Price Elasticity of Supply Flashcards
Define Price Elasticity of Supply
The responsiveness of quantity supplied to a change in the price of a good or service.
What does P.E of Supply measure?
How willing producers are to supply more when the price of a good or service increases or the strength of the law of supply for a particular good or service.
How do you calculate the P.E of supply?
change in quantity supplied ÷ original supply x change in price ÷ original price
What does it mean if the coefficient is above 1?
Supply is price elastic
- This means that the % change in Qs is greater than the % change in price. Firms can increase/decrease production quickly when price changes.
- Producers are very responsive to a change in price.
What does it mean if the coefficient is below 1?
Supply is price inelastic
- This means that the % change in Qs is less than the % change in price. Firms find it hard to change production levels quickly.
- Producers are not very responsive to a change in price.
What does it mean if the coefficient is equal to 0?
Supply is perfectly inelastic and price changes will have no effect on supply
What does it mean if the coefficient is infinity?
Supply is perfectly inelastic meaning a small price change will result in an infinite change in supply
What are the factors affecting the price elasticity of supply?
- Time
- Nature of Industry
- Ability to Store Inventories
How does time affect the price elasticity of supply?
- The more time a producer must respond to a change in price, the more supply elastic the good tends to be. In the short run, a producer is usually unable to increase the amount available for sale. However, as time passes most goods become more supply elastic.
Provide an example of time
For example, the amount of available oil is fairly inelastic in the short term, however, over time, exploration and discovery may increase the supply of oil and make the supply curve more elastic.
How does the nature of industry affect the price elasticity of supply?
If a good can be produced quickly then the supply will be more elastic. However, if a good takes a long time to produce than supply will be inelastic.
Provide an example of nature of industry
For example, supply of most agricultural crops tends to be inelastic as planting decisions are made months before harvesting.
If the price of corn increases more cannot be grown within a few days.
However, manufacturing industries such as clothing, iPad or textbooks can increase production quickly in the case of a price increase. Supply is elastic.
How does the availability to store inventories affect the price elasticity of supply?
It makes supply more elastic because producers can quickly adjust the quantity supplied in response to price changes, either by releasing stock when prices rise or holding back inventory when prices fall. This responsiveness reduces the impact of price fluctuations, making supply more elastic.
What would happen without an inventory storage?
Without inventory storage, supply tends to be more inelastic, as producers are limited in their ability to adjust supply quickly, especially in the short term.
What is the effect of an increase in price on quantity supplied?
Producers cannot immediately expand production in response to an increase in price.
In the short run firms have more flexibility to respond to the higher price and expand production.
In the long run, firms have much greater capacity to increase quantity supplied.
Why does the government place taxes on goods and services?
To raise revenue and to affect resource allocation.
In Australia there is a goods and services tax (GST) levied on most goods and services and excise duties which are levied on petrol, alcohol and tobacco.
What is the effect of tax on producers?
When a tax is placed on a good it will increase the price paid by consumers, decrease the price received by producers and decrease the quantity sold.
What effect does tax have on the supply curve?
The supply curve will shift up by the amount of the tax.
The equilibrium price will increase, and the equilibrium quantity will decrease
How can tax be more effective in raising revenue?
If it is imposed on goods with relatively inelastic demand.
How can tax be more effective in reducing consumption?
If it’s imposed on goods with relatively elastic demand.
Who does the burden of tax fall on more when demand is relatively inelastic?
The incidence (burden) of tax will fall more heavily on consumers
Who does the burden of tax fall on more when demand is relatively elastic?
The incidence (burden) of tax will fall more heavily on producers
For a given change in either demand or supply, is it possible to predict how much price will change?
Yes, if we know both the price elasticity of demand and supply
The simple formula is:
% ∆ Price = % ∆ Demand ÷ (Ed + Es)
