PRICE ELASTICITY OF SUPPLY

Qammer Shahzad
Lecturer
FG Degree For Men Peshawar Cantt
 Introduction
• Sellers of a good increases the quantity supplied
when
– the price of the good rises
– when their input prices fall
– when their technology improves
• These are qualitative statements about supply
• To give a quantitative explanation we use the
concept of elasticity
 Price Elasticity of Supply
• 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
 Elastic and Inelastic Supply
• Supply of a good is said to be elastic if the quantity supplied
responds substantially to changes in the price.
• responds substantially: Slight(small) change in price bring large
change in supply, Elastic Supply
• 10% change in price brings 100% change in quantity supplied
then it is elastic supply
• Supply is said to be inelastic if the quantity supplied responds
only slightly to changes in the price
• responds only slightly: large change in price bring only a small
change in quantity supplied, Inelastic Supply
• 50% increase in price, leads to only 10% change in quantity
supplied, it is inelastic supply
 Determinants of Elasticity of Supply
• Following are the determinants of elasticity of
supply:
– Flexibility of sellers to change the amount of the good
they produce
• If supply is flexible then supply is elastic
• If supply is inflexible then supply is inelastic
– time period being considered
• more elastic in the long run than in the short run
In short run productive capacity cannot be increased.
In long run 1. New factory can be installed
2. New sellers enter the market
Hence supply is more responsive to price in the long run
 Time in Economics
• Factors of Production: Land, Labour, Capital,
Organization/enterprenuership
• Long Run: When all the factors of production are variable
(Variable means they can be changed to increase
production). Output can be permanently increased. Supply
is elastic
• Short Run: Time in which only one or two factors are
variable rest are constant. Labour is variable
• Land, organization and capital are constant , labour is
variable. Output can be temporarily increased. Supply is
less elastic.
 The Variety of Supply Curves
• Five case of price elasticity of supply can be
enumerated
• Case 1: Elasticity of Supply = 0
• Case 2: Elasticity of Supply < 1
• Case 3: Elasticity of Supply = 1
• Case 4: Elasticity of Supply > 1
• Case 5: Elasticity of Supply =
Case 1: Perfectly Inelastic Supply
Case 2: Inelastic Supply
Case 3: Unitary Elastic Supply
Case 4: Elastic Supply
Case 5: Perfectly Elastic Supply
 Variation of Elasticity on a Curve
An industry in which firms have limited capacity for
Production, they do not have straight line curves.
• For low levels of quantity supplied, the elasticity
of supply is high,
• This indicates that firms respond substantially to
changes in the price.
• In this region, firms have capacity for production
that is not being used, such as plants and
equipment sitting idle for all or part of the day.
• Small increases in price make it profitable for
firms to begin using this idle capacity.
• As the quantity supplied rises, firms begin to
reach capacity.
• Once capacity is fully used, increasing
production further requires the construction
of new plants. (Extra Expense)
• To induce firms to incur this extra expense, the
price must rise substantially, so supply
becomes less elastic.
 APPLICATIONS OF ELASTICITY
• Business decisions regarding setting of prices
– Whether to increase or decrease the price
– Elasticity of demand..
– If demand is elastic, small increase in price leads to large
change in demand.
– Revenue = Price x Quantity
– If price is increased it will cause rise in revenue.
– P= 20 Rs, Q= 100 Revenue= 2000
– P= 30 Rs, Q= 10 Revenue= 300
• In case of elastic demand increase in price leads to fall in
revenue.
 – If demand is inelastic, large increase in price leads
to small change in demand.
– Revenue = Price x Quantity
– If price is increased it will cause rise in revenue.
– P= 20 Rs, Q= 100 Revenue= 2000
– P= 30 Rs, Q= 90 Revenue= 2700
• In case of inelastic demand increase in price
leads to rise in revenue.
• Helps Govt in Imposition of taxes
– GST
– Federal Excise Duty (FED)
– Import and Export Tarriffs
• These taxes lead to change in prices.
• Inelastic demand more taxes can be imposed, it
will lead to increase in tax revenue
• Elastic demand more taxes cannot be imposed,
because it will lead to decrease in tax revenue
??Questions??