Over time price elasticity of supply tends to become more elastic, which means that producers would increase the quantity supplied by a larger percentage than an increase in price.
2. Number of Firms
The larger the number of firms, the more likely the supply is elastic. This is because other firms can jump in to fill in the void in supply.
3. The Mobility of Factors of Production
If factors of production are mobile, then the price elasticity of supply tends to be more elastic. This means labor and other manufacturing inputs can be brought in from other location to increase capacity quickly.
4. The Level of Stocks
If a firm has unused raw materials , components and finished products that are available for use, then the form is more able to respond quickly to a change in price as it can supply these stocks to the market.
5. Agricultural / Industrial Products
In agriculture, time is required to increase output in response to rise in prices of goods. The supply of agricultural goods is fairly inelastic. As regards the supply of manufactured consumer goods, it is comparatively easy to increase production in a short period.
Types of Price Elasticity of Supply
Perfectly Inelastic Supply
(PES = 0), The Quantity Supplied doesn’t change as the price changes.
Relatively Inelastic Supply
(0 < PES < 1), Quantity Supplied changes by a lower percentage than a percentage change in price.
Unitary Elastic Supply
(PES = 1), Quantity Supplied changes by the same percentage as the change in price.
Relatively Elastic Supply
(1 < PES < ∞), The Quantity Supplied changes by a larger percentage than the percentage change in price.
Perfectly Elastic Supply
(PES = ∞), Suppliers will be willing and able to supply any amount at a given price but none at a different price.
Significance of PES for decision makers
The knowledge of PES helps to make firm more competitive and therefore generate more sales revenue and profits. Firms can become more responsive to changes in market price in several ways which includes the following:
- keeping large inventories
- improving storage systems
- improving distribution systems
- developing and training employees to boost labour occupational mobility.
- creating spare capacity
The government might also be interested in PES in labour markets as it helps explain difference in wages. Government may seek to encourage an inflow of migrant workers to help relieve shortage of labour and improve the PES in the labour market.