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📈 What is Price Elasticity of Supply?

Price Elasticity of Supply (PES) measures how responsive the quantity supplied by producers is to changes in price. It answers: "If price rises by 10%, how much more will producers supply?"

Key Point: PES shows how quickly producers can respond to price changes. High PES means producers can rapidly increase output when prices rise. Low PES means supply is constrained and can't respond quickly, even with higher prices.

The PES Formula (Midpoint Method)

PES = (% Change in Quantity Supplied) / (% Change in Price)
Using midpoint method:
PES = [(Q2 - Q1) / ((Q2 + Q1)/2)] / [(P2 - P1) / ((P2 + P1)/2)]

Simple Example

Wheat price rises from $200 to $240 per tonne. Farmers increase supply from 10,000 to 11,500 tonnes.

% Change Quantity = (11,500 - 10,000) / 10,750 = 14.0%
% Change Price = (240 - 200) / 220 = 18.2%
PES = 14.0% / 18.2%
PES = 0.77 (Inelastic)

Interpretation: Wheat supply is inelastic. Even with 18% price increase, farmers only increased supply by 14%. They can't grow crops faster.

Interpreting PES Values

PES Value Classification Meaning Examples
PES > 1 Elastic Supply very responsive Manufactured goods, services
PES = 1 Unit Elastic Proportional response Some processed foods
PES < 1 Inelastic Supply not very responsive Agricultural products, minerals
PES = 0 Perfectly Inelastic Fixed supply Rare art, beachfront land
PES = ∞ Perfectly Elastic Instant supply response Digital downloads (theoretical)

Key Differences: PES vs PED

Aspect PES (Supply) PED (Demand)
Measures Producer/seller response Consumer/buyer response
Direction Positive (price ↑, quantity ↑) Negative (price ↑, quantity ↓)
High elasticity means Easy to increase production Easy to reduce consumption
Low elasticity means Hard to increase production Hard to reduce consumption

Factors Affecting PES

1. Production Time

  • Short production time = Elastic: T-shirts can be made quickly
  • Long production time = Inelastic: Wine takes years to produce

2. Spare Capacity

  • Spare capacity = Elastic: Factory running at 60% can easily increase output
  • At full capacity = Inelastic: Factory at 100% can't produce more quickly

3. Storage Capability

  • Easy to store = More elastic: Canned goods can be stockpiled
  • Perishable = Less elastic: Fresh fish must be sold immediately

4. Factor Mobility

  • Mobile resources = Elastic: Workers can easily switch to producing different products
  • Specialized resources = Inelastic: Vineyard land can't easily grow other crops

5. Time Period

  • Immediate (1 week): Very inelastic (fixed stock)
  • Short run (few months): Somewhat elastic (increase shifts, overtime)
  • Long run (years): Very elastic (build new factories, hire staff)

Real Product PES Examples

Product Short-Run PES Long-Run PES Why Different
Wheat 0.2 0.8 Can plant more next season
Gold 0.1 0.4 New mines take years
Housing 0.3 1.2 Construction takes time
Smartphones 1.5 2.5 Factories can ramp up
Haircuts 0.8 1.8 Can hire more stylists
Downloaded music ∞ ∞ Infinite copies instantly

Why PES Matters

For Producers:

  • Plan capacity investments (elastic supply needs less capacity buffer)
  • Price setting (inelastic supply allows charging more during demand spikes)
  • Inventory management (elastic supply needs less safety stock)

For Markets:

  • Price stability (elastic supply = stable prices, inelastic = volatile prices)
  • Shortage/surplus response (how quickly markets adjust)
  • Impact of taxes/subsidies (who bears the burden)
💡 Supply Shock Impact

Elastic Supply: Prices rise temporarily, supply adjusts quickly, prices stabilize
Inelastic Supply: Prices spike dramatically, supply can't respond, shortages persist
Example: COVID masks had inelastic supply initially (PES ~0.3), causing prices to jump 500%. Within 6 months, PES rose to 2.0 as factories converted, prices normalized.

⚠️ Important Notes

PES is always POSITIVE (unlike PED which is negative) because price and quantity supplied move in the same direction.

PES varies significantly by time period. Always specify short-run vs long-run.

Government policies affect PES. Regulations, licensing, zoning can make supply more inelastic.

🔢 Calculating Price Elasticity of Supply

Example 1: Coffee Shop Staffing

Scenario: Cafe wages rise, more workers available

Wage: $22/hour → $25/hour
Workers willing to work: 12 → 16
% Change Quantity = (16 - 12) / 14 = 28.6%
% Change Price = (25 - 22) / 23.5 = 12.8%
PES = 28.6% / 12.8%
PES = 2.23 (Elastic)

Interpretation: Labor supply for cafe work is elastic. Small wage increase attracts many workers (students, part-timers).

Example 2: Commercial Property Development

Short-Run (6 months):

Office rent: $500 → $650 per m²/year
Available space: 100,000 → 102,000 m²
PES = 0.12 (Highly inelastic)
Can't build new buildings in 6 months

Long-Run (3 years):

Same rent increase
Available space: 100,000 → 125,000 m²
PES = 1.45 (Elastic)
New buildings completed, supply responds

Example 3: Agricultural Production

Scenario: Dairy price increase

Milk price: $0.50 → $0.70 per liter
Weekly supply: 1M → 1.1M liters
% Change Quantity = (1.1 - 1.0) / 1.05 = 9.5%
% Change Price = (0.70 - 0.50) / 0.60 = 33.3%
PES = 9.5% / 33.3%
PES = 0.29 (Inelastic)

Why inelastic?

  • Cows already producing at capacity
  • Can't quickly breed more cows
  • Farmers already using all available land
  • Would take years to expand dairy operations

Comparing Industries

Industry Price Change Supply Change PES Type
Manufacturing (electronics) +20% +35% 1.75 Elastic
Fresh vegetables +30% +15% 0.50 Inelastic
Consulting services +25% +50% 2.00 Elastic
Beachfront hotels +40% +5% 0.13 Very inelastic

Market Equilibrium Impact

When Demand Increases:

Elastic Supply (PES = 2.0):

Demand ↑ 20%
Price rises only 8%
Quantity increases 16%
Result: Modest price increase, big quantity increase

Inelastic Supply (PES = 0.3):

Demand ↑ 20%
Price rises 18%
Quantity increases only 5%
Result: Large price spike, small quantity increase
Key Insight: Elastic supply keeps prices stable when demand changes. Inelastic supply causes volatile prices. This is why housing (inelastic) has boom-bust cycles while consumer electronics (elastic) have stable prices despite huge demand swings.

Tax Burden and Elasticity

Who pays when government adds tax? Depends on PES and PED.

Inelastic Supply + Elastic Demand:

Example: Tax on professional sports tickets
Supply: Fixed (stadium capacity) PES = 0.1
Demand: Flexible (entertainment options) PED = 2.0
Result: Sellers bear 95% of tax
Can't increase supply, must absorb tax

Elastic Supply + Inelastic Demand:

Example: Tax on gasoline
Supply: Flexible (refineries adjust) PES = 1.5
Demand: Inflexible (must drive) PED = 0.3
Result: Buyers bear 80% of tax
Suppliers pass costs to consumers

🌍 Real-World Supply Elasticity Examples

1
COVID-19 Mask Supply Response

Pandemic creates sudden demand spike

March 2020 (Immediate Period):

Price: $2 → $8 per mask (300% increase)
Global supply: 50M → 60M per day (20% increase)
PES = 20% / 300% = 0.07
Nearly perfectly inelastic

June 2020 (3 months later):

Price stabilized: $3 per mask
Supply: 200M per day (300% increase from baseline)
PES = 1.5 (now elastic)
Factories converted, new producers entered
💡 Supply Transformation

Initial PES of 0.07 (inelastic) caused massive price spikes and shortages. Within 3 months, PES rose to 1.5 (elastic) as clothing factories pivoted, new entrants emerged, and supply chains adapted. Prices fell 60% from peak.

2
NZ Housing Market

Auckland housing demand surge (2015-2021)

Short-Run (1-2 years):

Average price: $800k → $1.2M (50% increase)
Dwellings: 500,000 → 510,000 (2% increase)
PES = 0.04 (extremely inelastic)

Why So Inelastic?

  • Building consents take 6-12 months
  • Construction takes 12-18 months
  • Limited buildable land (geographic constraints)
  • Skilled labor shortages
  • Complex planning regulations

Result:

50% price increase + only 2% supply increase = Housing crisis. Inelastic supply meant demand surge created affordability crisis rather than building boom.

3
Uber Driver Supply

Surge pricing activates driver supply

Normal Friday Night:

Average fare: $20
Drivers active: 500

Concert Ends (Surge 2.5x):

Surge fare: $50 (150% increase)
Drivers active: 1,200 (140% increase)
PES = 140% / 150% = 0.93

Why Relatively Elastic:

  • Drivers can start working within 15 minutes
  • App notifies drivers of surge pricing
  • No capital investment needed (already own cars)
  • Flexible schedule (off-duty drivers return)

Outcome: Elastic driver supply means surge pricing works. Higher prices attract drivers, reducing wait times. If supply was inelastic, prices would stay high without more rides available.

4
Software Development Capacity

Tech company scales development team

Immediate (1 month):

Developer salary: $100k → $130k (30% increase)
Team size: 50 → 52 developers (4% increase)
PES = 0.13 (very inelastic)
Reason: Can only hire immediately available talent

Medium-Term (6 months):

Same salary increase
Team size: 50 → 65 developers (30% increase)
PES = 1.0 (unit elastic)
Reason: Recruited nationally, trained juniors

Long-Term (2 years):

Same salary level maintained
Team size: 50 → 85 developers (70% increase)
PES = 2.33 (elastic)
Reason: Offshore teams, coding bootcamp graduates, automation tools
Time Period Matters: Same price change, vastly different supply responses. PES of 0.13 (1 month) → 1.0 (6 months) → 2.33 (2 years). This is why tech salaries are sticky in short run but adjust in long run.

🎯 Test Your Knowledge

Complete this quiz on Price Elasticity of Supply

1. What does Price Elasticity of Supply measure?
How much consumers will buy
How responsive producers are to price changes
The cost of production
Market demand levels
2. If PES = 2.0, supply is classified as:
Inelastic
Elastic
Perfectly inelastic
Unit elastic
3. Which factor makes supply MORE elastic?
Long production time
Spare production capacity
Specialized equipment needed
Immediate time period
4. Which product typically has the MOST inelastic supply in the short run?
Manufactured clothing
Fresh agricultural produce
Software downloads
Consulting services
5. Price increases 25%, quantity supplied increases 10%. What is PES?
0.4 (inelastic)
2.5 (elastic)
1.0 (unit elastic)
Cannot determine
6. Supply elasticity generally increases as:
Time period decreases
Time period increases
Demand decreases
Prices fall
7. When supply is inelastic and demand increases, what happens to price?
Falls significantly
Stays the same
Rises significantly
Becomes negative
8. Digital downloads (music, software) have PES closest to:
0 (perfectly inelastic)
0.5 (inelastic)
1.5 (elastic)
∞ (perfectly elastic)
9. Unlike PED, PES is always:
Negative
Positive
Zero
Greater than 1
10. A factory running at full capacity will have:
Highly elastic supply
Inelastic supply (can't increase output easily)
Perfectly elastic supply
Negative supply elasticity

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