Understanding Public Goods

 

Understanding Price Elasticity of Supply

Price elasticity of supply (PES) is the degree of responsiveness of quantity supplied for a good to a change in its own price. In formula, it can be written as: PES = % of change in quantity supplied / % of change in price

The main aim of PES is nothing more than to measure the ability of firms/ producers/ companies to respond to any increase in demand/ price. In some situations, producers can be very responsive and hence high value of PES. This is known as price elastic in supply. On the other hand, the same producers are not responsive and so the value of PES must be low. In more extreme situations, PES can be zero which means perfectly inelastic in supply

What are the determinants of PES?

a. Time period under consideration. If firms are given a very short time frame, perhaps they are unable to respond at all to any increase in demand/ price. The logic is simple. Depending on what industries we are discussing about but all of them are almost unable to produce or give anything in the immediate period. Consider a hobby shop selling some rare collectible figures. All the stocks are shipped from Taiwan, China and Hong Kong to Malaysia. Even if a hardcore collector is willing to pay 3/4/5 times the market price, if the retailers are out of stock they would probably be unable to give anything in the immediate period. This is because the next batch of stocks will probably arrive in the next few months. The same goes for farmers. If they given only one day to grow fresh lemons, bananas and chillies, they are probably unable to provide anything at all since all of them take time to grow. The same goes for new houses. You don't expect a construction firm to complete a condominium/ apartment in one or two days. Of course the ability to supply is zero. But if they are given more time, then they will be able to adjust factors of production for instance buying more raw materials, hire more skilled workers, adjust the size of land and others, then they will become more responsive to market demand and the PES will gradually increase over the time

b. Whether finished stocks can be kept or not. Vegetables and most crops have short shelf lives. They cannot be stored for long. So, let's just say that the market price suddenly increases, there is a possibility that farmers are unable to respond by increasing the market supply. The reason is, there is nothing in the storage! So, how can they be responsive to price increase? If that is the case PES is usually inelastic. On the other hand, coffee beans and oil can be kept. If the market price is good, coffee farmers and oil producing countries can easily flood the market with such output, hence supply becoming more elastic

c. Whether the firm has spare capacity or not. Spare capacity in this case refers to factors of production that are not put to full use such as workers and equipments. If there is unused capacity, then an increase in market price means firms would be able to become more responsive by making all the employees work and machines running. Supply will become price elastic. On the other hand, if the factory is already running to its maximum capacity, no matter how high the price can go, it is not possible to make the workers work any longer or the machines operating further. Think about this. Being a student, if you already have so much homework thrown to you by your lecturer, I am sure that if there is any additional homework given to you, you probably will tell the lecturer that there is no way that you can cope with the volume already. In this case, your supply is price inelastic. This is the case for any industries. As long as production hits bottleneck, there is no way quantity of output can be further increased

d. Factors of production are mobile or not. If workers are occupationally mobile, then supply may become price elastic. In other words, workers must be able to multi-task. If the market price increases, then firms may need more help so that the quantity supplied can be increased. Being able to get some of the workers from other departments to help out is crucial and if not supply will become price inelastic. For instance, the college where I am currently lecturing is said to be price elastic in supply. In case if there is a sudden increase in the number of students who take CIE Economics, lecturers currently teaching Edexcel Economics can be diverted to where they are needed. Likewise, occupational immobility is the main reason why supply of any firms can become price inelastic

e. Number of firms. The greater is the number of firms, the more elastic will be the supply. If the market price for one particular good increases, it will create an incentive for more factories or farmers to start producing it. As such, supply can be greatly increased in the near future

f. Whether the production process is complicated or not. Goods that can be easily produced, fast and do not need to go through many stages of production process will be more responsive to an increase in price. Most manufacturing goods fall under this category. On the other hand, if the production process is lengthy then supply is usually price inelastic such as agricultural produce

The List of the Most Important Definitions for Chapter 2 (CIE AS): The Price System

Here you go,

1. Ad-valorem tax: An indirect tax that is levied based on certain percentage rate of the selling price

2. Cross elasticity of demand: An economic concept that measures the responsiveness of demand for a good to a change in the price of another good

  

3. Competitive demand: A situation where one good can be used in place of another

4. Complementary goods: Goods which have to be consumed together

5. Change in demand: It is when there is a change or shift in the market demand curve

6. Change in quantity demanded: It is when the demand for a product changes as a result of a change in its own price

7. Change in supply: It is when there is a change or shift in the market supply curve

8. Change in quantity supplied: It is when the supply for a product changes as a result of a change in its own price

9. Consumer surplus: The difference between what consumers are willing and able to pay and what they are actually paying at the market price

10. Demand curve: A curve that shows how much of a good or service will be demanded by consumers at a given price in a given period of time

11. Demand schedule: A table that shows the quantities of a product bought at different prices in a given period of time

12. Derived demand: This is where the demand for factors of production is as a result of the demand for that final good or service

13. Direct tax: A tax that is directly paid to the government by working individuals and firms

14. Disequilibrium: A situation where there is an imbalance between demand and supply in a market

15. Equilibrium: A situation where the quantity demanded for a good in the marketplace is exactly equal to the quantity supplied

16. Income elasticity of demand: An economic concept that measures the responsiveness of demand for a good to a change in income

17. Income inelastic in demand: Is when a change in income leads to a smaller than proportionate change in the demand for a particular good

18. Income elastic in demand: Is when a change in income leads to a larger than proportionate change in the demand for a particular good

19. Inferior goods: Goods or services where its demand will fall whenever there is an increase in income

20. Incidence of tax: Refers to the burden of taxation

21. Indirect tax: A tax that is imposed upon expenditure

22. Joint demand: A situation where two goods have to be consumed together

23. Joint supply: A situation where the production of one good leas to the production of another related good

24. Normal goods: Goods or services where their demand will increase whenever there is an increase in income

25. Necessity: Goods or services where its consumption is essential for survival

26. Price elasticity of demand: An economic concept that measures the responsiveness of quantity demanded for a good to a change in its own price

27. Price inelastic in demand: Is when a change in price leads to a smaller than proportionate change in the quantity demanded for a good

28. Price elastic in demand: Is when a change in price leads to a larger than proportionate change in the quantity demanded for a good

29. Perfectly elastic in demand: Is when all goods are bought at a given price

30. Perfectly inelastic in demand: Is when a change in price does not have any effect onto the quantity demanded for a good

31. Price elasticity of supply: Measures the responsiveness of quantity supplied for a good to a change in its own price

32. Price inelastic in supply: Is when a change in price leads to a smaller than proportionate change in the quantity supplied of a good

33. Price elastic in supply: Is when a change in price leads to larger than proportionate change in the quantity supplied of a good

34. Perfectly elastic in supply: Is when all goods are sold at a given price

35. Perfectly inelastic in supply: Is when a change in price does not have any effect onto the quantity supplied of a good

36. Price mechanism: The interaction of demand and supply to allocate scarce resources and resolve the problem of infinite wants

37. Producer surplus: The difference between the market price and the lowest price that producers are willing and able to sell at

38. Supply curve: A curve that shows how much of a good and service that will be supplied by producers at a given price in a given period of time

39. Supply schedule: A table that shows the quantities of a product that is sold at different prices in a given period of time

40. Substitute goods: Goods that can be used in the place of another

41. Specific tax: An indirect tax with a fixed amount for every unit of output

42. Subsidies: A grant given by the government to reduce the production costs of a good or service

43. Total revenue: Total income that firms receive from sales

44. Unitary price elasticity of demand: Is when a change in price leads to a proportionate change in the quantity demanded for a good

45. Unitary price elasticity of supply: Is when a change in price leads to a proportionate change in the quantity supplied of a good