Unit 2.6: Price elasticity of supply
This lesson focuses on the price elasticity of supply. You will have already established that there is a direct relationship between the price of a product and the level of quantity supplied. However, it would be wrong for students to think that the rate of change of quantity supplied does not vary, depending on the good or service. I find that students will very often get the factors that determine PES and PED confused and presume that factors such as degree of necessity also impact on supply. I explain the factors that determine PES in the following way: It is safe to assume that all entrepreneurs would normally wish to raise output levels following a rise in price, ceteris paribus. The question is can they? Are they able to gain access to additional raw materials or skilled labour? Does the factory have spare capacity and lastly, how long is the production process? The page contains a simple investigation exercise, containing simple calculations. Elasticity calculations can be found on the paper three (HL only paper).
What factors determine the extent to which the quantity supplied for different goods and services changes in response to movements in selling price.
Lesson time: 70 minutes
To understand the concept of price elasticity of supply, as the responsiveness of
quantity supplied to a change in price along a given supply curve.
To calculate PES using the following equation - PES (percentage change in quantity supplied) percentage change in price.
Explain the determinants of PES, including time, mobility of factors of production, unused capacity and ability to stock pile components and supplies.
1. Beginning question
Firms will adjust their supply of a good or service in response to changes in the selling price. Following a rise in the price, which of the following businesses will find it easiest to raise their output levels?
- car manufacturers
- bespoke shoe producers
- coffee producers.
Key term: Price elasticity of supply
A measure of the responsiveness of quantity supplied to changes in price. When the price of a good or service changes we would also expect a change in the quantity supplied BUT not a change in supply – i.e a movement along the supply curve not a shift in the supply curve.
The degree to which the quantity supplied changes depends on the price elasticity of supply for the product, measured by the formulae:
% change in quantity supplied for the good or service / % change in the price of the product.
Range of price elasticity of supply (PES) values
Goods and services with a PES value > 1 and < infinity are PES elastic (i.e a top heavy fraction). Following a change in the price of a good or service then the % change in quantity supplied for the product is greater than the initial % change in price.
Goods and services with a PES value < 1 and > 0 are PES inelastic (i.e a bottom heavy fraction). Following a change in the price of product the % change in quantity supplied for the good or service is less than the initial % change in price.
Goods and services with a PES value = 1 have unitary elasticity. Following a change in price the resulting % change in quantity supplied will be equal to the % change in price.
Available as a class handout at: PES notes
The following diagrams illustrate the supply curve for two products, one represents a firm producing children's toys and the other an olive farmer. Which is which?
Activity 3: A comparison of two businesses
Diagram 1 illustrates the market for children's toys, or indeed many manufactured products.
(a) Illustrate on the diagram a rise in demand for children's toys. Draw the new equilibrium.
(b) Following the rise in demand for their product, how is the factory owner likely to change her production levels in response to both higher demand and higher prices?
(c) How easy will this be for the factory owner, presuming that skilled labour and sufficient raw materials are available to increase production levels?
A comparison with the olive farmer
Diagram 2 illustrates the market for olives, or indeed many agricultural or primary products.
(a) Illustrate on the diagram a rise in demand for olives. Draw the new equilibrium.
(b) Following the rise in demand for his olives, how is the olive farmer likely to change his production levels in response to both higher demand and higher prices?
(c) How easy will this be for the farmer?
Activity 4: Other determinants of PES
Describe the impact of the following on the level of PES for any good or service.
(a) The degree to which costs rise in response to changes in output
(b) The level of unused capacity in the production unit
(c) The degree of mobility of the necessary factors of production
(d) The ability of the business to store stock or other raw materials
Activity 5 investigation
Investigate how long it takes to produce the following items:
- a Toyota car
- coffee (from planting the original tree to drinking your first cup)
- drilling for oil
- bespoke suit.
Explain the likely impact of your findings on the price elasticity of supply?
Activity 6: Degree of elasticity
Place the following descriptions in the box below the arrow, indicating the likely degree of PES elasticity associated with the statement:
PES inelasticity (PES=0) PES=1 Perfect elasticity (PES=∞)
Goods with a PES close to 0 would be those with ________ spare capacity. They are also likely to have a ________ production time, use highly ________________ factor resources, such as skilled labour or scarce resources. They are generally but not always agricultural / _____________ products.
By contrast, goods with a high PES, will be those where the production facility has ____________ spare capacity. They are also likely to have a ________ production time, use factor resources, which are easy to substitute, such as ________ labour or __________ resources. PES elastic goods are usually __________ goods or _____________.
Activity 7 (Paper three type)
Watch the following short video before attempting the short questions that follow:
1. Using the formulae % change in supply / % change in price, calculate the PES elasticity of the following goods and services and state whether each is PES elastic, inelastic or PES unitary:
a. Price goes from 50 TL to 90 TL forcing supply to increase from 60 units to 100
b. Supply rises from 10 – 20 following a rise in price from 10 TL to 50 TL
c. Price falls from 100 – 50 and supply is unchanged
d. Supply rises from 10 – 30 when price rises from 100 TL to 110 TL
Activity 8 – practise questions
1. A computer manufacturer produces computers and increases the price from $ 600 to $ 800. Following the rise in price, the quantity supplied by the firm, each week, rises from 1 million to 1.1 million units. In the months that follow the weekly output rises further to 1.8 million units
(a) Calculate the level of PES in the short run
(c) Explain why the level of PES is greater in the long run than the short run
2. The price and output of coffee beans is included in the table below:
$ per Kg
4 July 2018
13 August 2018
22 October 2018
11 March 2019
a. Complete the table by calculating the PES for coffee
b. Explain why the PES for the crop is PES inelastic
c. Use an explanation of PES theory to explain why the price of coffee fluctuates over relatively short periods of time?
3. Assign each of the following products to one of the following PES and PED curves - ski equipment, bespoke shoes, diamonds, tickets for a football stadium, cheap T-shirts and bread:
Activity 9: Reflection activity
Reflect on how PES theory can be used to explain some topical applications of economic theory, which may be of use in your IB course?
Activity 10: Link to the assessment (HL)
PES questions will generally be found in paper one, with examples of PES questions including:
Explain why the price elasticity of supply for primary commodities tends to be lower than the price elasticity of supply for manufactured products. [10 marks]
“The price elasticity of supply for primary products tends to be lower than that for manufactured goods and services.” Using real life examples, evaluate the implications of this for producers of primary products, manufactured goods and services. [15 marks]
The concept of supply elasticity is also one of the more popular concepts to include in an IA portfolio, for example an article concerning the low PES of oil or other primary commodities and how this impacts on the market price for that product.