How to Calculate Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) quantifies how the quantity supplied of a good or service responds to changes in its market price. Businesses use PES to anticipate market reactions to pricing strategies, while policymakers use it to evaluate the impact of taxes or regulations. Understanding PES aids in production planning and market interventions.

Components of the Calculation

Calculating Price Elasticity of Supply requires two primary components: the percentage change in quantity supplied and the percentage change in price.

The percentage change for any variable is determined by taking the new value, subtracting the old value, dividing the result by the old value, and then multiplying by 100. For instance, if quantity supplied increases from 200 units to 250 units, the change is 50 units. Dividing 50 by 200 yields 0.25, or a 25% increase.

Similarly, if the market price rises from $10.00 to $12.00, the price change is $2.00. Dividing $2.00 by $10.00 gives 0.20, indicating a 20% increase in price.

Applying the PES Formula

The core Price Elasticity of Supply formula divides the percentage change in quantity supplied by the percentage change in price.

Suppose the percentage change in quantity supplied is 15%, and the percentage change in price is 5%. Applying the formula, 15% divided by 5% yields a PES of 3.0.

For a more detailed example, consider a tech company producing 10,000 units of an electronic component at $50 per unit. If the price rises to $60 per unit, and production increases to 12,500 units, first calculate the percentage change in quantity supplied: ((12,500 – 10,000) / 10,000) 100 = 25%.

Next, compute the percentage change in price: (($60 – $50) / $50) 100 = 20%. Finally, divide the percentage change in quantity supplied (25%) by the percentage change in price (20%). This calculation results in a Price Elasticity of Supply of 1.25.

While the direct percentage change method is common, the midpoint method can also be employed for larger fluctuations. This method calculates percentage changes using the average of the initial and new values in the denominator.

Understanding the Calculated Values

A PES greater than 1.0 indicates elastic supply, meaning quantity supplied changes more than price. Producers with elastic supply can significantly adjust their output in response to minor price movements.

Conversely, a PES less than 1.0 signifies inelastic supply, meaning quantity supplied changes less than price. Many agricultural products often exhibit inelastic supply in the short term.

A PES equal to 1.0 represents unitary elasticity, meaning quantity supplied changes proportionally to price. Perfectly elastic supply occurs when a minuscule price change leads to an infinite change in quantity supplied, often depicted as a horizontal supply curve.

Perfectly inelastic supply is characterized by a PES of 0.0, meaning quantity supplied does not change regardless of price. This is represented by a vertical supply curve, where production capacity is fixed. For example, the supply of rare historical artifacts might be perfectly inelastic.

Determinants of Supply Responsiveness

Supply elasticity is influenced by several factors. The time horizon for producers to adjust operations is a primary determinant. In the short run, limited capacity leads to more inelastic supply. Over a longer period, producers can acquire new machinery, expand facilities, or hire more labor, making supply more elastic.

The availability and mobility of inputs also play a role; scarce or difficult-to-transport raw materials make supply less responsive. Production capacity and ease of switching between goods also affect elasticity. If a company can easily reallocate resources to produce more of a high-priced item, its supply will be more elastic. The ability to store goods without significant cost or spoilage can also increase supply elasticity, as producers can hold inventory and release it when prices rise.