ECO 0101

Microeconomics

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Chapter 3

Supply & Price Elasticity of Supply

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Learning Outcome
 Explain the meaning of supply, law of supply and market supply
 Construct a supply schedule and supply curve
 Distinguish between a change in quantity supply and change in supply
 Explain the determinants of supply
 Explain the concept of elasticity
 Calculate the elasticity of supply
 Explain five degree of price elasticity of supply
 Explain the determinants of price elasticity of supply

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Definition of supply

Supply is defined as the ability and willingness

to sell or produce a particular product and
services in a given period of time at a particular
price, ceteris paribus

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Law of Supply
Law of supply states that the higher the price of a good, the greater is the
quantity supplied for that good and the lower the price, the lower is the
quantity supplied, ceteris peribus.

𝑷 ↑ 𝑸𝒔 ↑ 𝑷 ↓ 𝑸𝒔 ↓

Positive relationship

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Cont…
 Supply: the quantity of a good that is offered for sale at all possible prices
 “When the price of a good rises, the quantity supplied will also rise.”
 There are 3 reasons for this
 As firms supply more, they are likely to find that beyond a certain level of output
cost rise more and more rapidly
 The higher the price of the good, the more profitable it becomes to produce
 If the price of a good remains high, new producers will be encouraged to set up in
production. Total market supply thus rises

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Supply Schedule and Curve
Supply Curve
Price Quantity 6

5
5 10
4
4 8

Price
3
3 6
2
2 4
1
1 2
0
2 4 6 8 10
Quantity

Supply
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Individual and Market Supply
INDIVIDUAL SUPPLY
The relationship between the quantity of a product supplied by a single
seller and its price

MARKET SUPPLY
The relationship between the total quantity of a product supplied by adding
all the quantities supplied by all sellers in the market and its price

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Determinants of supply
Proportion of
Price of related Expected future Technological
the expenditure
goods price advancement
on a product

The profitability The profitability

Improvement in Cost of
of alternative of goods in joint
infrastructure production
products supply

Government Number of The aims of Nature, random

policies sellers producers shocks

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Determinants of Supply
 The costs of Production – the higher the costs, the less profit will be made
at any price.
 The main reasons for a change in this costs are:
 Change in input prices – costs of production will rise if wages, raw material prices,
rents, interest rates or any other input prices rise
 Change in technology – technological advances can fundamentally alter the costs of
production
 Organizational changes – various cost savings can be made in many firms by
reorganizing production
 Government policy – costs will be lowered by government subsidies and raises by
various taxes

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Cont…
 The profitability of alternative products – supply of the first good falls.
Other goods are likely to become more profitable if:
 Their prices rises
 Their costs of production fall

 The profitability of goods in joint supply – sometimes when one good is

produced, another good is also produced at the same time

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Cont…
 Nature, ‘random shocks’ and other unpredictable events – weather
diseases, wars affecting the supply of imported raw materials, the
breakdown of machinery, earthquakes, floods and fire, etc

 The aims of producers – A profit-maximizing firm will supply a different

quantity to maximize sales – firms are profit maximisers

 Expectations of future price changes – If a price is expected to rise,

producers may temporarily reduce the amount they sell – release them on
to the market only when the price does rise

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Changes in Quantity Supplied vs.
Changes in Supply
Changes in Quantity Supplied
• Movement along the same supply curve
• Price changes and other factors are constant
• Downward movement – decrease in quantity
supplied (Contraction)
• Upward movement – increase in quantity
supplied (Expansion)
Changes in Supply
• Shift in the supply curve
• Occurs when there are changes in factors other
than the price (price remains constant)
• Increase in supply – shift to the right
• Decrease in supply – shift to the left
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 Factor
Price
• The cost of production
• The profitability of alternative
products
• The profitability of goods in joint
supply
• Nature, ‘random shocks’ and other
unpredictable events
• The aims of producers
• Expectations of future price changes
Effect
• Price changes cause movements along a supply curve
• Price decreases are associated with contraction in the
particular quantity supplied
• Price increases are associated with expansion in the
particular quantity supplied
• A change in any one of these factors will cause a shift in
the supply curve itself
• With increases or decreases in supply at every possible
price
• Curve will shift to the right if increase
• Curve shift to the left if decrease
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Active Learning 2
Draw a supply curve for the software
What happens to it in each of the following scenarios?
A. Retailers cut the price of the software
B. A technological advance allows the software to be produced at lower
cost

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A. Fall in price of software

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B. Fall in cost of producing the software

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Price Elasticity
of Supply

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Price Elasticity of Supply

Definition:

Measures the sensitivity / responsiveness of the quantity

supplied due to a change in the price of a product or
service.

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Price Elasticity of Supply Formula

𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑

𝜀𝑠 =
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

(𝑛𝑒𝑤 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 − 𝑜𝑙𝑑 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦)

× 100%
𝑜𝑙𝑑 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝜀𝑠 =
(𝑛𝑒𝑤 𝑝𝑟𝑖𝑐𝑒 − 𝑜𝑙𝑑 𝑝𝑟𝑖𝑐𝑒)
× 100%
𝑜𝑙𝑑 𝑝𝑟𝑖𝑐𝑒

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Degrees of Price Elasticity of Supply
1. Fairly elastic
 The coefficient is larger than one
 The percentage change in quantity supplied is greater than the percentage change in
price
 Quantity supplied is very responsive to a change in price that a small percentage
change in price leads to a bigger percentage change in quantity supplied

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Elastic Supply Curve

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Cont…
2. Fairly inelastic
 The coefficient is less than one
 A percentage change in price leads to a smaller percentage change in quantity
supplied
 Quantity supplied is not very responsive to a price change

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Inelastic supply curve

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Cont…
3. Unitarily elastic
 If the coefficient is equal to one
 The percentage change in quantity supplied is equal to the percentage change in
price
 If the price change by 10%, the resulting change in quantity supplied will also be
10%

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Unitarily elastic

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Cont…
4. Perfectly elastic
 Refers to demand which is super sensitive to a price change
 A small percentage change in price brings about an infinite percentage change in
quantity supplied
 The coefficient is infinity
 The supply curve is horizontal

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Perfectly elastic

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Cont…
5. Perfectly inelastic
 Has a coefficient of zero
 Quantity supplied does not change as price changes
 Supply curve is vertical

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Perfectly inelastic

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Determinants of Price Elasticity of
demand

Technology Nature of the Amount that

Time period
improvements market costs rise

Availability and
Gestation
mobility factors Perishability
period
of production

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 Determinants of Price Elasticity of
Supply
 The amount that costs rise as output rises
 The less the additional costs of producing additional output, the more will firms be
encouraged to produce for a given price rises: the more elastic will supply be

 Time period
 Time greatly influences the elasticity of supply, unlike with the elasticity of demand
 In the short term, supply tends to be inelastic due to insufficient time to organize and
adjust supply to demand (e.g. Agricultural products)
 However, in the long term, supply becomes more elastic
 Sellers are more responsive to changes in price, since they can adjust their supply or
production (eg. Manufacturing products)

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Cont…
 Gestation period
 Refers to the time needed to produce something
 Is a product can be produced in a short period of time, sellers can respond quickly to
a price change
 Eg. If the price of stationary increases, producers will increase the quantity supplied
immediately, as the gestation period is short
 So, in this case, supply is elastic
 Technology Advancements
 Modern methods of production expand output and thus, the supply tends to be
elastic. The number of output produced in a given period of time is lower when old
methods of production are used

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Cont…
 Availability and mobility of factors of production
 When factors of production, such as land, labour, and capital are available and can
easily be moved from one occupation to another, supply tend to be more elastic

 Nature of the market

 When products can be sold in different markets, supply becomes more elastic. This
is because a price fall in one market can be a good thing for other market

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Cont…
 Perishability
 There are perishability products such as agricultural products (eg. Fruits and
vegetables) and supply tend to be inelastic
 Changes in price do not affect supply much because sellers cannot store perishable
products for long periods of time
 In the case for less perishable products such as manufactured products (eg. Cars,
shoes, and canned food), the supply is more elastic
 If sellers expect a price increase in another two month, they may store these
products for future sale

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Tutorial : Demand
A grocery store observes that at RM 2.00 per gallon of milk, buyers
purchase 800 galloons per day. The next week, the grocery store increases
its price to RM 3.00 per gallon and buyers purchase 700 gallons per day.

You are required to:

a) Sketch the demand curve for the case above
b) Calculate the price elasticity of demand for milk

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6

0
500 600 700 800 900
Demand

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 The change in quantity demanded = 100
 The change in price = RM 1.00

Elasticity

(700 − 800)
× 100%
= 800
(3 − 2)
× 100%
2
−12.5%
=
50%

= −0.25

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