Price Elasticity of Supply (PES) measures how responsive the quantity supplied of a good or service is to changes in its price, assuming all other factors remain constant.
What is price elasticity of supply?
Price elasticity of supply is an essential concept in economics that helps explain how suppliers react to changes in market prices. It tells us how much more or less producers are willing and able to supply when the selling price changes.
Definition: Price elasticity of supply (PES) is the measure of the responsiveness of the quantity supplied of a good or service to a change in its price.
The supply of a product is said to be elastic if a small change in price leads to a significant change in quantity supplied.
Conversely, supply is considered inelastic if even a large change in price causes only a small change in the quantity supplied.
The value of PES is always positive due to the law of supply: higher prices incentivise more production, while lower prices discourage it. However, the degree of responsiveness varies across different products and industries, making PES a useful tool for economic analysis.
How to calculate PES
PES is calculated using the following formula:
PES = (Percentage change in quantity supplied) ÷ (Percentage change in price)
This formula provides a numerical value that reflects how sensitive supply is to changes in price.
Example calculation
Imagine a scenario where the price of coffee increases from £4 to £5 per cup (a 25% increase), and the quantity supplied rises from 1000 cups to 1200 cups per day (a 20% increase). The calculation would be:
PES = (20 ÷ 25) = 0.8
This indicates that supply is relatively inelastic since the PES value is less than 1.
To calculate percentage changes, students should use the midpoint (arc) method to ensure consistent results:
Percentage change in quantity = [(New Quantity - Original Quantity) ÷ (Average Quantity)] × 100
Percentage change in price = [(New Price - Original Price) ÷ (Average Price)] × 100
Where:
Average Quantity = (New Quantity + Original Quantity) ÷ 2
Average Price = (New Price + Original Price) ÷ 2
Using the midpoint method helps avoid bias caused by the direction of the change and provides a more accurate measure of elasticity.
Interpreting PES values
The numerical value of PES gives insight into the flexibility of supply in a market. Each range of values has a specific interpretation, indicating different levels of responsiveness:
Perfectly inelastic supply (PES = 0)
Quantity supplied does not change at all, regardless of price.
Represented by a vertical supply curve.
Example: A fixed number of seats in a stadium. No matter how high the price goes, the number of seats available stays the same.
Relatively inelastic supply (0 < PES < 1)
Quantity supplied changes less than proportionally to a change in price.
Supply is not very responsive.
Common for goods that require significant time or resources to increase output, such as seasonal agricultural products.
Unitary elastic supply (PES = 1)
Quantity supplied changes exactly proportionally to the change in price.
A 10% increase in price leads to a 10% increase in quantity supplied.
Graphically represented by a supply curve with a constant slope through the origin.
Relatively elastic supply (PES > 1)
Quantity supplied changes more than proportionally to the change in price.
Firms can increase supply quickly and easily.
Example: A t-shirt manufacturer with spare capacity can easily respond to price increases by producing more.
Perfectly elastic supply (PES = ∞)
Suppliers are willing to supply any quantity at a specific price, but none at a lower or higher price.
Represented by a horizontal supply curve.
Theoretical scenario often associated with perfectly competitive markets, where firms are price takers.
Factors affecting PES
The responsiveness of supply to changes in price is influenced by a variety of factors. These affect how quickly and efficiently producers can adjust output levels.
1. Time period (short run vs long run)
Time is a crucial determinant of PES. The longer the time period a firm has to adjust production, the more elastic supply becomes.
Short run: At least one factor of production is fixed. Firms may face constraints such as limited factory space or labour availability. Supply tends to be more inelastic because output cannot easily be increased.
Long run: All factors of production are variable. Firms can build new facilities, hire more workers, or adopt new technology. Supply is more elastic, as firms have time to react to price changes.
Example: A car manufacturer cannot immediately expand output when car prices rise due to limitations in capacity and resource availability. Over time, however, the firm can invest in new factories and equipment, making supply more elastic in the long run.
2. Spare capacity
Firms operating below their full production capacity can increase output quickly when prices rise.
More spare capacity = more elastic supply.
If factories are already working at full capacity, the firm cannot produce more without major investment, leading to inelastic supply.
Example: A bakery with idle ovens and staff can bake more bread as prices rise, showing high elasticity.
3. Availability of factors of production
The ease of acquiring additional inputs like labour, land, and capital affects PES.
If skilled workers, raw materials, or machinery are readily available, firms can scale production quickly.
When factors are scarce or specialised, increasing output becomes difficult, and supply is inelastic.
Example: A diamond miner cannot easily find and extract more diamonds, as they are rare and mining is capital intensive. This limits supply elasticity.
4. Ability to store stock
Goods that can be stored without significant loss of value enable firms to respond to price rises by releasing existing stock into the market.
This makes supply more elastic.
Perishable goods, or products that degrade quickly (like fresh milk or electricity), are difficult to store, resulting in inelastic supply.
Example: A firm selling mobile phones can keep stock in warehouses and release it during high-demand periods, leading to high PES.
5. Flexibility of production
The greater the ability to switch between different products or adjust production levels, the more flexible a firm’s production is.
Flexible firms are better able to respond to price changes, increasing PES.
Firms with rigid production processes or heavy investment in specific technologies have low flexibility and hence inelastic supply.
Example: A clothing manufacturer can quickly shift production from shirts to trousers if demand and prices change, whereas a nuclear power station cannot change its output rapidly.
The importance of time in determining PES
The time dimension plays a central role in determining the elasticity of supply. The difference between the short run and long run influences how firms respond to changes in market conditions.
Short run: supply is inelastic
In the short run, production inputs such as capital and labour are fixed or limited.
Firms face capacity constraints and cannot easily expand production.
Supply cannot respond quickly, even if prices increase.
The PES value is low in the short run, often close to zero.
Example: A farmer cannot instantly increase the wheat harvest after a price rise because planting and growing require time. The farmer must wait for the next planting season to increase output.
Long run: supply becomes elastic
Over time, firms have more flexibility to adjust inputs and invest in additional resources.
New firms may enter the market, increasing the total supply.
Existing firms can expand operations, adopt new technologies, and train or hire more workers.
As a result, PES is higher in the long run.
Example: A technology company can build new assembly lines or outsource production to meet rising demand for smartphones over a longer period.
The greater the time available for producers to respond, the more elastic the supply tends to be. This distinction is crucial when evaluating policy impacts, supply shocks, and market dynamics.
Real-world applications of PES
Understanding PES is valuable for several reasons:
Business decisions: Firms can make informed decisions about pricing, investment, and production planning by estimating how quickly they can respond to changes in price.
Government policy: When imposing taxes or subsidies, the government must consider PES. If supply is inelastic, a tax may not significantly reduce quantity supplied but will affect prices and revenue. If supply is elastic, subsidies may lead to substantial increases in output.
Market forecasting: Analysts use PES to anticipate how markets will react to changes in demand, costs, or government intervention.
For instance, in housing markets, the low elasticity of supply in many urban areas contributes to rapidly rising prices when demand increases, as construction cannot keep pace.
FAQ
Agricultural goods typically have a more inelastic supply compared to manufactured goods due to several physical and biological limitations. In agriculture, production is heavily dependent on natural conditions, such as weather, soil quality, and seasons. Farmers cannot instantly increase output in response to price changes because growing crops or raising livestock takes time, often months. Inputs like land are also fixed in the short run, limiting capacity to expand. Additionally, perishable nature of produce reduces the ability to store and delay supply. In contrast, manufactured goods are usually produced in controlled environments, allowing firms greater flexibility to adjust output levels quickly. Production lines can often operate longer hours or be scaled up with additional workers or shifts. Materials and inputs for manufacturing are also more easily acquired, stored, and substituted, making supply more elastic. Therefore, differences in production flexibility, time lags, and perishability explain why agricultural supply tends to be less responsive than manufacturing supply.
The price elasticity of supply plays a crucial role in determining how effectively producers respond to sudden demand shocks. If PES is elastic, producers can swiftly increase output in response to higher demand without causing a dramatic rise in price. This helps maintain market stability, as quantity adjusts rather than just price. For example, in a market with flexible manufacturing, a surge in demand can be met with extra production shifts, leading to only a modest price increase. However, if PES is inelastic, supply cannot adjust quickly, leading to a sharp rise in prices and only a minor increase in quantity supplied. This is particularly true in industries with fixed resources or slow production cycles, such as housing or agriculture. In such cases, the inability to meet demand can result in overheating of the market, potential shortages, and increased volatility. Thus, the elasticity of supply determines whether a market reacts to demand changes through price adjustments, quantity changes, or both.
Yes, technological advances often increase the price elasticity of supply by improving production efficiency and flexibility. When firms adopt modern technologies—such as automation, computerised inventory systems, or just-in-time production—they can scale output more quickly and with lower marginal costs. This responsiveness allows them to adjust supply levels promptly in reaction to price changes. For instance, a car manufacturer with robotic assembly lines can quickly ramp up or scale down production, depending on market signals. Additionally, technologies that enhance communication and logistics, such as supply chain management software or real-time demand forecasting, help firms allocate resources more effectively, reducing lead times. This improved responsiveness leads to a flatter supply curve, representing greater elasticity. Even in industries traditionally seen as inelastic, such as agriculture, innovations like genetically modified crops or precision farming can increase responsiveness. In essence, technological progress reduces constraints on production, storage, and distribution, making supply more adaptable and elastic over time.
Understanding PES is essential for policymakers because it influences the effectiveness and distributional impact of indirect taxes and subsidies. When the supply of a good is inelastic, producers cannot easily adjust quantity in response to the policy. In such cases, an indirect tax (like VAT or excise duty) tends to lead to higher prices for consumers, as suppliers pass on most of the tax burden. On the other hand, if supply is elastic, producers can reduce output or shift resources, meaning they may absorb more of the tax, and prices rise less. With subsidies, the opposite applies. If supply is elastic, the subsidy leads to a significant increase in output and a noticeable reduction in price for consumers, amplifying the policy's intended effect. However, if supply is inelastic, the subsidy mainly benefits producers, with little expansion in output. Therefore, knowledge of PES helps governments predict outcomes and design tax/subsidy policies that are both efficient and equitable.
PES varies significantly across different labour markets based on factors such as skill level, training time, mobility, and regulatory barriers. In low-skilled labour markets, supply tends to be more elastic because workers can be recruited and trained relatively quickly, and the job requirements are less specialised. For example, firms hiring warehouse staff can often adjust employment levels in response to wage changes with little delay. In contrast, high-skilled or professional labour markets (e.g., doctors, engineers) usually have inelastic supply in the short term due to long training periods, certification requirements, and lower labour mobility. A wage increase may not immediately result in more qualified professionals entering the workforce, as the training pipeline can take years. Furthermore, legal and institutional constraints, such as work permits and licensing, may limit labour flow across regions or countries. Therefore, PES in labour markets depends heavily on how quickly and easily firms can recruit suitable workers in response to wage or demand changes.
Practice Questions
Explain two factors that influence the price elasticity of supply (PES) of a product.
The price elasticity of supply is influenced by the availability of spare capacity and the time period. If a firm has significant spare capacity, it can quickly increase output when prices rise, making supply more elastic. For example, a factory with unused machinery and labour can easily ramp up production. Additionally, time is crucial: in the short run, firms face constraints due to fixed resources, leading to inelastic supply. However, in the long run, firms can invest in new resources and adjust production methods, making supply more elastic as they are better able to respond to price changes.
With reference to a diagram, explain how the elasticity of supply affects the impact of a subsidy on producers.
When supply is elastic, a subsidy leads to a larger increase in quantity supplied, as producers can easily expand output. In this case, producers benefit more because they can increase sales significantly and gain higher total revenue. Conversely, if supply is inelastic, the quantity supplied increases only slightly, limiting the benefit producers receive. Although they still gain from higher prices or reduced costs, the extent of gain is less than under elastic conditions. A diagram would show a larger horizontal shift in quantity when supply is elastic, compared to a smaller shift with a steeper supply curve when it is inelastic.
