Application of Elasticity of Supply

Definition:
In economics, the price elasticity of supply is defined as a numerical
measure of the responsiveness of the quantity supplied of product (A) to a change
in price of product (A) alone. It is the measure of the way quantity supplied reacts
to a change in price.

Calculating the Price Elasticity of Supply

Calculating the price elasticity of supply when the price changes from $9.00
to $10.00"
First we need to find the data we need. We know that the original price is $9
and the new price is $10, so we have Price (OLD) =$9 and Price (NEW) =$10.
From the chart we see that the quantity supplied when the price is $9 is 150 and
when the price is $10 are 210. Since we're going from $9 to $10, we have Supply
(OLD) =150 and QSupply(NEW) =210, where "Supply" is short for "Quantity
Supplied". So we have:

Price (OLD) =9
Price (NEW) =10
QSupply(OLD) =150
QSupply(NEW) =210
To calculate the price elasticity, we need to know what the percentage change in
quantity supply is and what the percentage change in price is.

[210 - 150] / 150 = (60/150) = 0.4

So we note that % Change in Quantity Supplied = 0.4 (This is in decimal terms.

In percentage terms it would be 40%). Now we need to calculate the percentage
change in price.

Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is:

[Price (NEW) - Price (OLD)] / Price (OLD)

By filling in the values we wrote down, we get:

[10 - 9] / 9 = (1/9) = 0.1111

We have both the percentage change in quantity supplied and the percentage
change in price, so we can calculate the price elasticity of supply.

Final Step of Calculating the Price Elasticity of Supply

We go back to our formula of:

PEoS = (% Change in Quantity Supplied)/(% Change in Price)

We now fill in the two percentages in this equation using the figures we calculated.
PEoD = (0.4)/(0.1111) = 3.6

When we analyze price elasticities we're concerned with the absolute value, but
here that is not an issue since we have a positive value. We conclude that the price
elasticity of supply when the price increases from $9 to $10 is 3.6.

Price Elasticity of Supply

When there is a relatively inelastic supply for the good the coefficient is low;

when supply is highly elastic, the coefficient is high. Supply is normally more
elastic in the long run than in the short run for produced goods. As spare capacity
and more capital equipment can be utilized the supply can be increased, whereas in
the short run only labor can be increased. Of course goods that have no labor
component and are not produced cannot be expanded. Such goods are said to be
"fixed" in supply and do not respond to price changes.

The quantity of goods supplied can, in the short term, be different from the
amount produced, as manufacturers will have stocks which they can build up or
run down.
The value of elasticity of supply is positive, because an increase in price is likely
to increase the quantity supplied to the market and vice versa.  
FACTORS THAT DETERMINE ELASTICITY OF SUPPLY

The elasticity of supply depends on the following factors. The value of price
elasticity of supply is positive, because an increase in price is likely to increase the
quantity supplied to the market and vice versa. The elasticity of supply depends on
the following factors:

1. SPARE CAPACITY:
How much spare capacity a firm has - if there is plenty of spare capacity, the
firm should be able to increase output quite quickly without a rise in costs and
therefore supply will be elastic
2. STOCKS:
The level of stocks or inventories - if stocks of raw materials, components and
finished products are high then the firm is able to respond to a change in
demand quickly by supplying these stocks onto the market - supply will be
elastic
3. EASE OF FACTOR SUBSTITUTION:
Consider the sudden and dramatic increase in demand for petrol canisters
during the recent fuel shortage. Could manufacturers of cool-boxes or producers
of other types of canister have switched their production processes quickly and
easily to meet the high demand for fuel containers?
If capital and labor resources are occupationally mobile then the elasticity of
supply for a product is likely to be higher than if capital equipment and labor
cannot easily be switched and the production process is fairly inflexible in
response to changes in the pattern of demand for goods and services.
4. UTIME PERIOD:
Supply is likely to be more elastic, the longer the time period a firm has to adjust
its production. In the short run, the firm may not be able to change its factor
inputs. In some agricultural industries the supply is fixed and determined by
planting decisions made months before, and climatic conditions, which affect the
production, yield.

Economists sometimes refer to the momentary time period - a time period

that is short enough for supply to be fixed i.e. supply cannot respond at all to a
change in demand.
ILLUSTRATING PRICE ELASTICITY OF SUPPLY
 Explanation with Examples

 When supply is Perfectly Inelastic, a shift in the demand curve has no effect
on the equilibrium quantity supplied onto the market. As the elasticity rises,
the supply curve gets flatter, which shows that the quantity supplied responds
more changes in the price Examples include the supply of tickets for sports or
musical venues, and the short run supply of agricultural products (where the
yield is fixed at harvest time) the elasticity of supply = zero when the supply
curve is vertical. As a hypothetical example, consider the supply curve of the
land. Suppose that no matter how much someone would be willing to pay for
an additional piece, more land cannot be created. Also, even if no one wanted
all the land, it still would exist. In such a case, land would have a vertical
supply curve, with zero elasticity.
 When supply is Perfectly elastic a firm can supply any amount at the same
price. This elasticity alternative exists when the price is fixed, that is, an
infinite range of quantities is associated with the same price. Perfectly elastic
demand can occur, in theory, when buyers have the choice among a large
number of perfect substitutes in the consumption of a good. In an analogous
way, perfectly elastic supply can occur when sellers have the choice among a
large number of perfect substitutes in the production. A hypothetical example
of perfectly elastic supply comes with a generic cheese sandwich, such as that
sold by Manny Mustard and thousands of others. The production cost of
combining labor, kitchen utensils, mayonnaise, cheese, and bread are one
dollar per sandwich. This cost is the same for one sandwich or one billion
sandwiches. There is no increasing opportunity cost. There are no economies
of scale.
 As such, the supply of generic cheese sandwiches is perfectly elastic. If
buyers pay a buck each, one dollar, they get as many generic cheese
sandwiches as they want. If buyers should lower the price they offer for
generic cheese sandwiches by an infinitesimally small amount, then sellers do
not supply any generic cheese sandwiches. If buyers should raise the price they
offer for generic cheese sandwiches by an infinitesimally small amount, then
sellers supply an infinitely large amount.
 Relatively Inelastic means that relatively large changes in price cause
relatively small changes in quantity. In other words, quantity is not very
responsive to price. More specifically, the percentage change in quantity is less
than the percentage change in price. Relatively inelastic demand occurs when
buyers can choose from among a small number of imperfect substitutes-in-
consumption. One hypothetical example of relatively inelastic supply is
Mona Mallard Duct Tape.

While it might seem as though duct tape (that shiny gray tape that is used for
every conceivable purpose EXCEPT sealing ventilation ducts) is easily
produced by switching resources from the production of cellophane tape,
electrical tape, or adhesive tape, Mona Mallard Duct Tape has a special
"something" that generates a relatively elastic supply. That special something
is quagliminium, a rare adhesive substance found only in the natural vegetation
growing in the isolated country of Northwest Queoldiolia. Therefore, to
increase the quantity supplied of duct tape, Mona Mallard must acquire greater
amounts of quagliminium, which is always an expensive proposition. As such,
the supply of Mona Mallard Duct Tape is relatively inelastic.
 Relatively elastic means that relatively small changes in price cause relatively
large changes in quantity. In other words, quantity is very responsive to price.
More specifically, the percentage change in quantity is greater than the
percentage change in price. Relatively elastic demand occurs when buyers can
choose from among a large number of very close substitutes-in-
consumption. One example of relatively elastic supply is Wacky Willy
Stuffed Amigos (those cute and cuddly stuffed armadillos and tarantulas). The
production and thus quantity supplied of these can be easily expanded by
acquiring additional resources at about the same cost of the resources already
employed. The semi-skilled labor used (sewers, stuffers, packers, shippers) is
easy to train. The materials used (cloth, stuffing, thread) are readily available.
It is just not a big deal to increase production. As such, the supply of Wacky
Willy Stuffed Amigos is relatively elastic. The price received by The Wacky
Willy Company only needs to change a little to induce significant changes in
the quantity supplied.

 Unit elastic means that any change in price causes an equal proportion change
in quantity. Quantity changes are matched by price changes. More specifically,
the percentage change in quantity is equal to the percentage change in price.
Unit elastic demand occurs when buyers can choose from among a modest
number of substitutes in the consumption of a good. 
 In economics, elasticity is the ratio of the percent change in one variable to the
percent change in another variable. It is a tool for measuring the responsiveness
of a function to changes in parameters in a relative way. Commonly analyzed
are elasticity of substitution, price and wealth.

 An "elastic" good is one whose price elasticity of demand has a magnitude

greater than one. Similarly, "unit elastic" and "inelastic" describe goods with
price elasticity having a magnitude of one and less than one respectively.

 The degree to which a demand or supply curve reacts to a change in price is the
curve's elasticity. Elasticity varies among products because some products may
be more essential to the consumer. Products that are necessities are more
insensitive to price changes because consumers would continue buying these
products despite price increases. Conversely, a price increase of a good or
service that is considered less of a necessity will deter more consumers because
the opportunity cost of buying the product will become too high.

 A good or service is considered to be highly elastic if a slight change in price

leads to a sharp change in the quantity demanded or supplied. Usually these
kinds of products are readily available in the market and a person may not
necessarily need them in his or her daily life. On the other hand, an inelastic
good or service is one in which changes in price witness only modest changes
in the quantity demanded or supplied, if any at all. These goods tend to be
things that are more of a necessity to the consumer in his or her daily life.
Applications
As the price of a good rises, consumers will usually demand a lower quantity
of that good; they may consume less of that good, substitute it with another
product, etc. The greater the extent to which demand falls as price rises, the greater
the price elasticity of demand. Conversely, as the price of a good falls, consumers
will usually demand a greater quantity of that good: consuming more, dropping
substitutes, etc. However, there may be some goods of which consumers cannot
consume less or for which adequate substitutes cannot be found. Prescription
drugs, fuel, and food are some examples of these. For such goods, demand does
not greatly decrease as the price rises, and elasticity of demand can be considered
low.

Further, elasticity will normally be different in the short term and the long
term. For example, for many goods the supply can be increased over time by
locating alternative sources, investing in an expansion of production capacity, or
developing competitive products which can substitute. One might therefore expect
that the price elasticity of supply will be greater in the long term than the short
term for such a good, that is, that supply can adjust to price changes to a greater
degree over a longer time.

This applies to the demand side as well. For example, if the price of petrol
rises, consumers will find ways to conserve their use of the resource. However,
some of these ways, like finding a more fuel-efficient car, take time. So consumers
as well may be less able to adapt to price shocks in the short term than in the long
term.
 The concept of elasticity has an extraordinarily wide range of applications in
economics. In particular, an understanding of elasticity is useful to understand the
dynamic response of supply and demand in a market, to achieve an intended result
or avoid unintended results. Supply and demand does not always guarantee buyers
or sellers; this depends on their competitive positions within the market. For
example, a business considering a price increase might find that doing so lowers
profits if demand is highly elastic, as sales would fall sharply. Similarly, a business
considering a price cut might find that it does not increase sales, if demand for the
product is price inelastic.

Elasticity is also used to analyze social policies. For example, the tobacco
settlement in the United States led to significant price and tax increases on
cigarettes. PED's could be used to determine the incidence of taxes and the demand
response to the increase prices.
 Bhagwan Mahavir College of Management

Name: Jayesh Khatwani (21)

Kajal Lad (22)
Nency Lakdawala (23)
Kishan Lukhi (24)
Hemali Mangrola (25)
Subj: Economics For Managers.
Topic: Application of Elasticity of Supply.
Submitted To: Mr. Sanjay Ghosh.
Submitted On: 5th Dec. 2009