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IB DP Economics Study Notes

2.6.2 Factors Affecting Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) gauges the degree to which the quantity supplied of a good or service responds to a change in its price. The elasticity of supply isn't constant; it varies based on several factors. This section will explore in depth the three primary determinants: the time period, the mobility of factors of production, and spare capacity. Additionally, understanding the non-price determinants of supply is crucial for a comprehensive grasp of factors affecting PES.

An image of determinants of price elasticity of supply

Time Period

The temporal aspect is pivotal in determining the PES for a product. The elasticity can differ significantly based on whether we're considering the short run or the long run. A detailed exploration of this can be found in the definition and calculation of Price Elasticity of Supply, which further explains the quantitative aspect of PES.

Short Run

  • Definition: The short run in economics refers to a time frame wherein at least one factor of production is fixed. This could be machinery, land, or any other resource that can't be quickly adjusted.
  • Implications for PES:
    • Due to these fixed factors, firms often find it challenging to drastically alter production levels in the short run.
    • Consequently, supply tends to be more inelastic during this period.
    • For instance, consider the dairy industry. If the price of milk rises suddenly, dairy farmers can't immediately increase their herd size overnight. It takes time to breed and raise additional cattle.

Long Run

  • Definition: The long run is a period wherein all factors of production are variable. Firms have the flexibility to adjust all resources over this time frame.
  • Implications for PES:
    • Given the flexibility, firms can modify their production levels more freely in response to price changes.
    • This makes supply more elastic in the long run.
    • Extending the dairy example: Over a more extended period, farmers can invest in more cattle, adopt advanced milking technologies, or even expand their farmland to accommodate more livestock. The applications of Price Elasticity of Supply delve deeper into how these adjustments impact supply elasticity over various time periods.

Mobility of Factors of Production

The ease with which resources used in production (like labour, land, and capital) can transition between different uses significantly affects the PES. The non-price determinants of demand also influence how these factors play out in market dynamics.

Labour Mobility

  • Definition: Labour mobility refers to the ability of workers to switch jobs, industries, or locations.
  • Implications for PES:
    • A high degree of labour mobility means that workers can quickly move to industries where they're most needed, allowing those industries to ramp up production in response to price increases.
    • For instance, during a construction boom, if bricklayers, electricians, and architects can easily transition from other sectors or regions, the construction industry's supply becomes more elastic.

Capital Mobility

  • Definition: This refers to the ease with which physical assets (like machinery) can be repurposed or moved to produce different goods.
  • Implications for PES:
    • If capital is highly mobile, industries can adjust their production levels more swiftly in response to price changes.
    • Consider a factory with machinery that can be easily reconfigured to produce different electronic items. If there's a sudden surge in demand for tablets over mobile phones, the factory can swiftly shift its production focus.

Land Mobility

  • Definition: While land itself is immobile, its purpose or use can change.
  • Implications for PES:
    • If land can be swiftly repurposed, it can influence the elasticity of supply for the products or services related to that land.
    • For instance, an urban plot used for parking can be transformed into a commercial building if the demand (and thus price) for commercial space rises.
IB Economics Tutor Tip: Understanding PES's determinants—time period, factor mobility, and spare capacity—is crucial for analysing market responses to price changes and strategic business planning.

Spare Capacity

Spare capacity is another crucial determinant of PES. It refers to any additional production capacity that a firm can utilise without significant new investments. The concept of income elasticity of demand (YED) can be complementary in understanding how consumer income levels can affect the demand side, which in turn influences supply decisions.

Presence of Spare Capacity

  • Definition: This refers to situations where firms have underutilised resources, be it machinery, workers, or infrastructure.
  • Implications for PES:
    • Having spare capacity allows firms to increase production without incurring significant additional costs.
    • This makes supply more elastic, as firms can rapidly respond to price changes.
    • For example, a car manufacturing plant operating at 70% capacity can increase its production levels quickly if there's a sudden spike in demand for cars.

Absence of Spare Capacity

  • Definition: This is when a firm is operating at or near its maximum capacity.
  • Implications for PES:
    • Without any spare capacity, it's challenging for firms to increase production in the short run without substantial investments.
    • This scenario renders the supply inelastic. Even if prices rise, the firm can't boost its supply without incurring significant costs, like setting up a new facility.
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A summary table of the determinants of PES.

IB Tutor Advice: For exams, illustrate your understanding of PES by citing real-world examples that demonstrate how time, factor mobility, and spare capacity influence supply elasticity in different industries.

In conclusion, understanding these determinants of PES is essential for predicting how supply might adjust to price changes. The time frame, the mobility of resources, and the presence or absence of spare capacity all play instrumental roles in shaping the elasticity of supply.

FAQ

The geographical distribution of factors of production can have a profound impact on their mobility and, subsequently, on PES. If factors of production, especially labour and capital, are concentrated in specific regions or locations, their mobility might be limited. For instance, if a particular region specialises in car manufacturing and has most of the country's skilled automobile workers, it might be challenging for a sudden boom in another industry, say electronics, to attract these workers quickly. This geographical concentration can make the supply inelastic. Conversely, a more even distribution of factors across regions can enhance mobility, allowing for a more elastic supply as industries can adjust more readily to price changes.

Government policies and regulations can either facilitate or hinder the mobility of factors of production. For instance, policies that promote education and training can enhance labour mobility by equipping workers with diverse skills, allowing them to transition between industries more easily. On the other hand, strict immigration policies might limit labour mobility by restricting the inflow of foreign workers. Similarly, regulations that impose heavy taxes or duties on the import and export of machinery can limit capital mobility. In essence, government interventions can play a decisive role in determining how easily factors of production can move, thereby influencing the PES.

Sunk costs refer to costs that have already been incurred and cannot be recovered. In the context of spare capacity and PES, if a firm has made significant sunk investments in machinery or infrastructure that is currently underutilised, it might be more inclined to ramp up production when prices rise. This is because the firm would want to utilise its existing resources to the fullest and recover its sunk costs. As a result, the presence of significant sunk costs can make the supply more elastic, as firms with spare capacity are more responsive to price changes, aiming to maximise their returns on previous investments.

Some industries might have a more elastic supply in the short run due to the nature of their production processes and the resources they utilise. For instance, service-based industries, like software development or consultancy, might have a more elastic supply because they can quickly adjust their output by hiring more staff or increasing working hours. On the other hand, industries that rely heavily on natural resources or have longer production cycles, like agriculture or mining, might have a more inelastic supply in the short run. This is because they can't instantly increase their output in response to price changes due to the time it takes to extract resources or grow crops.

Technological advancement can significantly enhance the mobility of capital, thereby influencing the Price Elasticity of Supply (PES). As technology progresses, machinery and equipment often become more versatile and adaptable. For instance, with advancements in manufacturing technology, a single piece of machinery might be reconfigured to produce a variety of products. This adaptability means that capital (in this case, machinery) can be swiftly repurposed in response to market demands. As a result, the supply can adjust more rapidly to price changes, making it more elastic. In essence, technological progress can make capital more mobile, allowing producers to respond more flexibly to market conditions and thus influencing PES.

Practice Questions

Explain how the mobility of factors of production can influence the Price Elasticity of Supply (PES) for a product.

The mobility of factors of production plays a pivotal role in determining the Price Elasticity of Supply (PES) for a product. If factors such as labour and capital are highly mobile, it means they can be easily reallocated or repurposed across different sectors or regions. For instance, if workers can swiftly transition between industries, or if machinery can be readily adapted to produce various goods, then supply can adjust more quickly to price changes. This increased adaptability makes the supply more elastic. Conversely, if there's limited mobility, it restricts the ability of producers to adjust supply in response to price changes, leading to a more inelastic supply.

How does the presence or absence of spare capacity impact the PES in the short run?

The presence or absence of spare capacity significantly impacts the Price Elasticity of Supply (PES) in the short run. If a firm has spare capacity, meaning it has underutilised resources such as machinery or labour, it can quickly ramp up production in response to a price increase without incurring substantial additional costs. This ability to adjust production swiftly makes the supply more elastic. On the other hand, if a firm is operating at its maximum capacity, it will find it challenging to increase production immediately. As a result, even if prices rise, the firm's supply remains relatively unresponsive, rendering it inelastic in the short run.

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