The Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied of a product or service to the change in its price. It is an important concept in microeconomics that helps businesses and policymakers understand how changes in price will affect the number of items supplied and make informed decisions about pricing, production and distribution of products.
The elasticity of supply formula is: The Price Elasticity of Supply = Percentage (%) change in Quantity Supplied / Percentage (%) change in Price
When the price of a good or service increases, the quantity supplied typically increases as well. However, the rate of increase in quantity supplied may not be the same as the rate of increase in price. This is where PES comes into play. PES measures the percentage change in quantity supplied in response to a percentage change in price.
Types of Price Elasticity of Supply
Economists consider PES to be associated with the law of supply which states that as the price of a product increases, suppliers tend to raise the number of products for sale in order to maximise profits.
To put it simply, if the consumers demand more bananas over oranges, resulting in a price increase for bananas; fruit producers tend to shift their focus more towards growing bananas rather than oranges.
Furthermore, there are four different types of price elasticity of supply. Let's take a closer look at them.
1. Perfectly Elastic Supply
If a small change in the price of an item results in an infinite change in the quantity supplied, the supply is considered perfectly elastic. This means that suppliers are willing and able to supply an unlimited quantity of the good at a specific price.
2. Perfectly Inelastic Supply
If a change in price has no effect on the quantity supplied, the supply is considered perfectly inelastic. This occurs when the supplier, regardless of price change, is unable to increase or decrease the quantity of the product being supplied.
3. Relatively Elastic Supply
If the percentage change in quantity supplied is greater than the percentage change in price, the supply is considered relatively elastic. This indicates that the supplier is sensitive to price fluctuations and can adjust the quantity supplied accordingly.
4. Relatively Inelastic Supply
If the percentage change in quantity supplied is less than the percentage change in price, the supply is considered relatively inelastic. This means the supplier is less responsive to price changes and can only make minor changes to the quantity supplied.
Factors Affecting Price Elasticity of Supply
The Price elasticity of supply is also dependent on a few factors similar to the elasticity of demand. Understanding them will help organisations better manage their product supply. Let’s take a deep dive into the five determinants of price elasticity of supply.
1. Production Costs
If the production costs of a product are high, the supply may be more inelastic as suppliers are not able to increase production easily. On the other hand, if the production costs are low, the supply is likely to be more elastic.
2. Availability of Substitutes
The availability of substitute goods is one of the crucial factors affecting price elasticity of supply. If there are many substitute goods available, then the supply of a good is likely to be more elastic as suppliers can easily shift production to other goods.
3. Nature of the Product
One of the important determinants of price elasticity of supply is the nature of the product itself. For example, goods that are essential for basic needs, such as food and clothing, tend to have a relatively inelastic supply, while luxury goods, such as jewellery and expensive cars, tend to have a more elastic supply.
4. Production Process
The production process of a good can also impact its PES. For example, goods that can be produced quickly and easily, such as food products, tend to have a more elastic supply, while goods that require more time and effort to produce, such as complex machinery, tend to have a more inelastic supply.
5. Time frame
The PES of a product can vary depending on the time frame considered. In the short run, the supply of some goods may be more inelastic due to limited production capabilities, while in the long run, the supply may become more elastic as businesses have time to adjust production and increase supply.
Moreover, the factors affecting price elasticity of supply play a significant role in determining the responsiveness of the quantity supplied of a product to a change in its price. You can also have a look at elasticity vs inelasticity of demand to understand how it affects supply. Now, let’s look at how it can help businesses and pricing managers.
Why is Price Elasticity of Supply Important to Understand for Businesses?
Knowing how PES works is important to businesses, as it can help them determine the optimal pricing strategy across their product portfolio. If a product has an elastic PES, a business may not want to increase the price as it may result in a large decrease in quantity supplied and vice versa if it has inelastic PES.
Policymakers also use PES to determine the impact of taxes or subsidies on the quantity supplied of a good or service. If a good or service has an elastic PES, a tax may result in a large decrease in the quantity supplied.
However, if a good or service has an inelastic PES, a tax may not significantly affect the quantity supplied. Similarly, subsidies will have a greater impact on items with an elastic PES than those with an inelastic PES.
Likewise, companies can leverage their understanding of products’ price elasticity of supply to determine a robust pricing strategy and maintain maximum profit margins. However, doing manual research into each aspect of each product and making changes is extremely draining and time-consuming.
To ward off such delays and inefficiencies, today’s AI pricing platforms help conduct in-depth market research and suggest and implement optimal price changes in dramatically less time. You can have a look at SYMSON’s solutions so you can focus on other more important aspects.
Do you want a free demo to try how SYMSON can help your business with margin improvement or pricing management? Do you want to learn more? Schedule a call with a consultant and book a 20 minute brainstorm session!
