2.6 Price Elasticity of Supply [PES]

Question 1

What is price elasticity of supply?

Answer 1

Measures the responsiveness of quantity supplied to changes in price

Question 2

How do you calculate price elasticity of supply?

Answer 2

PES = % Quantity supplied / % Price

Question 3

What is the good when PES > 1

Answer 3

the supply of the good is price elastic, meaning that firms are responsive to changes in price

Question 4

What is the good when PES < 1

Answer 4

supply is price inelastic = unresponsive

Question 5

What is the good when PES = 0

Answer 5

supply is perfectly price inelastic, a change in price has no effect on quantity supplied (eg. a football stadium, regardless of price it has a maximum output/ seats)

Question 6

What are the determinants of PES?

Answer 6

TICCS:

Time
Marginal Costs
Unused Capacity
Substitution of FOPs

Question 7

How is “Time” a determinant of PES?

Answer 7

In the SR the supply of a product is price inelastic as firms do not necessarily have the resources to increase output.
In the LR, firms can adjust their production to price changes in the market.
(Firms with high levels of inventories tend to have the supply of their product being price elastic as they can increase supply rapidly if there are changes to market price)

Question 8

How are “Marginal costs” a determinant of PES?

Answer 8

Additional costs of producing 1 extra unit of output
Owing to the law of diminishing marginal returns, the marginal costs (MC) of production will increase up to a certain level of output due to the marginal FOPs becoming more expensive to employ. Therefore a firm will not be willing nor able to produce at a price below the MC as it would be making a loss. So, if the firm is able to increase its output without its MC raising at a faster rate the supply of its product is price elastic.

Question 9

How is “Unused Capacity” a determinant of PES?

Answer 9

Refers to the firms spare productive capacity
A firm with plenty of spare capacity can increase the quantity supplied of its product relatively easily without experiencing an increase in its average cost of production. In this case, the supply of the product is price elastic.

Question 10

How is the “Substitution of FOPs” a determinant of PES?

Answer 10

The easier it is to substitute FOPs the more price elastic the supply of the firms product is, as the firm can adjust to changes in the market price
In contrast, if FOPs cannot be easily substituted, the supply of the product is price inelastic.
We refer to immobility of FOPs:
- Geographical immobility
eg. difficult to relocate from Europe to Australia due to relocation costs
- Occupational immobility
eg. difficult to transfer the skills from 1 occupation to another