SESSION 4:

4.0

PRICE ELASTICITIY OF SUPPLY

All things being equal, suppliers will supply more of a commodity when its market price rises and less when the market price falls for the obvious reason that they seek to maximize profits. The extent to which quantity supplied responds to a change in market price of a commodity is measured by price elasticity of supply. 4.1 Objectives

Introduction

By the end of the Session you should be able to: a) b) c) d) e) 4.2 define price elasticity of supply calculate both the point and arc price elasticity of supply explain the price elasticity of supply coefficient explain the determinants of price elasticity of supply explain the importance and uses of price elasticity of supply.

Definition of Price Elasticity of Supply

Price elasticity of supply is the degree of responsiveness of the quantity supplied of a commodity to a change in its market price. 4.3 Measurement of Price Elasticity of Supply Economists measure this by dividing percentage (or proportionate) change in quantity supplied by percentage (or proportionate) change in the market price of the commodity. Percentage (Proportionate) change in quantity supplied PED = Percentage (Proportionate) change in market price 4.3.1 Point Price Elasticity of Supply The point price elasticity of supply (PES) is measured as: PES =

Qs P Qs P = Qs P P Qs

Where: Qs = the original quantity supplied P Qs P = the original market price = change in quantity supplied (new quantity minus old quantity) = change in market price (new market price minus old market price)

4.3.2 Arc Price Elasticity of Supply The arc price elasticity of supply is measured as:

Q P Q ( P + P2 ) = 1 (Q1 + Q2 ) ( P + P2 ) P (Q1 + Q2 ) 1

Where: Q1 = the original quantity supplied Q2 = the new quantity supplied P1 = the original market price P2 = the new market price Q = change in quantity supplied (new quantity minus old quantity) P = change in market price (new market price minus old price)

4.4

Interpretation of the Coefficient of Price Elasticity of Supply

The law of supply states that if the market price of a product increases (positive change), the quantity supplied also increases (another positive change). If the market price falls (negative change) the quantity supplied will also fall (another negative change). Thus, the price elasticity of supply coefficient for a typical commodity that obeys the law of supply is always positive. The price elasticity of supply coefficient can be less than, equal to or greater than one and is given special explanation when it is equal to zero or infinity. 4.4.1 Elastic Supply (PES >1) The supply of a commodity is said to be price elastic when the price elasticity of supply coefficient is greater than one (1). This means a change in market price causes a comparatively larger change in quantity supplied or the percentage change in price is less than the percentage change in quantity supplied.

4.4.2 Inelastic Supply (PES < 1) The supply of a commodity is said to be price inelastic when the price elasticity of supply coefficient is less than one (1). In this case a change in market price causes a comparatively smaller change in quantity supplied or the percentage change in market price is greater than the percentage change in quantity supplied.

4.4.3 Unit Elastic Supply (PES =1) The supply of a commodity is said to be price unit elastic when the price elasticity of supply is exactly equal to1. It means that the percentage change in price causes the same percentage change in quantity supplied. For example, if a 10 percent increase in price results in a 10 percent increase in quantity supplied.

4.4.4 Perfectly Elastic Supply (PES = infinity or undefined) The supply of a commodity is said to be perfectly elastic when the price elasticity of supply coefficient is equal to infinity () or undefined. This is where a change in price causes a proportionately infinitely larger change in quantity supplied.

4.4.5 Perfectly Inelastic Supply (PES = 0) The supply of a commodity is said to be perfectly inelastic when the price elasticity of supply coefficient is equal to zero. This is where a change in price, no matter what the degree, causes no change in quantity supplied.

4.5 DETERMINANTS OF PRICE ELASTICITY OF SUPPLY The price elasticity of supply also varies widely across different products, and across suppliers of the same good. The supply of some products will be highly price elastic (a small percentage change in price will cause a comparatively large percentage change in quantity supplied). On the other hand, the supply for other products may be highly price inelastic (a large percentage change in price may cause a comparatively small percentage change in quantity supplied). The main factors that determine/ influence price elasticity of supply may include:

i)

The Availability and Mobility of Factors of Production

If factors of production are available then supply responds quickly and largely to a change in the price of a product (i.e. supply then tends to be more elastic) but less elastic (inelastic) when factors of production are not available. The more easily factors can be transferred from the production of one good to that of another, the greater the elasticity of supply. ii) Influence of the Weather

If the output of a product to a greater extent is dependent on favourable weather conditions, as in the case of agricultural products, output cannot be controlled by the producer. Hence the supply of such product tends to be less elastic (inelastic). iii) The Level of Technology

The extent to which output can be increased depends on the level of technology employed by the producer. Advanced technology used in production tends to make the supply of a product more elastic.

iv)

Cost of Production

If cost involved in the production of a product is very high, output cannot be easily increased when the market price increases unless the increase in price is great enough to absorb the extra cost so supply becomes more inelastic. ii) Degree of Perishability The supply of highly perishable products is relatively inelastic and that of a less perishable commodity is relatively elastic. The explanation is that highly perishable goods cannot be stocked for longer periods to be released when price for instance rises. iii) Time (Gestation Period) The price elasticity of supply tends to be greater in the longer period than the shorter period. The longer the period, the easier it is to shift factors of production among products, following a change in their relative prices. This holds for agricultural products, because of the natural time lag between planting and harvesting of crops. In the shortrun, the supply of most products tends to be relatively inelastic.

4.6
1.

Self Assessment Questions

(a) (b) What is price elasticity of supply? How is it measured?

2. 3.

How is the price elasticity of supply coefficient interpreted? Explain five (5) factors that determine the price elasticity of supply of a product.

4. The marketing department of a firm has estimated the supply function of a product produced by the firm to be: QS = 100,000 + 5P

where QS and P are the quantity supplied and price of the product respectively. (a) (i) How many of the product will be supplied at prices 20,000 and 23,000? Calculate the point price elasticity of supply when the price of the product increases from 20,000 to 23,000 and interpret your results.

5. The price elasticity of supply of a product is estimated to be 0.78. What percentage increase in price will cause a 60 percent increase in the quantity supplied of the product?