Price elasticity of supply(PES) changes the emphasis of elasticity away from the consumer to the producer. PES is the measurement of how producer supply responds to changes in the price of the product they sell. The value of the PES in a market is determined by the willingness and ability of producers in the market to change output in response to a change in price.

Definition and measurement of price elasticity of supply

Price elasticity of supply is the responsiveness of quantity supplied of a good to a change in its price. It is measured by the equation:

% change in Qs / % change P = PES

For example, if the price of strawberries increases from $2 per kg to $3 per kg (50 per cent increase) and quantity supplied increases from 400,000 kgs to 500,000 kgs (25 per cent increase).  This is shown in diagram 2.25 and is calculated as:

+25% QS / +50% P = +0.5

Interpretation

The value of PES is normally positive because of the law of supply. In the strawberry market example, the PES value of +0.5 means that for every 1 per cent increase in the price of strawberries, the quantity supplied increases by 0.5 per cent.

Price elastic supply

If the value is greater than 1 then the good’s supply is price elastic.  This means a change in price leads to a proportionately greater change in quantity supplied. If, for example, a 10 per cent increase in the price of hairdresser haircuts leads to a 15 per cent increase in the supply of hairdresser services, the PES would be:

+15% QS / +10% P = +1.5 PES

This means for every 1 per cent increase in the price of haircuts quantity supplied increases by 1.5 per cent.

This is a price elastic relationship because the proportionate change in quantity supplied is greater than the proportionate change in price. This is shown in diagram 2.26. Theoretically, the supply curve can be perfectly horizontal or perfectly elastic. This gives a PES of infinity. 

Unitary elasticity of supply

If the value is 1 then PES is unitary. This means that for every 1 per cent change in price, quantity supplied changes by 1%. In reality, it is unlikely a good will have a PES of 1, but the value could be close to 1. Any straight-line supply curve that passes through the origin has a PES value of 1.

Price inelastic supply

If the supply of a good has a PES of less than 1 then its supply is price inelastic.  This means that a change in the price of a good leads to a less than proportionate change in quantity supplied.  For example, in diagram 2.26(1) the price of cement rises from $200 per unit to $300 and quantity supplied increases from 15m units to 18m units supplied then the PES of cement is calculated as:

+20% QS / +50% P = 0.4 PES

This means for every 1 per cent increase in the price of cement quantity supplied increases by 0.4 per cent. This is a price inelastic relationship because the proportionate change in quantity supplied is less than the proportionate change in price.

Theoretically, the supply curve can be perfectly vertical or perfectly inelastic. This gives a PES value of 0. 

Determinants of price elasticity of supply

Time

In the short run, the supply of a good tends to be inelastic. This is because producers find it difficult to increase output when the factors of production used to produce the good are difficult to change quickly when price changes. Over time, producers find it easier to respond to an increase in price because they can change the factors of production used to increase output, and supply becomes more price elastic. This is shown in diagram 2.27.

If, for example, a house-builder knows that the price of new houses is increasing at an annual rate of 10 per cent then they can plan to build new houses, but it will be several months or even years before they can complete construction and increase supply. Diagram 2.27 shows an increase in quantity supplied in the short run of 5,000 houses or 5 per cent which is a PES of:

+5% / +10% = 0.5 PES

In the long run, the quantity supplied of housing increases by 20,000 houses or 20 per cent which is a PES of:

+20% / +10% = 2 PES

In the long run, the supply of new houses has become more price elastic.

Availability of factors of production

The easier it is for producers to access factors of production, the more elastic PES tends to be. Roadside car cleaning businesses are generally quick to set up and operate because the land, labour and capital needed to clean cars are relatively accessible.

On the other hand, electricity supply through power stations has an inelastic PES because the resources needed to set up and operate a power station are more difficult to access. Where resources are relatively difficult to access, costs tend to rise quickly when producers try to increase output, and this will make the supply of electricity relatively inelastic.

Stock and used capacity

Where producers have spare capacity and available stock, supply tends to be relatively price elastic. For example, in a recession, a car manufacturer may have plenty of spare capacity in production and a high level of unsold stock because of low demand for cars. If the price of cars increases the car manufacturer can increase supply by utilising unused production facilities and selling available stock which makes the supply of cars price elastic.

Application of price elasticity of supply (HL only)

Commodities

The supply of primary commodities tends to be relatively inelastic because it is difficult for producers to respond to a change in price.  The supply of the agricultural sector, for example, is limited by the growing seasons of farmers. If a coffee producer plants a coffee bush it takes 3 to 4 years before it can be harvested and coffee plants can only be harvested twice a year. This makes the supply of coffee relatively price inelastic.

Manufactured goods

The supply of manufactured goods is more price elastic in comparison to primary products because producers can change supply in response to a change in price more quickly. This is because manufacturers are not limited by growing seasons. Assuming a manufacturer of smartphones has spare capacity, they can increase supply almost immediately if there is a price increase. Manufactured goods can also be stored more easily than agricultural goods which tend to be perishable.  If manufacturers hold a stock of goods then they can respond to an increase in price by releasing that stock onto the market. Similarly, if the price of a manufactured good decreases producers can hold their output in stock and relatively easily decrease quantity supplied.