The Price Elasticity of Supply and Its Determinants

The law of supply states that higher prices raise the quantity supplied. The price elasticity of supply measures how much the quantity supplied responds to changes in the price. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price.

The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce. For example, beachfront land has an inelastic supply because it is almost impossible to produce more of it. By contrast, manufactured goods, such as books, cars, and televisions, have elastic supplies because price elasticity of supply a measure of how much the quantity supplied of a good responds to « change wi the price of that good, computed as the percentage change •n quantity supplied divided by the percent age change in peace firms thai produce them can run their factories longer in response to a higher price.

In most markets, a key determinant of the price elasticity of Supply is the time period being considered. Supply is usually more elastic in the long run than in the short run. Over short periods of time, firms cannot easily change the size of their factories to make more or less of a good. Thus, in the short run, the quantity supplied i> not very responsive to the price. By contrast, over longer period», firms can build new factories or close old ones. In addition, new firms can enter a market/and old firms can shut down. Thus, in the long run, the quantity' supplied can respond substantially to price changes.

Computing the Price Elasticity of Supply

Now that we have a general understanding about the price elasticity of supply, let'* be more precise. Economist» compute the price elasticity of supply as the percentage change in the quantity supplied divided by the percentage change in the price. That is,

Price elasticity of *upply - ^revntye chan^ ,n ^.xnhtv ^luM Percentage change m price

For example, suppose that an increase in the price of milk from $.2.85 to $3.15 a gallon raises the amount that dairy fanners produce from 9,000 to 11XXX) gallons per month. Using the midpoint method, see calculate the percentage change in prke as

Percentage change in prk* - (3,15 - 2.85) / 3.00 x 11» - 10 percent

Similarly, we calculate the percentage change in quantity supplkd as

Percentage .hange in quantity supplied - (11,000 - WO) / 10,0CK> x 100 - 20 petccnt In this case, the price elastkily of supply is

Pricv elasticity of supply = fp ^rcent = ^

In this c>-imple, the elasticity of 2 indicates that the quantity supplied changes proportionately twice as much as the price.

The Variety of Supply Curves

Because the price elastkily of supply measures the responsiveness of quantity supplied to the price, it is reflected in the appearance of the supply curve. Figure 5 shows five cases. In the extreme case of a zero elasticity, as shown in pane) (a), supply is perfectly tnrinsfrc, and the supply curve is vertical. In this case, the quantity supplied is the same regardless of lite price. As tlx* elastkily rises, lite supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price. At the opposite extreme, shown in panel |e>, supply is perfectly elastic. This occurs as the price elastkily of supply approaches infinity and the supply curse becomes horizontal, meaning that very small changes in Ihe prke lead to very large changes in the quantity supplied.

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