2.6 elasticity of suppyl Flashcards
PES
price elasticity of supply
a measure of how much the qty supplied of a good changes when there is a change in its own price
PES = %∆Qs/%∆P
PES ALW +VE
law of supply
As the price of a product increases, the quantity supplied will usually increase, ceteris paribus.
why is PES alw +ve?
LAW OF SUPPLY
There is a positive relationship between the quantity supplied of a good and its price, so the sign of the percentage change in quantity and price will be the same. When the price of a good increases, ceteris paribus, the quantity supplied of the good will also increase (and when the price decreases the quantity supplied also decreases). This means that mathematically PES is always a positive number.
PES>1
price elastic supply
A situation where a change in price leads to a proportionately greater change in the quantity supplied.
PES diagram axes
y-$
x-qty
0<PES<1
price inelastic supply
A situation where a change in price leads to a proportionately smaller change in the quantity supplied.
PES = 1
unitary elastic supply
A situation where a change in price leads to an equal change in the quantity supplied.
pes = ∞
perfectly elastic supply
A situation where a tiny change in price would lead to an infinite change in the quantity supplied.
determinants of PES
- time period considered - immediate = little variation
- mobility (flexibility) of FOP
- unused capacity - not at max capacity - workers not full time+unused factory space
- ## ability to store stock - demand increase, can release stock quickly
how does time period considered affect FOP
The time lag between the moment the price of a good changes and the producer’s ability to adjust resources and production to respond to the price change is an important factor that affects the value of PES.
When there is a change in the price of a good, in the very immediate moment after the change, firms are unable to vary the level of supply very much. They cannot instantly increase or decrease the factors of production (amount of inputs) that they use. Therefore, the value of PES will be very inelastic or even perfectly inelastic (PES = 0) in the immediate moment after the price change.
For example, if soft drink firms have already planned their production of drinks for October (autumn in the northern hemisphere) and there is a sudden unusual heatwave that increases demand for soft drinks and increases their price, the quantity supplied of soft drinks will not likely change by much. The soft drinks firms will not be able to change their production levels instantly. Even if the firm has more stock, it would still take a couple of days to distribute it to retailers.
In the short or medium term, firms might be able to increase the quantity of some of the factors of production in some areas and readjust their production plans, giving them greater flexibility. This would be the case represented by S2 on the diagram. If price rises from P1 to P2, quantity supplied may increase a little, from Q1 to Q2. However, firms might not be able to increase, for example, the amount of machines they have or the size of the factory, areas which need a longer period of time for adjustment.
When the period of time is long, firms have complete flexibility to change their factors of production in order to respond to any price changes, so the value of PES will be much more elastic, as represented by S3 in Figure 2. If price rises from P1 to P2, quantity supplied may change by a large amount, from Q1 to Q3, over a long period of time.
how does mobility (flexibility) and cost of FOP affect PES
when firm is producing a certain product, it uses a specific combination of FOP, some or which are more specialised than others or more costly than others
when though price of good increases, producer firm may not be able to easily move or adapt resources to increase production of that good in response to a price rise. resources may be large and immobile, or they may be costly, which increases the risks to teh firms using them.
The more mobile (flexible) its factors of production are, the more responsive a firm can be to changes in price by increasing or reducing the quantity supplied to the market, and therefore the greater the PES.
For example, services such as hairdressing, housekeeping and gardening would have higher PES than primary commodities or heavy industrial goods. The resources needed for hairdressing or gardening are not as specialised and are less costly than those for producing oil, minerals or high-tech products. Firms in service industries can more easily hire additional workers or reduce the hours their employees work when demand changes. Therefore, the supply for these kinds of services tends to be more elastic.
how does unused capacity affect PES
When firms are not using their production resources at their maximum capacity – for example, their workers are not working full-time or there is unused space in their factories – they can easily increase the production output of their product without increasing their costs significantly. In these cases, a firm’s ability to increase its output and respond to an increase in price will be easier and therefore PES will be greater.
If, on the other hand, the firm is working at maximum capacity – its machines are working constantly, workers are all employed full-time and there is no room in the factory for extra equipment – it will be more difficult and costly to respond to a price increase. For example, increasing a factory’s output by one more unit could require a whole new factory, which is costly, difficult and time-consuming to build, therefore PES will be smaller. Firms will be more reluctant to respond to price increases by increasing output.
how does ability to store stock affect PES?
If a firm has the capacity to store stock, which means keeping inventories of a good in a warehouse, the supply can be more responsive to a change in price.
Going back to the soft drink manufacturer example used earlier, if there is an unusually warm autumn and soda companies have stock of their drinks in storage, they can easily respond to an unexpected increase in demand, and price, by releasing the stock to the market quickly.
means to make supply more elastic (6)
- increase stock
- improve tech - move FOP more easily
- faster distribution methods - increase output faster
- increase capacity of factories
- reduce COP - less risk associated w changing qty supplied
- make production tech more flexible - can produce more kinds of products - can switch demand to wtv available
PES of primary commodities vs manufactured goods
Most primary commodities have a lower PES (more inelastic supply) than manufactured products. This is because of the long time period or high levels of investment needed to increase production, which affects the ability of producers to react to price changes.
For example, firms in the oil industry need time to make the necessary investments in oil extraction sites to increase production. It is also very costly to seek out new sources of oil, so firms might wait before responding to price increases.
In the case of agriculture, farmers need at least one planting season to respond to price changes with changed production levels. In most countries, there is a limited amount of arable land to be brought into cultivation, and/or the soil quality may already be depleted by farming. The productivity of land may only be increased through improved technology in seeds, fertilisers and irrigation systems, or through long-term soil regeneration methods. Thus, it is difficult for farmers to react quickly to price changes, making supply quite inelastic, especially during a planting season.
For example, firms in the oil industry need time to make the necessary investments in oil extraction sites to increase production. It is also very costly to seek out new sources of oil, so firms might wait before responding to price increases.
Price fluctuations are substantially larger in the case of inelastic supply. Large price fluctuations mean large revenue fluctuations and therefore unstable total revenues for primary producers.
