Chapter 3 · Elasticities
Price elasticity of supply
Compare elastic, inelastic and unit-elastic supply curves. Explain price elasticity of supply and the perfectly elastic and inelastic cases.
The economic idea
Elasticity measures responsiveness using percentage changes, so the coefficient is independent of the units in which price and quantity are measured.
Price elasticity of supply measures the responsiveness of quantity supplied to a change in the price of a good or service, ceteris paribus. PES is calculated as the percentage change in quantity supplied divided by the percentage change in price.
Price and quantity supplied normally move in the same direction, so PES is positive. Supply is elastic when PES is greater than one, inelastic when it lies between zero and one, and unit elastic when it is equal to one.
The main determinants of PES are the time period, availability of spare capacity, stocks of finished goods, storability, the mobility of factors of production and the length and complexity of the production process.
The time period is often decisive. In the momentary or short run, at least one production constraint may be fixed. In the long run, firms can vary more inputs, expand capacity, reorganise production and new firms may enter, making supply more elastic.
Reading elastic supply
“Quantity supplied” is measured on the horizontal axis and records the amount producers are willing and able to offer for sale.
“Price” is measured on the vertical axis and records the good’s own price.
“S” is the supply schedule. Moving along it changes price and quantity supplied while input costs, technology, taxes and other supply determinants are held constant.
The measurement point: A
“A” identifies the position at which PES is being measured. The guide lines connect it to “P” on the price axis and “Q” on the quantity axis. It is an observation on “S”, not a market equilibrium.
What the current elastic case means
At the measurement point, the percentage change in quantity supplied is proportionately greater than the percentage change in price, so PES is greater than one.
Moving “A” along the same straight curve can change the elasticity coefficient even though the curve’s slope remains constant. Elasticity uses percentage changes and therefore depends on the price and quantity at which it is measured.
What limits the movement along supply
A higher price gives firms an incentive to increase quantity supplied along the existing supply curve, but incentive is not the same as capacity. Output can increase substantially only when firms can obtain inputs, use spare capacity, release stocks or alter production within the relevant time period.
Make the constraint specific to the question. A bakery with unused ovens and available staff may increase output quickly. A grower cannot bring forward the next harvest merely because price rises. Link the constraint to the size of the quantity response; “firms want to earn more” explains the incentive but not PES.
How to interpret a price change
Choose two price–quantity observations on the unchanged “S” curve. A change in price creates movement along supply, not a shift of supply.
Calculate the percentage change in quantity supplied and the percentage change in price using a consistent method.
Divide the percentage change in quantity supplied by the percentage change in price and classify the resulting coefficient.
Use the context to explain the physical and time constraints that make the observed response possible or prevent it from being larger.
What the current state establishes
The coefficient describes the size of the quantity response, not the size of the price change itself and not whether supply has shifted.
Common mistakes to avoid
- A steep supply curve is not automatically inelastic and a flat curve is not automatically elastic. PES must be calculated from percentage changes.
- “A” is not an equilibrium point. A supply-only diagram contains no demand curve with which to determine equilibrium.
- A change in the good’s own price causes movement along supply. A change in input costs, technology, taxes or another non-price determinant shifts supply and is not a PES movement along one curve.
How to draw this diagram
- Title the diagram “Price elasticity of supply”. Label the horizontal axis “Quantity” and the vertical axis “Price”.
- Draw S first and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Project important intersections to the axes with dashed guide lines and label the outcomes.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- PES applies to a particular product, market and time period. Short-run and long-run estimates can differ substantially.
- Ceteris paribus is required. A simultaneous change in costs, technology, taxes or productive capacity shifts supply rather than measuring movement along one curve.
- Point elasticity describes responsiveness at one position; an estimate over a larger discrete change should use an appropriate arc method.
- PES predicts the quantity response to price but does not by itself identify profitability, welfare or the distribution of gains between market participants.