SECTION 2

The allocation
of resources

5 Microeconomics and macroeconomics

6 The role of markets in allocating resources 11 Price elasticity of demand
7 Demand 12 Price elasticity of supply
8 Supply 13 Market economic system
9 Price determination 14 Market failure
10 Price changes 15 Mixed economic system
 Price elasticity of supply
Supply is said to be
price elastic if producers can quite easily increase supply without a time delay if
there is an increase in the price of the product.

This can help to give such firms a

competitive advantage as they are able to respond to changes in price.

Price elasticity of supply (PES) measures the degree of responsiveness of

quantity supplied of a product following a change in its price.

Calculating price elasticity of supply

Percentage change in quantity supplied % ΔQS

Percentage change in price % ΔP
 Price elasticity of supply
Price elasticity of supply (PES) measures the degree of responsiveness of
quantity supplied of a product following a change in its price.

Calculating price elasticity of supply

Percentage change in quantity supplied
% ΔQS
Percentage change in price
% ΔP

The market price of beans increases from $2 per kilo to $2.20 per
kilo, causing quantity supplied to rise from 10,000 units to 10,500 units then the

PES is calculated as:

» Percentage change in quantity supplied =
» Percentage change in price =
» PES =
 Price elasticity of supply
Price elasticity of supply (PES) measures the degree of responsiveness of
quantity supplied of a product following a change in its price.

Calculating price elasticity of supply

Percentage change in quantity supplied
% ΔQS
Percentage change in price
% ΔP

The market price of beans increases from $2 per kilo to $2.20 per
kilo, causing quantity supplied to rise from 10,000 units to 10,500 units then the

PES is calculated as:

» Percentage change in quantity supplied = (10,500 – 10,000)/10,000 = +5%
» Percentage change in price = ($2.20 – $2)/$2 = +10%
» PES = +5%/+10% = 0.5
What this means is that the supply of beans is hardly affected by the change in
price — that is, supply is relatively price inelastic. Note that the value of PES is
positive due to the law of supply — an increase in price tends to increase the
quantity supplied.
 Price elasticity of supply
Interpreting supply curve diagrams and price elasticity of supply
The value of PES reveals the degree to which the quantity supplied of a product
responds to changes in price.
The calculation of PES generally has 2 possible
outcomes:
» If PES is greater than 1, supply is price elastic — that is, quantity supplied
is responsive to changes in price.
This is because the percentage change in quantity supplied is greater than the
percentage change in price

A price elastic supply curve

 Price elasticity of supply

» If PES is less than 1, supply is price inelastic — that is, quantity supplied is
relatively unresponsive to changes in price.
This is because the percentage change in quantity supplied is less than the percentage change in price.

A price inelastic supply curve

 Price elasticity of supply
Three special cases which are theoretical possibilities:

1. The perfectly price inelastic supply curve

2. The perfectly price elastic supply curve

3. The unitary price elasticity supply curve

 Price elasticity of supply

» If the PES of a product is equal to 0, then supply is perfectly price inelastic —

that is, a change in price has no impact on the quantity supplied. This suggests
that there is absolutely no spare capacity for suppliers to raise output,
irrespective of increases in price.
 Price elasticity of supply
» If the PES of a product is equal to infinity (∞) then supply is perfectly price elastic —
that is, the quantity supplied can change without any corresponding
change in price.
For example, a software developer selling products online
can very easily increase supply to match higher levels of demand, without any
impact on the price level. Due to the spare capacity that exists, suppliers are able to raise
output at the current price level.
 Price elasticity of supply
» If the PES for a product is equal to 1 then supply has unitary price elasticity —
that is, the percentage change in the quantity supplied matches
the percentage change in price. Any upward-sloping supply
curve that starts at the origin will have unitary price elasticity.
 Price elasticity of supply

Activity
Discuss in pairs why the price elasticity of supply of the following products will differ:

a Smartphones
b Organic vegetables
c Fresh fl owers
d Hotels
e Ferrari cars
 Price elasticity of supply

Determinants of price elasticity of supply

» The degree of spare productive capacity — if a firm has plenty of spare

capacity then it can increase supply with relative ease, without increasing
its costs of production. This means that supply is relatively price elastic.

For example, Coca-Cola’s bottling plants can produce 10,000 bottles of water in
just 60 seconds, so it is very easy for the world’s largest beverage company
with plenty of spare productive capacity to respond to changes in price. In
general, the supply of goods and services is highly price elastic during an
economic recession when there are spare (unused) resources
such as land, capital and labour.
 Price elasticity of supply

Determinants of price elasticity of supply

» The level of stocks — if a firm has unused raw materials, components and
finished products (collectively known as stocks or inventories) that are
available for use, then the fi rm is more able to respond quickly to a change in
price as it can supply these stocks on to the market. Not all inventories are
sold to consumers — raw materials and components (parts used in the
production process, such as gearboxes and motors for cars) are used in the
production process. In addition, some types of stock (such as pencils and ball
bearings) are easier to store than others (such as fresh milk or organic
vegetables), so it will be easier to increase their supply if prices increase. This
means that the higher the level of stocks of fi nished goods (such as cars) that
are ready for sale, the more price elastic supply tends to be.

Stocks (or inventories) are the raw materials,

components and finished goods (ready for sale) used in the production process.
 Price elasticity of supply

Determinants of price elasticity of supply

» The number of producers in the industry — the more suppliers of a product

there are in the industry, the easier it tends to be for firms to increase their output
in response to a price increase.

there is plenty of competition in the restaurant trade, so suppliers will be highly responsive to
increases in price. Hence, the greater the number of fi rms in an industry, the
more price elastic supply tends to be. By contrast, high barriers to entry in the
pharmaceutical industry mean that there are very few suppliers in the industry,
so supply tends to be price inelastic.
 Price elasticity of supply

Determinants of price elasticity of supply

» The time period — in the short run, most fi rms are not able to change their
factor inputs, such as the size of their workforce or the fi xed amount of capital
equipment they employ.

For example, in agricultural farming, the supply of

fresh fruit and vegetables is dependent on the time it takes to harvest the
products and climatic conditions beyond the control of the suppliers. Hence,
supply is less responsive to changes in price in the short run. Supply is more
likely to be price elastic in the long run because fi rms can adjust their levels of
production according to price changes in the market.