Cambridge O Level2281

Price elasticity of supply (PES)

Economics 2281 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 PES: Special Cases
  4. 4Factors Affecting Price Elasticity of Supply

1. What is Price Elasticity of Supply?

Price elasticity of supply (PES) measures how responsive the quantity supplied of a good is to a change in its price. In simple terms, it tells us how much or how little supply 'stretches' when the price goes up or down. If a small price increase causes a big increase in the quantity suppliers are willing to sell, we say supply is 'elastic'. If even a large price increase only brings a small increase in quantity supplied, we say supply is 'inelastic'. Economists and businesses use PES to understand how quickly production can adapt to new price signals in the market.

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 degree of responsiveness, not just the direction of the change in supply.

Fun fact

The global supply of helium is highly inelastic because it is a finite resource collected as a by-product of natural gas extraction. It's very difficult to just 'make more' even if the price skyrockets.

Worked example 13 marks

A rise in the market price of a product causes a firm's supply to extend. A fall in price causes it to contract. Does this mean supply is price elastic?

  1. 1

    Step 1: Recall the definition of PES. PES is not just about the direction of change, but the *responsiveness* or *magnitude* of the change.

  2. 2

    Step 2: Note that supply extending with a price rise is the law of supply, which is true for nearly all supply curves, whether they are elastic or inelastic.

  3. 3

    Step 3: To determine if supply is elastic, we would need to know the *percentage* change in quantity supplied and the *percentage* change in price.

  4. 4

    Answer: Not necessarily. All normal supply curves show that quantity supplied increases as price increases. For supply to be price elastic, the percentage increase in quantity supplied must be greater than the percentage increase in price. We do not have enough information to conclude this.

Recap

  • Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a price change.
  • 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).
  • Understanding PES helps firms predict how changes in market price will affect their production levels and revenue.
  • It is a crucial concept for understanding how markets adjust to changes in demand.

Quick check

  1. In your own words, what does it mean if the supply of a product is 'price inelastic'?2 marks

2. Calculating and Interpreting PES

To get a precise measure of PES, we use a formula. The formula compares the percentage change in the quantity supplied with the percentage change in the price that caused it. The resulting number tells us exactly how elastic or inelastic supply is. A value greater than 1 means supply is price elastic. A value less than 1 means supply is price inelastic. A value exactly equal to 1 means supply has unitary elasticity.

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

% Change in Quantity Supplied = ((New Quantity - Original Quantity) / Original Quantity) * 100

% Change in Price = ((New Price - Original Price) / Original Price) * 100

Key term

Unitary Elastic Supply: When the percentage change in quantity supplied is exactly equal to the percentage change in price, resulting in a PES value of 1.

Common pitfall

A common mistake is to put the percentage change in price in the numerator. Remember, quantity always goes on top for elasticity formulas (Q comes before P alphabetically).

Worked example 14 marks

The price of a bunch of carnations increases from 100 cents to 200 cents. In response, a flower farm increases its monthly supply from 10,000 bunches to 12,000 bunches. Calculate the PES for carnations and interpret the result.

  1. 1

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

  2. 2

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

  3. 3

    Step 3: Calculate PES using the formula. PES = % Change in Quantity Supplied / % Change in Price = 20% / 100% = 0.2.

  4. 4

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

Worked example 22 marks

If the price of a smartphone app increases by 20% and the quantity supplied by developers increases by 50%, what is the PES?

  1. 1

    Step 1: Identify the given percentage changes. % Change in Price = 20%. % Change in Quantity Supplied = 50%.

  2. 2

    Step 2: Apply the PES formula. PES = % Change in Quantity Supplied / % Change in Price.

  3. 3

    Step 3: Substitute the values. PES = 50% / 20% = 2.5.

  4. 4

    Answer: The PES is 2.5. Since this is greater than 1, supply is price elastic.

Recap

  • The formula for PES is (% change in Qs) / (% change in P).
  • If PES > 1, supply is price elastic.
  • If PES < 1, supply is price inelastic.
  • If PES = 1, supply has unitary elasticity.
  • The PES value is always positive because price and quantity supplied move in the same direction.

Quick check

  1. A 15% rise in price causes a 5% rise in quantity supplied. Is supply elastic or inelastic?1 mark
  2. What is the formula for PES?1 mark

3. The Spectrum of PES: Special Cases

While most goods have a PES between 0 and infinity, there are five key categories to know, including two special theoretical extremes. Understanding these helps you analyse supply curves visually. A steeper supply curve is more inelastic, while a flatter one is more elastic.

  1. Perfectly Inelastic (PES = 0): Quantity supplied does not change at all, regardless of the price. The supply curve is a vertical line.
  2. Inelastic (0 < PES < 1): Percentage change in quantity supplied is less than the percentage change in price. The supply curve is steep.
  3. Unitary Elastic (PES = 1): Percentage change in quantity supplied is equal to the percentage change in price. Any straight supply curve that passes through the origin has unitary elasticity.
  4. Elastic (PES > 1): Percentage change in quantity supplied is greater than the percentage change in price. 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.

Key term

Perfectly Inelastic Supply: A situation where the quantity supplied remains constant regardless of any change in price, resulting in a PES value of 0.

Examiner insight

Examiners frequently use diagrams. Be ready to identify the type of PES from the shape of a supply curve or to draw a supply curve that reflects a given PES value.

Fun fact

The supply of a mobile network's data might be considered almost perfectly elastic up to its network capacity. The cost of one more person using a gigabyte of data is near zero, so the company is willing to supply a huge amount at the going price.

Worked example 13 marks

The supply curve for seats at a football stadium for a specific match is a vertical line at 75,000 seats. What is the PES for these seats? Explain your answer.

  1. 1

    Step 1: Identify the shape of the supply curve. A vertical supply curve means the quantity supplied is fixed.

  2. 2

    Step 2: Relate the fixed quantity to the PES concept. If the price of tickets doubles, the quantity of seats available remains 75,000. The change in quantity supplied is zero.

  3. 3

    Step 3: Calculate the PES. The percentage change in quantity supplied is 0%. PES = 0% / (% Change in Price) = 0.

  4. 4

    Answer: The PES is 0. This is perfectly inelastic supply. The quantity of seats is fixed at 75,000 and cannot be increased for that specific match, no matter how high the price goes.

Recap

  • A vertical supply curve means PES = 0 (perfectly inelastic).
  • A horizontal supply curve means PES = ∞ (perfectly elastic).
  • A steep supply curve suggests inelastic supply (PES < 1).
  • A flat supply curve suggests elastic supply (PES > 1).
  • Any straight supply curve through the origin (0,0) has PES = 1 (unitary elastic).

Quick check

  1. What is the PES value for a perfectly elastic supply curve?1 mark
  2. Draw a diagram showing a price inelastic supply curve.2 marks

4. Factors Affecting Price Elasticity of Supply

The PES of a product is not random; it depends on several real-world production constraints and possibilities. Understanding these factors is key to applying the concept of PES to different industries and scenarios. The main question to ask is always: 'How easy is it for producers to change their output level in response to a price change?'

Key term

Spare Capacity: The extent to which a firm or factory is operating below its maximum possible output, meaning it can increase production without needing new capital.

Examiner insight

For questions on determinants, don't just list the factor. You must explain *how* and *why* it makes supply more or less elastic to earn full marks.

Fun fact

The supply of Christmas trees is inelastic in December. If prices suddenly spike, you can't grow a 6-foot tree in a week. However, the decision to plant more trees for future years makes the long-run supply more elastic.

Worked example 14 marks

Explain two reasons why the price elasticity of supply for new houses is likely to be low (inelastic).

  1. 1

    Reason 1: Time period. House construction is a very long process. It can take months or years to acquire land, get planning permission, and build the property. Therefore, in the short run, it is almost impossible to significantly increase the supply of new houses in response to a sudden price rise, making supply highly inelastic.

  2. 2

    Reason 2: Availability of resources/Factor mobility. Building houses requires specific resources like land, skilled construction workers (e.g., bricklayers, electricians), and materials. These resources may be scarce or not easily moved to where they are needed. If there is a shortage of skilled labour or suitable land, firms cannot easily expand production, leading to inelastic supply.

Recap

  • The longer the time period, the more elastic supply becomes as firms can adjust all their production factors.
  • If a firm has plenty of spare capacity, its supply will be more elastic.
  • High levels of stock (inventory) allow a firm to respond quickly to price rises, making supply more elastic.
  • The easier it is to move factors of production (labour, capital) into an industry, the more elastic its supply will be.
  • Complex production processes that take a long time tend to have inelastic supply.

Quick check

  1. Does supply become more or less elastic over a longer time period? Explain why.2 marks
  2. Name two factors that determine PES.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 handmade wooden chair rises from $200 to $250. As a result, a carpenter increases production from 10 to 11 chairs per month. Calculate the PES for these chairs and state whether supply is elastic or inelastic.4 marks
  3. Explain two factors that could cause the supply of a product to be price elastic.4 marks
  4. Why is the price elasticity of supply for most agricultural products, like wheat or coffee, typically low in the short run?4 marks
  5. Draw a fully labelled diagram showing a perfectly inelastic supply curve. Give a real-world example of a product that would have this type of supply.3 marks
  6. A firm finds that a 5% increase in the price of its product leads to a 15% increase in the quantity it supplies. Calculate the PES and explain what the value means.3 marks
  7. Using numerical values, distinguish between price elastic supply and price inelastic supply.4 marks
  8. A car factory is operating at only 70% of its maximum capacity. How would this likely affect its price elasticity of supply for cars? Explain your answer.4 marks
  9. Compare the likely PES for natural rubber tapped from trees with the PES for synthetic, factory-made rubber. Justify your answer.5 marks
  10. 'The single most important determinant of price elasticity of supply is the time period under consideration.' To what extent do you agree with this statement?6 marks

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