Cambridge IGCSE0455

Price elasticity of supply (PES)

Economics 0455 Chapter Notes

What this chapter covers

Price elasticity of supply (PES) - Definition of PESPrice elasticity of supply (PES) - Calculation of PESPrice elasticity of supply (PES) - Determinants of PES
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In this chapter

  1. 1What is Price Elasticity of Supply?
  2. 2Calculating and Interpreting PES
  3. 3The Spectrum of Supply Elasticity
  4. 4Determinants of Price Elasticity of Supply

1. What is Price Elasticity of Supply?

Price elasticity of supply (PES) is a crucial concept that measures how responsive the quantity supplied of a product is to a change in its price. In simple terms, it tells us how much or how little suppliers will increase their output when the market price goes up. If a small price rise causes suppliers to massively increase production, we say supply is 'elastic'. If a large price rise only leads to a tiny increase in production, supply is 'inelastic'. Understanding PES is vital for businesses when making production plans and for governments when considering the impact of taxes or subsidies.

PES = Percentage change in quantity supplied / Percentage change in price

PES = %ΔQS / %ΔP

Key term

Price Elasticity of Supply (PES): A measure of the responsiveness of the quantity supplied of a good or service to a change in its price.

Examiner insight

Examiners look for a clear understanding that PES is about the *responsiveness* of supply. Simply stating that price and quantity supplied change is not enough; you must comment on *how much* they change relative to each other.

Worked example 13 marks

A phone manufacturer observes that when the price of their new model increases by 10%, they increase the number of units they supply to retailers by 15%. Without performing a calculation, state whether the supply for this phone is price elastic or price inelastic. Explain your reasoning.

  1. 1

    Step 1: Compare the percentage change in quantity supplied with the percentage change in price.

  2. 2

    Step 2: The percentage increase in quantity supplied (15%) is greater than the percentage increase in price (10%).

  3. 3

    Step 3: When the quantity supplied is more responsive than the price change, supply is considered price elastic.

  4. 4

    Conclusion: The supply for this phone is price elastic because the percentage change in quantity supplied is larger than the percentage change in price.

Recap

  • PES measures the responsiveness of quantity supplied to a change in price.
  • A high PES value means supply is very responsive to price changes (elastic).
  • A low PES value means supply is not very responsive to price changes (inelastic).
  • The formula for PES is the percentage change in quantity supplied divided by the percentage change in price.
  • Firms and governments use PES to predict how supply will react to market changes.

Quick check

  1. What does it mean if a good has 'elastic' supply?1 mark
  2. State the formula for PES.1 mark

2. Calculating and Interpreting PES

To calculate PES, we use a two-step process. First, we find the percentage change in quantity supplied and the percentage change in price. Then, we divide the first by the second. The resulting number tells us the type of elasticity. A value less than 1 means supply is price inelastic. A value greater than 1 means supply is price elastic. A value of exactly 1 means supply has unitary elasticity, where the percentage change in quantity supplied is identical to the percentage change in price.

Percentage Change = ((New Value - Old Value) / Old Value) * 100

PES = % Change in Quantity Supplied / % Change in Price

Key term

Inelastic Supply: A situation where the percentage change in quantity supplied is less than the percentage change in price, resulting in a PES value between 0 and 1.

Examiner insight

Show all your working in calculation questions. Marks are awarded for correctly calculating the percentage changes, not just for the final PES value.

Common pitfall

A common mistake is calculating the percentage change using the new price or quantity as the denominator. Always divide the change by the *original* value.

Worked example 14 marks

The price of a bunch of carnations rises from 100 cents to 200 cents. In response, a flower farm increases the quantity it supplies per month from 10,000 to 12,000 bunches. Calculate the PES for carnations and comment on your result.

  1. 1

    Step 1: Calculate the percentage change in quantity supplied. %ΔQS = ((12,000 - 10,000) / 10,000) * 100 = (2,000 / 10,000) * 100 = 20%.

  2. 2

    Step 2: Calculate the percentage change in price. %ΔP = ((200 - 100) / 100) * 100 = (100 / 100) * 100 = 100%.

  3. 3

    Step 3: Calculate PES using the formula. PES = %ΔQS / %ΔP = 20% / 100% = 0.2.

  4. 4

    Step 4: Interpret the result. Since the PES value (0.2) is less than 1, the supply of carnations is price inelastic. This means the quantity supplied is not very responsive to the change in price.

Recap

  • If PES > 1, supply is price elastic.
  • If PES < 1, supply is price inelastic.
  • If PES = 1, supply has unitary elasticity.
  • Always use the original price and quantity as the base for percentage change calculations.
  • The PES value is always positive because the supply curve slopes upwards.

Quick check

  1. If a 20% rise in price leads to a 10% rise in quantity supplied, what is the PES?2 marks
  2. Is a PES value of 2.5 considered elastic or inelastic?1 mark

3. The Spectrum of Supply Elasticity

PES can be categorized into five distinct types, each represented by a different supply curve shape. Understanding these helps visualize how different markets work.

  1. Perfectly Inelastic (PES = 0): The quantity supplied is fixed and does not change, no matter the price. The supply curve is a vertical line. Think of seats in a football stadium on match day.
  2. Inelastic (0 < PES < 1): A large change in price leads to a smaller percentage change in quantity supplied. The supply curve is steep.
  3. Unitary Elastic (PES = 1): The percentage change in quantity supplied is exactly equal to the percentage change in price. Any straight-line supply curve that starts from the origin (0,0) has unitary elasticity.
  4. Elastic (PES > 1): A small change in price leads to a larger percentage change in quantity supplied. The supply curve is relatively flat.
  5. Perfectly Elastic (PES = ∞): Producers will supply any amount at one specific price, but nothing at any other price. The supply curve is a horizontal line. This is a theoretical extreme but can be approximated in highly competitive global commodity markets.

Key term

Perfectly Inelastic Supply: Occurs when the quantity supplied remains constant regardless of any change in price, giving a PES value of 0.

Fun fact

The supply of land in a city like central London or Manhattan is almost perfectly inelastic. No matter how high prices go, you can't create more land.

Worked example 14 marks

A unique painting by a deceased artist is put up for auction. Draw and label the supply curve for this painting and state its PES value. Justify your answer.

  1. 1

    Step 1: Identify the key constraint. There is only one of this specific painting in existence, and no more can be produced.

  2. 2

    Step 2: Relate this to supply. This means the quantity supplied is fixed at 1, regardless of how high the price goes at auction.

  3. 3

    Step 3: Draw the supply curve. It will be a vertical line at Quantity = 1. The axes should be labelled 'Price' (vertical) and 'Quantity' (horizontal).

  4. 4

    Step 4: State the PES value. Because the quantity supplied does not change at all (%ΔQS = 0), the PES is 0.

  5. 5

    Justification: The supply is perfectly inelastic because it is impossible to produce more of the item, so quantity supplied cannot respond to price increases.

Recap

  • A vertical supply curve means PES = 0 (perfectly inelastic).
  • A steep supply curve means PES < 1 (inelastic).
  • A supply curve from the origin means PES = 1 (unitary).
  • A shallow supply curve means PES > 1 (elastic).
  • A horizontal supply curve means PES = ∞ (perfectly elastic).

Quick check

  1. What is the shape of a perfectly elastic supply curve?1 mark
  2. If a supply curve is a straight line starting from the y-axis above the origin, is it elastic or inelastic?1 mark

4. Determinants of Price Elasticity of Supply

The PES of a product is not random; it is determined by several key factors related to the production process. The more easily and quickly a producer can change their output level, the more elastic supply will be. The main determinants are:

  1. Time Period: This is the most important factor. In the immediate moment (market period), supply is often perfectly inelastic as firms can't instantly produce more. In the short run, they can use existing capacity more intensively, making supply somewhat elastic. In the long run, they can build new factories or train more staff, making supply highly elastic.
  2. Spare Production Capacity: If a firm has unused machinery and idle workers, it can quickly increase output when prices rise. This makes supply more elastic.
  3. Stock Levels: Firms that hold high levels of inventory (stocks) of finished goods can supply them to the market immediately when prices rise, making supply very elastic in the short term.
  4. Factor Mobility: This refers to the ease of switching resources (labour, capital) into producing the good. If it's easy to find skilled workers and get raw materials, supply will be more elastic.
  5. Production Complexity & Length: Goods that are simple and quick to make (e.g., t-shirts) have more elastic supply than goods that are complex and take a long time to produce (e.g., commercial aircraft, new housing).

Key term

Factor Mobility: The ease with which factors of production, such as labour or capital, can be moved from one productive use to another.

Examiner insight

When asked to compare the PES of two products, always refer to specific determinants. For example, don't just say 'supply of cars is inelastic'; say 'supply of cars is inelastic in the short run because building a new factory takes years'.

Worked example 14 marks

Explain why the PES for agricultural products like wheat is often lower than the PES for manufactured goods like pencils.

  1. 1

    Step 1: Apply the 'time' determinant. Wheat has a long growing season. Once a crop is planted, the supply cannot be increased until the next harvest, making it very inelastic in the short run.

  2. 2

    Step 2: Apply the 'production complexity/length' determinant. Pencils are relatively simple to manufacture. Production can be ramped up quickly by running more shifts or turning on idle machines.

  3. 3

    Step 3: Apply the 'stock levels' determinant. It is easier and cheaper to store pencils than perishable wheat. Firms can hold large stocks of pencils, making supply elastic.

  4. 4

    Conclusion: The PES for wheat is lower (more inelastic) due to long production times and biological constraints. The PES for pencils is higher (more elastic) due to simple production, the ability to hold stocks, and the potential for spare capacity.

Worked example 23 marks

A firm making handmade leather bags has no spare factory space and all its skilled workers are fully employed. How would this affect its price elasticity of supply? Explain your answer.

  1. 1

    Step 1: Identify the relevant determinants. The key factors here are spare capacity and availability of labour (a factor of production).

  2. 2

    Step 2: Analyse the impact. The firm has no spare capacity and no more available skilled workers. This means it cannot easily increase its production level, even if the price of bags rises significantly.

  3. 3

    Step 3: Conclude on PES. These constraints make the firm's price elasticity of supply very low, or inelastic. To increase supply, it would need to invest in a new factory and train new workers, which can only happen in the long run.

Recap

  • Supply is more elastic in the long run than in the short run.
  • Firms with spare capacity can respond to price changes more easily, making supply more elastic.
  • High stock levels allow firms to increase supply quickly, leading to higher elasticity.
  • The easier it is to get resources (factor mobility), the more elastic supply will be.
  • Complex products that take a long time to make have inelastic supply.

Quick check

  1. Is supply more elastic in the short run or the long run? Why?2 marks
  2. Name two factors that would make the supply of a good price inelastic.2 marks

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define 'price elasticity of supply' and state the formula used to calculate it.3 marks
  2. The price of a digital subscription service increases from $10 to $12 per month. As a result, the company finds it can handle an increase in the number of subscribers supplied from 5 million to 6.5 million. Calculate the PES for this service.4 marks
  3. Explain why the supply of beachfront holiday homes is likely to be price inelastic.4 marks
  4. Draw a diagram to illustrate a perfectly elastic supply curve and a perfectly inelastic supply curve. Label your axes and curves correctly.4 marks
  5. A firm has a PES of 0.4. If it plans to increase its quantity supplied by 8%, what percentage price increase must it expect to see in the market?3 marks
  6. Compare the likely price elasticity of supply for a fast-food burger with that of a nuclear power station. Justify your answer using two determinants of PES.6 marks
  7. Explain how the time period (short run vs. long run) affects the price elasticity of supply for most goods.4 marks
  8. A government wants to raise tax revenue by placing an indirect tax on a product. Should it choose a product with elastic or inelastic supply to maximise its revenue? Explain your reasoning.5 marks
  9. If a product has a PES of 1, what is this type of elasticity called? Describe the relationship between the percentage change in price and the percentage change in quantity supplied for such a product.2 marks
  10. Analyse how a firm's decision to invest in new, flexible manufacturing technology might affect the price elasticity of supply for its products.6 marks

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