Elasticity of Supply

Some companies are more sensitive toward price changes in terms of the quantity they produce, whereas other companies are not as sensitive. A price change can cause companies to increase or decrease the number of goods they supply. The elasticity of supply measures the response of firms to price changes. 

Elasticity of Supply Elasticity of Supply

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    What is the elasticity of supply, and how does it affect production? Why are some products more elastic than others? Most importantly, what does it mean to be elastic?

    Why don't you read on and find out all there is to know about the elasticity of supply?

    The Elasticity of Supply Definition

    The elasticity of supply definition is based on the law of supply, which states that the number of goods and services supplied will usually change when prices change.

    The law of supply states that when there is an increase in the price of a good or service, the supply for that good will increase. On the other hand, when there is a decrease in the price of a good or service, the quantity of that good will decrease.

    But how much will the quantity of a good or service decrease when there is a price decrease? What about when there is a price increase?

    The elasticity of supply measures how much the quantity supplied of a good or service changes when there is a price change.

    The amount by which the quantity supplied increases or decreases with a price change depends on how elastic the supply of a good is.

    • When there is a change in price and firms respond with a slight change in the quantity supplied, then the supply for that good is quite inelastic.
    • However, when there is a change in price, which leads to a more significant change in quantity supplied, the supply for that good is quite elastic.

    The ability of suppliers to alter the quantity of a good they produce directly impacts the degree to which the quantity supplied can change in response to a change in price.

    Think about a construction company that builds houses. When there is a sudden increase in the housing price, the number of homes built does not increase as much. That's because construction companies need to hire additional workers and invest in more capital, making it harder to respond to the price increase.

    Although the construction company can't start building a significant number of houses in response to the price increase in the short run, in the long run, constructing houses is more flexible. The company can invest in more capital, employ more labor, etc.

    Time has a strong influence on the elasticity of supply. In the long run, the supply of a good or service is more elastic than in the short run.

    Formula for Elasticity of Supply

    The formula for elasticity of supply is as follows.

    \(\hbox{Price elasticity of Supply}=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\)

    The elasticity of supply is computed as the percentage change in quantity supplied divided by the percentage change in price. The formula shows how much a change in price changes the quantity supplied.

    Elasticity of Supply Example

    As an example of elasticity of supply, let's assume that the price of a chocolate bar increases from $1 to $1.30. In response to the price increase of the chocolate bar, firms increased the number of chocolate bars produced from 100,000 to 160,000.

    To calculate the price elasticity of supply for chocolate bars, let's first calculate the percentage change in price.

    \( \%\Delta\hbox{Price} = \frac{1.30 - 1}{1} = \frac{0.30}{1}= 30\%\)

    Now let's calculate the percentage change in quantity supplied.

    \( \%\Delta\hbox{Quantity} = \frac{160,000-100,000}{100,000} = \frac{60,000}{100,000} = 60\% \)

    Using the formula

    \(\hbox{Price elasticity of Supply}=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\) we can calculate the price elasticity of supply for chocolate bars.

    \(\hbox{Price elasticity of Supply}=\frac{60\%}{30\%}= 2\)

    As the price elasticity of supply equals 2, it means that a change in the price of chocolate bars changes the quantity supplied for chocolate bars by twice as much.

    Types of Supply Elasticity

    There are five main types of supply elasticity: perfectly elastic supply, elastic supply, unit elastic supply, inelastic supply, and perfectly inelastic supply.

    Types of Supply Elasticity: Perfectly Elastic Supply.

    Figure 1 shows the supply curve when it is perfectly elastic.

    Elasticity of Supply Perfectly Elastic Supply StudySmarterFig 1. - Perfectly Elastic Supply

    When a good's elasticity of supply equals infinity, the good is said to have perfect elasticity.

    This indicates that the supply can accommodate a rise in the price of any magnitude, even if just slightly. It means that for a price above P, the supply for that good is infinite. On the other hand, if the price of the good is below P, the quantity supplied for that good is 0.

    Types of Supply Elasticity: Elastic supply.

    Figure 2 below shows the elastic supply curve.

    Elasticity of Supply Elastic Supply StudySmarterFig 2. Elastic Supply

    The supply curve for a good or service is elastic when the elasticity of supply is greater than 1. In such a case, a price change from P1 to P2 leads to a greater percentage change in the number of goods supplied from Q1 to Q2 compared to the percentage change in price from P1 to P2.

    For example, if the price were to increase by 5%, the quantity supplied would increase by 15%.

    On the other hand, if the price of a good were to decline, the quantity supplied for that good would decrease by more than the decrease in price.

    A firm has an elastic supply when the quantity supplied changes by more than the change in price.

    Types of Supply Elasticity: Unit Elastic Supply.

    Figure 3 below shows the unit elastic supply curve.

    Elasticity of Supply Unit Elastic Supply StudySmarterFig 3. - Unit Elastic Supply

    A unit elastic supply occurs when the elasticity of the supply is 1.

    A unit elastic supply means that the quantity supplied changes by the same percentage as the change in price.

    For example, if the price were to increase by 10%, the quantity supplied would also increase by 10%.

    Note in Figure 3 the magnitude of the price change from P1 to P2 is equal to the magnitude of the change in quantity supplied from Q1 to Q2.

    Types of Supply Elasticity: Inelastic Supply.

    Figure 4 below shows a supply curve that is inelastic.

    Elasticity of Supply Inelastic Supply StudySmarterFig 4. - Inelastic Supply

    An inelastic supply curve occurs when the elasticity of supply is less than 1.

    An inelastic supply means that a change in price leads to a much smaller change in quantity supplied. Notice in Figure 4 that when the price changes from P1 to P2, the difference in quantity from Q1 to Q2 is smaller.

    Types of Supply Elasticity: Perfectly Inelastic Supply.

    Figure 5 below shows the perfectly inelastic supply curve.

    Elasticity of Supply Perfectly Inelastic Supply StudySmarterFig 5. - Perfectly Inelastic Supply

    A perfectly inelastic supply curve occurs when the elasticity of supply equals 0.

    A perfectly inelastic supply means that a change in price leads to no change in quantity. Whether the price triples or quadruples, the supply remains the same.

    An example of a perfectly inelastic supply could be the Mona Lisa painting by Leonardo Da Vinci.

    The Elasticity of Supply Determinants

    The elasticity of supply determinants includes factors that influence the ability of a firm to change its quantity supplied in response to a price change. Some of the key determinants of the elasticity of supply include time period, technological innovation, and resources.

    • Time period. In general, the long-term behavior of supply is more elastic than its short-term behavior. In a short amount of time, businesses are less flexible in making adjustments to the scale of their factories in order to produce more or less of a certain good. Therefore, the supply tends to be more inelastic in the short term. In contrast, over more extended periods, firms have the opportunity to construct new factories or shut down older ones, hire more labor, invest in more capital, etc. Therefore, the supply, in the long run, is more elastic.
    • Technological innovation. Technological innovation is a crucial determinant of the elasticity of supply in many industries. When companies use technological innovation, which makes production more efficient and productive, they can supply more goods and services. A more effective manufacturing method will save expenses and make it possible to produce larger quantities of goods at a cheaper cost. Therefore, a price increase would lead to a greater increase in quantity, making the supply more elastic.
    • Resources. Resources that a firm uses during its production process play an essential role in determining the responsiveness of a firm to a price change. When the demand for a product rises, it may be impossible for a firm to meet that demand if the manufacture of their product depends on a resource that is becoming rare.

    Elasticity of Supply - Key takeaways

    • The elasticity of supply measures how much the quantity supplied of a good or service changes when there is a price change.
    • The formula for elasticity of supply is \(\hbox{Price elasticity of Supply}=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\)
    • There are five main types of supply elasticity: perfectly elastic supply, elastic supply, unit elastic supply, inelastic supply, and perfectly inelastic supply.
    • Some of the key determinants of the elasticity of supply include time period, technological innovation, and resources.
    Frequently Asked Questions about Elasticity of Supply

    What is meaning of elasticity of supply?

    The elasticity of supply measures how much the quantity supplied of a good or service changes when there is a price change.

    What determines elasticity of supply?

    Some of the key determinants of the elasticity of supply include time period, technological innovation, and resources. 

    What is an example of elasticity of supply?

    Increasing the number of chocolate bars produced more than the increase in price.

    Why is elasticity of supply positive?

    Due to the law of supply which states hat when there is an increase in the price of a good or service, the supply for that good will increase. On the other hand, when there is a decrease in the price of a good or service, the quantity of that good will decrease

    How do you increase elasticity of supply?

    By technological innovation that improves production productivity.

    What does negative elasticity of supply mean?

    It means an increase in price would lead to a decrease in supply, and a decrease in price would lead to an increase in supply.

    Test your knowledge with multiple choice flashcards

    The law of supply states that when there is an increase in the price of a good or service, the supply for that good will ___________.

    The law of supply states that when there is a decrease in the price of a good or service, the supply for that good will ___________.

    The _______ measures how much the quantity of a good or service changes when there is a price change. 

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