Definition: Price elasticity of supply is an economic measurement that calculates how closely the price of a product or service is related to the quantity supplied. In other words, it shows how a change in price will affect suppliers’ willingness to produce the good or service.
What Does Price Elasticity of Supply Mean?
It means that when the price of a product or service increases or decrease suppliers of the good or service are either more willing or less willing to produce it. This relationship depends on several factors including the:
- Availability of raw materials
- Complexity of the production cycle
- Mobility of factors
- Responsiveness of producers
- Capacity for excess production
- Ability to run production at full capacity
Goods or services that have a direct correlation between price and supply are considered elastic. This means that as the cost or price of a product changes, the willingness of suppliers to provide that product also changes. Increased prices for these types of products will encourage companies to produce them because they are able make a higher profit.
Conversely, a product that isn’t affected by increases or decreases in price is considered inelastic. This means that price changes don’t affect companies’ willingness to produce the product.
Let’s look at an example.
Jenny is an economist who follows the agricultural production in India. Due to unfavorable political conditions and an unstable economic environment, the price of a certain crop changes every week. Jenny wants to see how closes the quantity supplied is related to the changes in price, so she calculates the price elasticity of supply.
The price of crop increases from $4 to $5 and the quantity supplied increases from 10 units per supplier to 12 units per supplier on a weekly basis. What is the price elasticity of supply?
Percentage change of price = $5 / $4 – 1 x 100 = 25%
Percentage change of quantity supplied = 12 / 10 – 1 x 100 = 20%
Price elasticity of supply = 20% / 25% = 0.80
Jenny concludes that the supply of this crop is inelastic since the price elasticity of supply is less than 1. This means that companies are either unable or unwilling to produce more crops as the price increases. This could be due to limitations in technology, storage systems, distribution systems, employee training, and inventories need to be improved.