Importance of price elasticity of supply
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The document discusses price elasticity of supply (PES), which assesses how much quantity supplied changes in response to price changes. It explains that PES can be elastic, inelastic, perfectly elastic, or perfectly inelastic, and outlines factors influencing elasticity such as production capacity, stock levels, factor substitution ease, and time period for production adjustments. Furthermore, it highlights the significance of PES in various economic contexts, including housing supply, trade, commodity markets, labor market dynamics, and government interventions.
Importance of price elasticity of supply
- 1. The Importance of Elasticity of Supply (Blog articles on PES can be found here: http://www.tutor2u.net/blog/index.php/economics/categories/C230 Price elasticity of supply measures the relationship between change in quantity supplied and a change in price. Basically elasticity of supply shows the amounts that costs rise as production increases When Pes > 1, then supply is price elastic When Pes < 1, then supply is price inelastic When Pes = 0, then supply is perfectly inelastic When Pes = infinity, then supply is perfectly elastic following a change in demand Factors determining elasticity of supply 1. Spare production capacity – high Pes when businesses or the economy has plenty of spare capacity (also known as productive slack) e.g. when a market or economy is coming out of recession 2. Stocks of finished products and components – high level of stocks (inventories) means that supply can quickly be adjusted to meet changes in demand – important in commodity markets 3. The ease and cost of factor substitution - if both capital and labour resources are occupationally mobile then the elasticity of supply for a product tends to be high because capital and labour can be swapped with little loss of efficiency / productivity 4. Time period involved in the production process – Pes is higher the longer the time period that a firm is allowed to adjust its production levels. In some agricultural markets, momentary supply is fixed and is determined mainly by planting decisions made months before, and also climatic conditions, which affect the overall production yield. Areas of the AS and the A2 economics syllabus where price elasticity of supply is important o Housing supply – inelastic supply of new housing in response to rising demand – pushes up property prices with consequences for housing wealth, affordability etc o Trade: I.e. the ability of a nation’s export industries to respond to depreciation of the exchange rate if export demand grows o Commodity prices: Very inelastic supply of many hard and soft commodities – making prices more volatile – especially in markets where there is strong speculative activity o Labour market: Elasticity of supply of labour – a factor explaining wage differentials - migrant workers can help to relieve shortages of skilled labour and improve the elasticity of supply o Macroeconomics and the output gap: The changing elasticity of the short run aggregate supply curve (SRAS) at different points of the economic cycle – important in judging the risks of demand-pull inflationary pressure in the economy as economy recovers from recession o Elasticity of supply of renewable sources of energy as demand increases e.g. bio-fuels o Quasi public goods – i.e. public goods such as the airwaves, motorways, beaches etc which become crowded and congested – causing the marginal cost of supplying to an extra user to rise o Government intervention in a market – if you are answering questions on maximum and minimum prices or indirect taxes and subsidies, you can always make a useful analytical point about the importance of price elasticity of supply in affecting the results of any such market intervention.
- 2. Examples of some price elasticity of supply diagrams Price Output Supply (short run) P1 D1 Q1 P2 D2 Supply (long run) Q3 a b P3 c Price Output D1 D2 Q1 Q2 Perfectly elastic supply Q2 Price Quantity P2 P3 P1 Q2Q1 Q3 P4 P5 Supply Q4 Q5 D1 D2 D3 D4 D5 Pes > 1 Pes < 1