Elasticity of Supply

The Elasticity of Supply Definition

The elasticity of supply definition is based on the law of supply, which states that the number of goods and services supplied will usually change when prices change.

But how much will the quantity of a good or service decrease when there is a price decrease? What about when there is a price increase?

The amount by which the quantity supplied increases or decreases with a price change depends on how elastic the supply of a good is.

• When there is a change in price and firms respond with a slight change in the quantity supplied, then the supply for that good is quite inelastic.
• However, when there is a change in price, which leads to a more significant change in quantity supplied, the supply for that good is quite elastic.

The ability of suppliers to alter the quantity of a good they produce directly impacts the degree to which the quantity supplied can change in response to a change in price.

Although the construction company can't start building a significant number of houses in response to the price increase in the short run, in the long run, constructing houses is more flexible. The company can invest in more capital, employ more labor, etc.

Time has a strong influence on the elasticity of supply. In the long run, the supply of a good or service is more elastic than in the short run.

Formula for Elasticity of Supply

The formula for elasticity of supply is as follows.

\(\hbox{Price elasticity of Supply}=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\)

The elasticity of supply is computed as the percentage change in quantity supplied divided by the percentage change in price. The formula shows how much a change in price changes the quantity supplied.

Elasticity of Supply Example

As an example of elasticity of supply, let's assume that the price of a chocolate bar increases from $1 to $1.30. In response to the price increase of the chocolate bar, firms increased the number of chocolate bars produced from 100,000 to 160,000.

To calculate the price elasticity of supply for chocolate bars, let's first calculate the percentage change in price.

\( \%\Delta\hbox{Price} = \frac{1.30 - 1}{1} = \frac{0.30}{1}= 30\%\)

Now let's calculate the percentage change in quantity supplied.

\( \%\Delta\hbox{Quantity} = \frac{160,000-100,000}{100,000} = \frac{60,000}{100,000} = 60\% \)

Using the formula

\(\hbox{Price elasticity of Supply}=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\) we can calculate the price elasticity of supply for chocolate bars.

\(\hbox{Price elasticity of Supply}=\frac{60\%}{30\%}= 2\)

As the price elasticity of supply equals 2, it means that a change in the price of chocolate bars changes the quantity supplied for chocolate bars by twice as much.

Types of Supply Elasticity

There are five main types of supply elasticity: perfectly elastic supply, elastic supply, unit elastic supply, inelastic supply, and perfectly inelastic supply.

Types of Supply Elasticity: Perfectly Elastic Supply.

Figure 1 shows the supply curve when it is perfectly elastic.

Fig 1. - Perfectly Elastic Supply

This indicates that the supply can accommodate a rise in the price of any magnitude, even if just slightly. It means that for a price above P, the supply for that good is infinite. On the other hand, if the price of the good is below P, the quantity supplied for that good is 0.

Types of Supply Elasticity: Elastic supply.

Figure 2 below shows the elastic supply curve.

Fig 2. Elastic Supply

The supply curve for a good or service is elastic when the elasticity of supply is greater than 1. In such a case, a price change from P₁ to P₂ leads to a greater percentage change in the number of goods supplied from Q₁ to Q₂ compared to the percentage change in price from P₁ to P₂.

On the other hand, if the price of a good were to decline, the quantity supplied for that good would decrease by more than the decrease in price.

Types of Supply Elasticity: Unit Elastic Supply.

Figure 3 below shows the unit elastic supply curve.

Fig 3. - Unit Elastic Supply

A unit elastic supply means that the quantity supplied changes by the same percentage as the change in price.

Note in Figure 3 the magnitude of the price change from P₁ to P₂ is equal to the magnitude of the change in quantity supplied from Q₁ to Q₂.

Types of Supply Elasticity: Inelastic Supply.

Figure 4 below shows a supply curve that is inelastic.

Fig 4. - Inelastic Supply

An inelastic supply means that a change in price leads to a much smaller change in quantity supplied. Notice in Figure 4 that when the price changes from P₁ to P₂, the difference in quantity from Q₁ to Q₂ is smaller.

Types of Supply Elasticity: Perfectly Inelastic Supply.

Figure 5 below shows the perfectly inelastic supply curve.

Fig 5. - Perfectly Inelastic Supply

A perfectly inelastic supply means that a change in price leads to no change in quantity. Whether the price triples or quadruples, the supply remains the same.

The Elasticity of Supply Determinants

The elasticity of supply determinants includes factors that influence the ability of a firm to change its quantity supplied in response to a price change. Some of the key determinants of the elasticity of supply include time period, technological innovation, and resources.

• Time period. In general, the long-term behavior of supply is more elastic than its short-term behavior. In a short amount of time, businesses are less flexible in making adjustments to the scale of their factories in order to produce more or less of a certain good. Therefore, the supply tends to be more inelastic in the short term. In contrast, over more extended periods, firms have the opportunity to construct new factories or shut down older ones, hire more labor, invest in more capital, etc. Therefore, the supply, in the long run, is more elastic.
• Technological innovation. Technological innovation is a crucial determinant of the elasticity of supply in many industries. When companies use technological innovation, which makes production more efficient and productive, they can supply more goods and services. A more effective manufacturing method will save expenses and make it possible to produce larger quantities of goods at a cheaper cost. Therefore, a price increase would lead to a greater increase in quantity, making the supply more elastic.
• Resources. Resources that a firm uses during its production process play an essential role in determining the responsiveness of a firm to a price change. When the demand for a product rises, it may be impossible for a firm to meet that demand if the manufacture of their product depends on a resource that is becoming rare.