Supply elasticity ***

Understanding Supply Elasticity

Supply elasticity measures how responsive the quantity supplied of a commodity is to changes in its price. This responsiveness is quantified by the elasticity of supply (ES), which is calculated as follows:

Or more specifically:

Where:

• ΔQ = change in quantity supplied
• ΔP = change in price
• P = original price
• Q = original quantity supplied

Here, ΔQ is the change in quantity supplied, Q is the initial quantity supplied, ΔP is the change in price, and P is the initial price.

Since price and quantity supplied typically move in the same direction, ES is usually a positive value.

Types of Elasticity of Supply

• Elastic Supply (ES > 1):
  • Supply is elastic when a percentage change in price leads to a larger percentage change in quantity supplied.
  • Example: If a 10% increase in price results in a 20% increase in quantity supplied, the supply is elastic.
  • Graphically, this is depicted as a relatively flatter supply curve.
• Inelastic Supply (ES < 1):
  • Supply is inelastic when a percentage change in price results in a smaller percentage change in quantity supplied.
  • Example: A 10% increase in price leading to only a 5% increase in quantity supplied indicates inelastic supply.
  • The supply curve in this case is relatively steeper.
• Unit Elastic Supply (ES = 1):
  • Supply is unit elastic when the percentage change in price results in an equal percentage change in quantity supplied.
  • Example: A 10% increase in price leading to a 10% increase in quantity supplied.
  • Any straight line supply curve passing through the origin exhibits unit elasticity.
• Perfectly Elastic Supply (ES = ∞):
  • Perfectly elastic supply occurs when a small change in price leads to an infinitely large change in quantity supplied.
  • Example: At a specific price, any quantity can be supplied, but any decrease in price results in zero supply.
  • This is represented by a horizontal supply curve.
• Perfectly Inelastic Supply (ES = 0):
  • Perfectly inelastic supply happens when changes in price do not affect the quantity supplied at all.
  • Example: The supply of land is perfectly inelastic because the quantity of land is fixed.
  • The supply curve in this case is vertical.

Determinants of Elasticity of Supply

• Nature of the Good:
  • The ease with which factors of production can be shifted affects supply elasticity.
  • Goods with easily transferable production factors have higher elasticity.
  • Durable goods, which can be stored, generally have higher supply elasticity compared to perishable goods.
• Definition of the Commodity:
  • The specificity of the commodity affects its supply elasticity.
  • Narrowly defined commodities tend to have higher elasticity.
  • Example: Switching production from red skirts to green skirts is easier than from skirts to trousers.
• Time Period:
  • Supply elasticity is higher in the long run than in the short run.
  • Over time, producers can adjust resources and production processes more easily.
  • In agriculture, there are natural time lags between planting and harvesting.
• Cost of Attracting Resources:
  • The ability to increase supply depends on attracting resources from other industries.
  • If the cost of attracting these resources is high, supply becomes relatively inelastic.
  • During full employment, the only available resources are those that can be diverted from other industries.
• Level of Price:
  • Elasticity varies at different price levels.
  • At high prices, producers may be operating near capacity and can’t easily increase supply further.
  • At low prices, producers might have surplus capacity that they can utilize if prices rise.

Managerial Decision Making and Supply Elasticity

Understanding supply elasticity is crucial for managerial decision making. Here are some ways it is used:

• Pricing Strategy:
  • Knowing the elasticity helps managers set prices that maximize revenue without losing too much quantity supplied.
  • For elastic supply, a price increase could lead to a significant increase in supply.
• Production Planning:
  • Elasticity information aids in adjusting production levels in response to price changes.
  • It helps in deciding whether to invest in new technology or expand production capacity.
• Resource Allocation:
  • Managers can allocate resources efficiently by understanding which products have elastic or inelastic supply.
  • For elastic supply, more resources can be diverted to production when prices are expected to rise.
• Inventory Management:
  • Elasticity helps in planning inventory levels, especially for durable goods with elastic supply.
  • For inelastic supply goods, managers need to ensure stable production irrespective of price changes.
• Market Entry and Exit Decisions:
  • Firms can decide to enter or exit markets based on the elasticity of supply.
  • Markets with highly elastic supply may be more competitive but offer opportunities for significant supply increases.

In conclusion, supply elasticity provides valuable insights into how quantity supplied responds to price changes. By analyzing supply elasticity, managers can make informed decisions about pricing, production, resource allocation, inventory management, and market strategies, leading to more efficient and profitable operations.