ELASTICITY AND ITS APPLICATION (wk54)

LEARNING OBJECTIVES
Under this topic, you will:
• Learn the meaning of the concept of elasticity
• Learn the meaning of the elasticity of supply
• Examine what determines the elasticity of supply
• Apply the concept of elasticity to price, to both supply
and demand, to income and demand and the
relationship between the changing prices of different
products on demand
• Examine what determines the elasticity of demand
• Understand the relevance of elasticity to total
expenditure and total revenue
• Apply the concept of elasticity in two different markets

PRICE ELASTICITY OF SUPPLY

Elasticity is a measure of the responsiveness of quantity demanded or quantity
supplied to one of its determinants.

Price elasticity of supply is a measure of how much the quantity supplied of a

good responds to a change in the price of that good, computed as the
percentage change in quantity supplied divided by the percentage change in
price.

Supply of a good is said to be elastic (or price sensitive) if the quantity supplied
responds substantially to changes in the price.
Supply is said to be inelastic (or price insensitive) if the quantity supplied
responds only slightly to changes in the price.

The Determinants of Price Elasticity of Supply

 The Time Period. In most markets, a key determinant of the price elasticity
of supply is the time period being considered. Supply is usually more
elastic in the long run than in the short run.
  Productive Capacity. In periods of strong economic growth, firms may be
operating at or near full capacity. If demand is rising for the product they
produce and prices are rising, it may be difficult for the firm to expand output to
meet this new demand and so supply may be inelastic.

When the economy is growing slowly or is contracting, some firms may find they
have to cut back output. if demand later increased and prices started to rise, it
may be much easier for the firm to expand output relatively quickly and so
supply would be more elastic.

 The Size of the Firm/Industry. It is possible that as a general rule, supply

may be more elastic in smaller firms or industries than in larger ones.

 The Mobility of Factors of Production. Consider a farmer whose land is

currently devoted to producing wheat. A sharp rise in the price of rape
seed might encourage the farmer to switch use of land from wheat to rape
seed relatively easily. The mobility of the factor of production land, in this
case, is relatively high and so supply of rape seed may be relatively elastic.

 Ease of Storing Stock/Inventory. In some firms, stocks can be built up to

enable the firm to respond more flexibly to changes in prices. In industries
where inventory build-up is relatively easy and cheap, the price elasticity of
supply is more elastic than in industries where it is much harder to do this.
Example fresh fruit industry.
Computing the Price Elasticity of Supply
The price elasticity of supply is computed as the percentage change in the
quantity supplied divided by the percentage change in the price.