Table of Contents
- What is the elasticity of supply?
- Understanding percentage change
- Types of elasticity of supply
- Factors affecting elasticity of supply
- Importance of elasticity of supply
- Factors that make up an inelastic supply
- Factors that make up an elastic supply
- Measurement of elasticity of supply
- A special application: Elasticity of supply of labor
What is the elasticity of supply?
The elasticity of supply in Economics is the measure of the degree of responsiveness of the quantity supplied of a commodity to its price. The law of supply indicates the direct relationship between the price of a particular commodity and the quantity supplied. Because price and quantity supplied move towards the same direction, the coefficient of the elasticity of supply is positive. That is if the price goes up, there will be an increase in supply. Talking about its elasticity, we talk about the rate at which supply will rise in response to an increase in price.
Supply can be elastic, inelastic, or neutral (unitary). It is elastic when a change in price leads to a change in the quantity supplied, inelastic when a change in price does not lead to any responsive change in the quantity supplied. When we say that supply is unitary elastic, it means that the change in price leads to a proportionate change in the quantity supplied (E=1).
We can also define the elasticity of supply as the percentage change in the quantity supplied divided by the percentage change in price. We express it in a formula thus;
ES = %∆Qs ⁄ %∆P Where;
ES = Elasticity of supply
%∆Qs = Percentage change in the quantity supplied
%∆P = Percentage change in price
Understanding percentage change
In the elasticity of demand and the elasticity of supply, we make many references to the phrase “percentage change” in price and quantity. Without this term, discussing the concept of elasticity will be incomplete.
What then is the meaning of percentage change?
Percentage change is a simple mathematical term that portrays the degree of change over time. It is a multipurpose concept in finance mostly to represent a change in the price of a security or commodities. We can apply it to any quantity we measure over time.
If for example, you want to calculate the percentage change in the price of a commodity, we involve both the old price and the new price. The formula for calculating the increase in price is new price minus old price divided by the old price, then multiply it by 100. We can express it mathematically as;
If the price decreases, we calculate it as old price minus new price divided by the old price, then multiply it by 100, thus;
%ΔP = Percentage change in price
OP = Old price
NP = New price.
The same thing applies to quantity, that is in cases where one wants to calculate the percentage change in quantity. It as well applies to any measurable item as well, that is the old figure and the new figure which are the two major variables in calculating the percentage change.
Analysts use this formula to track the prices of large market indexes and the prices of individual securities, also in comparing the values of different currencies.
Types of elasticity of supply
There are five types of price elasticity of supply namely:
- Fairly elastic supply
- Fairly inelastic supply
- Unitary elastic supply
- Perfectly elastic supply
- Perfectly inelastic supply
Fairly elastic supply (elastic supply)
Supply is fairly elastic when the percentage change in price leads to a greater change in the quantity supplied. The supply curve of a fairly elastic supply is a gradually sloping curve and its numerical value is ES>1. In other words, the magnitude of the change in supply is larger than that of the change in price.
Fairly inelastic supply (inelastic supply)
Supply is fairly inelastic when the percentage change in price leads to a smaller change in the quantity supplied. That is the percentage change in the quantity supplied is less than the percentage change in price. The numerical value of a fairly inelastic supply is greater than zero but less than one, that is ES<1.
The supply curve of a fairly inelastic supply is a rapidly sloping curve.
Unitary (neutral) Elastic supply
When we talk about a unitary elastic supply, it is a situation whereby the quantity supplied changes in the same proportion as the price. In other words, the percentage change in the quantity supplied is equal to the percentage change in price. If price and quantity supplied change in the same proportion, we then have a unitary or a neutral elastic supply. The supply curve is a positively sloping curve that is drawn from the origin with an elasticity of supply equal to one. The numerical value is ES=1.
The term unitary elastic supply is used to describe supply curves that are perfectly responsive to changes in price.
Usually, it is extremely difficult to encounter unitary elastic goods. Most times, a commodity is either elastic or inelastic in relation to the changes in the market.
There are certain implications of a unitary elastic supply in a business context. An example is when a company produces goods that are unitary elastic, it is an indication that the company should take notice of price fluctuations. When prices change, a company will then be able to respond by changing its level of production respectively.
Perfectly elastic supply
This refers to a situation whereby a slight change in price leads to a major responsive change in supply. A little rise in price can cause supply to rise to infinity while a fall in price can cause supply to fall drastically, that is to zero. In other words, a perfectly elastic supply is equal to infinity. This is an extreme case of elasticity which leads to an abnormal supply curve. The supply curve takes the form of a horizontal straight line, that is, the line runs across the x-axis and its numerical value is ES = ∞.
Perfectly inelastic supply
This is also an extreme case of elasticity of supply which causes the supply curve to become abnormal. A perfectly inelastic supply is also known as a zero elastic supply. This implies that a change in the price of a commodity, either an increase or a decrease may not cause any change in the quantity supplied. In other words, it remains zero which is its numerical value.
The supply curve of a perfectly inelastic supply is a vertical straight line that describes that the quantity supplied remains to zero no matter the changes in price. We can express it as ES=0.
Factors affecting elasticity of supply
The nature of the commodities
The availability of substitutes is an important factor that determines the elasticity of supply. Also, the ease to channel raw materials towards the production of other commodities increases elasticity. The supply of durable goods is more elastic than that of non-durable goods. This is because of the ability to store them for a longer period of time.
The supply for a product is more elastic when the producer has more time to respond to the changes in price. In other words, the supply of commodities is more elastic in the long run than in the short run. This is because of the assumption that one can utilize all factors of production to increase supply in the long run. In the short run, the producer can increase only labor, and even at that, some of these changes can be unbearably expensive. It is easier for a producer who has available storage capacity and unused capacity to quickly respond to the changes in price in his market if the variable factors are readily available.
For example, a coffee farmer cannot respond immediately to an increase in price because of the time it takes for it to be due. He may be able to respond quickly if he has adequate storage facilities where he had stored the coffee he previously harvested.
The nature of the industry
The nature of a firm is a considerable factor that affects the elasticity of supply. This has a share in indicating the extent to which the firm can increase its production in response to the increase in the price. If the producer has easy access to inputs especially raw materials, it will be very easy to increase output.
Nature can place restrictions on the supply of commodities. Here it is difficult for the producer to respond swiftly to an increase in price.
If producers are willing to take risks, the supply of their commodities will be more elastic. On the other hand, if they are not willing to take risks, supply will be less elastic. For example, if tax rates are high, a rise in price will not induce much response by producers.
The elasticity of supply varies among different prices. When prices are high, producers tend to produce almost beyond their capacity. This makes it difficult for them to respond to a continuously increasing price. On the other hand, when prices are fairly low, producers tend to have more extra capacity to which they will need when there is a further rise in price.
Availability of raw materials
Supply is more elastic when raw materials are available for further production. It becomes easier to respond swiftly to the increase in price than in a situation whereby raw materials are less available.
The ease to move factors of production from one use to another affects the elasticity of supply. The higher the mobility, the greater the elasticity will become, and the lower the mobility, the less the elasticity will become.
Importance of elasticity of supply
Firms try to make the supply of their products more elastic in order to help them respond swiftly to increased demand. The elasticity of supply helps them to invest in spare capacity to increase production when demand and price rise. Studying the elasticity of supply helps firms to improve their efficiency and time management to increase supply. Here, firms are able to weigh the benefits of flexible supply against their cost of production.
The concept is helpful in terms of taking vital business decisions, it as well helps to determine the rewards of factors of production. It is the desire of every firm to be highly responsive to price changes and other market situations. This is because a high elasticity of supply improves a firm’s competitiveness, that is having a competitive edge over its rivals. This in return allows firms to generate more profit and revenue. The concept also helps the government in the course of deciding taxation policies. For example, when they levy high taxes on goods that have an inelastic supply, they will generate more revenue.
Firms can be highly responsive to changes in price and other market conditions in the following ways;
- Keep sufficient stocks by putting adequate storage facilities in place.
- Be flexible by allowing inward migration of labor where there is a shortage.
- Improve in enlarging their capacity and creating spare capacity.
- Avoid shortage of labor by providing proper training for workers.
- By developing better storage facilities.
- There should be the proximity of production to the market.
- Finding means to prolong the life span of their commodities.
- Improving technology and using the latest technology for efficiency.
- Having multitasking and flexible workers who can switch between roles in the firm.
- Having better channels of distribution and as well developing their distribution systems.
Factors that make up an inelastic supply
On the normal ground, as emphasized, firms will like to supply more when prices rise. Goods become more profitable. There are factors that make it difficult for the firm to supply more.
Operating close to full capacity
A firm has a limited ability to increase supply when it is operating close to full capacity. There may be the ability to get workers to work overtime but at some point, the firm will start running out of capacity to respond to rising prices in the long run. If there is no long-term capital investment, a firm will not be able to increase its supply.
Running out of raw materials
Supply will be inelastic when it runs out of raw materials/inputs. When this thing happens, it becomes physically impossible to increase supply. Usually, there comes a time when firms run out of factor inputs.
In the short term, supply is more inelastic. Capital is fixed in the short run because firms do not have time to build a larger factory. In other words, it takes time to invest in order to increase the size of the factory. In the long run, there is sufficient time to increase the size and production thereby causing supply to become more responsive. Agricultural products have an inelastic supply in the short run because it takes at least six months to grow some crops like maize and four years for crops like coffee.
Limited factors of production
Some firms experience constraints in factors of production such as labor especially when the work requires skilled labor.
Low level of stocks
When firms have a low level of stocks, there will be no surplus of goods to sell. If firms are able to pile their stocks, they will be able to respond to an increase in price and demand. perishable products cannot be stockpiled for a long time because they will decay, therefore, they have an elastic supply.
Houses are usually inelastic in supply in some areas because it is hard to find land or obtain permission to build houses.
A firm requires proper planning for its supply to be elastic since supply is inelastic in the short run. This planning is usually in anticipation of a future increase in demand. Though it is difficult and there are usually risks attached when demand fails to materialize.
Excess of demand oversupply
When the demand for a commodity exceeds its supply, it will definitely get to a stage whereby supply becomes inelastic. At this point, the firm exceeds its production capacity in the process of trying to meet these demands. In this situation, the supply becomes fairly inelastic and subsequently becomes perfectly inelastic.
Examples of goods with inelastic supply include nuclear products. It takes time to build these products when there is high demand. Only a few firms will be able to increase output promptly. Grapes and coffee are other examples because you cannot produce them within a short period of time. Also, flood defense is another inelastic good. If there is heavy rainfall and flooding, there will be a high demand for it. Supply for these products cannot take place overnight, it takes many months to construct them.
In cases of economic boom, the demand for products is very high while the firm is running out.
Factors that make up an elastic supply
When a firm is able to build spare capacity, the supply of its products will be elastic. Here firms invest more in building capacity in order to increase production when price and demand rise.
Availability of stocks and raw materials
There will be a surplus of goods to sell when a firm has a high level of stocks. This will lead to high flexibility in responding to an increase in demand and price. When raw materials and other inputs are readily available for production processes, it will be easier to respond swiftly to an increase in price. It will be as well easy to meet up the demand for the products.
Supply is more elastic in the long run because capital and other factors are variable, they are not fixed in supply. A firm will have more time to build its industry and increase productivity. in this case, the firm becomes more responsive to the increase in demand and increase in price.
Ease in employing other factors of production
If it is easy to employ factors, supply will be elastic. Flexibility in employing factors of production and switching one factor (labor) from one role to another in areas where there is a shortage of labor eases production and supply.
Competition increases the elasticity of supply. This is because of the fact that firms adopt strategies to gain an edge over their competitors.
Goods with elastic supply are those goods that are relatively easy to manufacture. Examples of such goods include transport services. A good driver only needs a driving license to carry out his transport services. Fishes are other goods with elastic supply and plastic products.
In cases of recession, firms experience a fall in demand and this implies an excess supply over demand. Firms will have unsold goods and a large stock. When demand and prices rise, the supply of the stock of these products will be highly elastic.
If supply is elastic, an increase in demand will cause a little increase in price and a little increase in demand.
Measurement of elasticity of supply
It is necessary for an organization to estimate the elasticity of supply. The reason is to make viable business decisions in different situations such as deciding the quantity supplied of products.
There are two common methods analysts use in measuring the elasticity of supply namely;
- Proportionate method
- Point method
Under this method, we calculate the elasticity of supply by dividing the percentage change in the quantity supplied by the percentage change in the price of the product. This is the common and primary method of calculating elasticity. The formula as stated from the beginning is;
ES = %∆Qs ⁄ %∆P Where;
ES = Elasticity of supply
%∆Qs = Percentage change in the quantity supplied
%∆P = Percentage change in price.
Using the point method, we measure the elasticity of supply at a specific point on the supply curve. Here we need to draw a tangent alongside the demand curve.
A special application: Elasticity of supply of labor
We can apply the concept of elasticity (price) of supply to labor. This is to shoe the quantity of labor supplied to changes in the wages and salaries. The elasticity of supply of labor sometimes becomes negative when the increase in wages and salaries associates with the decrease of the quantity of labor supplied.
Labor usually has a normal upward-sloping supply curve which implies that higher wages cause people to work more. They prefer working more for additional income to having leisure time.
On the other hand, an increase in wages may cause some people to cut down the length of time they work. This is because their minds are relaxed since they already have high pay and will want to seek more time for leisure activities. In this case, the supply curve becomes negative. This is a major cause of an abnormal supply curve as outlined above.
We have seen that elasticity of supply is the rate at which supply responds to changes in price. It is important to analyze it because it helps firms in the course of making viable business decisions as well as responding swiftly to an increase in the demand for their commodities.
We looked at the factors that affect the elasticity of supply such as the nature of goods, the nature of the industry, time factor, natural factors, the willingness of firms to take certain risks, price level, the availability of raw materials, and factor mobility.
As seen above, the five types of elasticity of supply include the perfectly elastic supply, perfectly inelastic supply, unitary elastic supply, fairly elastic supply, and fairly inelastic supply. The perfectly elastic and the perfectly inelastic supply are extreme cases of elasticity that cause the supply curve to have an abnormal slope.
The elasticity of supply, therefore, applies to real life as we gave an example with the elasticity of the supply of labor.
Chyou is a published author who focuses on the field of international business. After an established career facilitating mergers and acquisitions for medium to large corporations, Chyou turned to writing to help students better understand international business concepts.