Calculation, Determinants & Significance of PES

The Definition and Calculation of PES

The Definition and Calculation of PES

• The law of supply states that when there is an increase in price (ceteris paribus), producers will increase the quantity supplied and vice versa

  • Economists are interested in how much the quantity supplied will increase

• Price elasticity of supply (PES) reveals how responsive the change in quantity supplied is to a change in price

  • The responsiveness is different for different types of products

Calculation of PES

• PES can be calculated using the following formula

$\text{PES = }\frac{\% \mathrm{change} \mathrm{in} \mathrm{quantity} \mathrm{supplied}}{\% \mathrm{change} \mathrm{in} \mathrm{price}} = \frac{\%△ \mathrm{in}\hspace{0.17em}\mathrm{QS}}{\%△\mathrm{in} \mathrm{P}}$

• To calculate a % change, use the following formula

$\% \mathrm{Change} = \frac{\mathrm{new} \mathrm{value} - \mathrm{old} \mathrm{value}}{\mathrm{old} \mathrm{value}} \times 100$ 

 Interpreting PES values

The Values of PES Vary From 0 to Infinity (∞) and They Are Classified As Follows

Name	Explanation
Perfectly inelastic Value = 0	The QS is completely unresponsive to a change in P E.g. Fixed number of seats in a theatre
Relatively inelastic Value = 0→1	The %∆ in QS is less than proportional to the %∆ in P E.g Agricultural products
Relatively elastic Value = 1 → ∞	The %∆ in QS is more than proportional to the %∆ in P E.g T-shirts
Perfectly elastic Value = ∞	The %∆ in QS will fall to zero with any %∆ in P Supply is unlimited at a particular price This is a very theoretical scenario
Unitary elasticity Value = 1	Any supply curve that starts at the origin E.g. S1, S2 or S3 have a PES value equal to 1 The %∆ in P = %∆ in QS

The Determinants of PES

The Determinants of PES

• Some products are more responsive to changes in prices than other products

• The factors that determine responsiveness are called the determinants of PES and include:

  • Mobility of the factors of production
    If producers can quickly switch their resources between products, then the PES will be more elastic. For example, if prices of hiking boots increase and shoe manufacturers can switch resources from producing trainers to boots, then boots will be price elastic in supply

  • Availability of raw materials
    If raw materials are scarce, then PES will be low (inelastic). If they are abundant, PES will be higher (elastic)

  • Ability to store goods
    If products can be easily stored, then PES will be higher (elastic) as producers can quickly increase supply (for example, tinned food products). An inability to store products results in lower PES (inelastic)

  • Spare capacity
    If prices increase for a product and there is capacity to produce more in the factories that make those products, then supply will be elastic. If there is no spare capacity to increase production, then supply will be inelastic

  • Time period
    In the short run, producers may find it harder to respond to an increase in prices as it takes time to produce the product (e.g. avocados). However, in the long run, they can change any of their factors of production so as to produce more

The Significance of PES for Stakeholders

The Significance of PES for Stakeholders

• If producers have a high PES (elastic), then they are able to respond to increases in price very quickly

  • This is desirable as it means producers can increase revenues and profits if they can supply more

  • Firms can increase their PES by:

    • Creating more spare capacity on their production lines

    • Maintaining larger inventories

    • Using more modern technology

• If producers have a low PES (inelastic) then they are less able to respond to increases in price

  • This shortage in supply will mean that prices continue to rise, possibly causing inflation in the economy

• Governments are very interested in the PES of key markets in the economy as they want to ensure that these markets can respond quickly to rising demand

  • One example is the housing market

    • If the PES of housing is low (inelastic), property prices will become unaffordable with any increase in demand

  • Another example is the labour market

    • If the PES of labour is low (inelastic) then production costs of firms will rise quickly during periods of increasing demand when firms need to hire additional workers