2.4 Price Elasticity of Supply

In the last unit, we discussed the price elasticity of demand as the sensitivity of quantity demanded to changes in price. This guide will talk about a very similar topic, the price elasticity of supply. Like demand, price elasticity of supply describes a producer's sensitivity to changes in price.

For example, let's consider two firms producing headphones, firm A and firm B. Let's suppose that at a price of $50 per pair, both firms produce 10 headphones. Now, suppose the price increases to $75 per pair, and in response, firm A increases production to 12 headphones, whereas firm B increases to 20 headphones. Firm B's supply would be considered more price elastic, because it is more sensitive to price changes.

Calculating the price elasticity of supply is almost the exact same as calculating the price elasticity of demand.

The formula is:

Es = %ΔQs / %ΔP

Where Es is known as the price elasticity of supply coefficient and %Δ is shorthand for "percent change in."

For example, let's calculate firm B's price elasticity of supply using the data we were given:

Qs1 = 10

Qs2 = 20

%ΔQs = (20 - 10) / 10 * 100 = 100% increase

P1 = 50

P2 = 75

%ΔP = (75 - 50) / 50 * 100 = 50% increase

Thus, the price elasticity of supply is:

Es = 100 / 50 = 2

This tells us that a 50% increase in price corresponds to a 100% increase in quantity supplied. This is a relatively elastic supply, since we have a higher percent change in quantity than there was price.

This type of supply has a price elasticity of supply coefficient of zero, meaning that the quantity supplied does not change regardless of price changes. An example of this type of supply is for a company that has a monopoly on a certain product or service. If the price increases, the company will continue to supply the same amount of the product or service because there are no substitutes available and demand is likely to remain constant.

This type of supply has a price elasticity of supply coefficient between zero and one, meaning that the quantity supplied is only slightly responsive to price changes. An example of this type of supply is for a company that has a large fixed cost, such as a factory. If the price increases, the company may be able to increase the quantity supplied slightly, but it will not be able to increase it significantly because of the fixed costs involved in production.

This type of supply has a price elasticity of supply coefficient of one, meaning that the quantity supplied is exactly proportional to price changes. Thus, a % change in price will lead to an exactly equivalent % change in quantity supplied.

This type of supply has a price elasticity of supply coefficient greater than one, meaning that the quantity supplied is highly responsive to price changes. An example of this type of supply is for a company that can quickly increase production in response to higher prices, such as a company that produces a product with low production costs and high demand.

This type of supply has an infinite price elasticity of supply coefficient, meaning that the quantity supplied becomes infinite as the price increases. An example of this type of supply is for a product that has an unlimited number of suppliers, such as a commodity such as wheat or corn. If the price increases, more and more suppliers will enter the market, causing the supply to increase infinitely.