Ib Economics - Price Elasticity of Supply

This study note for IB economics covers Price Elasticity of Supply.

Concept of Price Elasticity of Supply (PES)

• Definition: Price elasticity of supply (PES) measures the responsiveness of the quantity supplied of a good to a change in its price.
• Formula: PES = Percentage Change in Quantity Supplied / Percentage Change in Price
• Interpretation:
  • Elastic Supply: PES > 1
  • Inelastic Supply: PES < 1
  • Unit Elastic Supply: PES = 1
  • Perfectly Elastic Supply: PES = ∞
  • Perfectly Inelastic Supply: PES = 0

2. Diagrams and PES Values

• Elastic Supply (PES > 1):
  • Diagram: The supply curve is relatively flatter.
  • Example: High-tech gadgets, where suppliers can quickly ramp up production in response to price changes.
  • Explanation: A small increase in price results in a large increase in quantity supplied.
• Inelastic Supply (PES < 1):
  • Diagram: The supply curve is relatively steeper.
  • Example: Agricultural products in the short term.
  • Explanation: A large increase in price results in a small increase in quantity supplied.
• Unit Elastic Supply (PES = 1):
  • Diagram: The supply curve is a 45-degree line.
  • Example: Goods for which suppliers can proportionately adjust their production levels.
  • Explanation: A percentage change in price leads to an identical percentage change in quantity supplied.
• Perfectly Elastic Supply (PES = ∞):
  • Diagram: The supply curve is horizontal.
  • Example: Market with perfect competition for homogenous products.
  • Explanation: Any change in price results in an infinitely large change in quantity supplied.
• Perfectly Inelastic Supply (PES = 0):
  • Diagram: The supply curve is vertical.
  • Example: Unique artworks or very short-term supply situations.
  • Explanation: Changes in price have no effect on the quantity supplied.

3. Determinants of PES

• Time:
  • Short Run: Supply is more inelastic because production capacity and inputs are fixed.
  • Long Run: Supply becomes more elastic as firms can adjust all factors of production.
• Mobility of Factors of Production:
  • High Mobility: If resources (labor, capital) can be easily moved from one production to another, supply is more elastic.
  • Low Mobility: Limited ability to move resources makes supply more inelastic.
• Unused Capacity:
  • High Unused Capacity: Firms can increase production without incurring higher costs, making supply more elastic.
  • Low Unused Capacity: Firms are operating at full capacity, making it hard to increase supply, hence inelastic supply.
• Ability to Store Stocks:
  • High Storage Capability: Firms can store goods when prices are low and sell when prices are high, increasing elasticity.
  • Low Storage Capability: Limited storage reduces the ability to adjust supply, making it more inelastic.

4. Applications of PES

• Primary Commodities:
  • Example: Agricultural products like wheat or coffee.
  • PES Characteristic: Relatively low PES due to the time needed to grow crops and the dependence on climatic conditions.
  • Explanation: Supply cannot quickly respond to price changes because of the long production cycle and natural constraints.
• Manufactured Products:
  • Example: Automobiles, electronics.
  • PES Characteristic: Relatively high PES because production processes can be adjusted more easily with available technology and resources.
  • Explanation: Manufacturers can increase production relatively quickly in response to price increases.

5. Real-World Examples

• Brazil's Coffee Supply: Due to long growth periods and dependence on weather, coffee supply is inelastic.
• China's Electronics Industry: Rapid advancements and flexible manufacturing make the supply of electronics highly elastic.

6. Glossary of Key Terms

• Elastic Supply: A situation where PES > 1.
• Inelastic Supply: A situation where PES < 1.
• Unit Elastic Supply: PES = 1, where percentage change in quantity supplied equals percentage change in price.
• Perfectly Elastic Supply: PES = ∞, where supply can change infinitely with a tiny change in price.
• Perfectly Inelastic Supply: PES = 0, where quantity supplied remains unchanged regardless of price changes.
• Mobility of Factors of Production: The ease with which factors of production can be shifted from one use to another.
• Unused Capacity: Production capability that is not currently being utilized.
• Primary Commodities: Raw materials or agricultural products.
• Manufactured Products: Goods that have been processed or manufactured.

7. Related Topics

• Demand and Supply Elasticity: Understanding both demand and supply elasticity can give a comprehensive view of market responsiveness.
• Market Structures: The impact of different market structures (perfect competition, monopoly, etc.) on PES.
• Government Policies: How taxes, subsidies, and regulations affect PES.

8. Multiple Choice Questions

1. What does a PES value of 0 indicate?
   • a) Perfectly inelastic supply
   • b) Perfectly elastic supply
   • c) Unit elastic supply
   • d) Inelastic supply
2. Which factor does NOT affect the price elasticity of supply?
   • a) Time
   • b) Mobility of factors of production
   • c) Consumer preferences
   • d) Ability to store stocks
3. A steep supply curve suggests:
   • a) Elastic supply
   • b) Inelastic supply
   • c) Perfectly elastic supply
   • d) Unit elastic supply
4. Why is the PES for manufactured goods typically higher than for primary commodities?
   • a) Manufactured goods have shorter production times.
   • b) Primary commodities can be stored easily.
   • c) The demand for primary commodities is higher.
   • d) None of the above
5. An increase in PES over the long run is primarily due to:
   • a) Higher consumer demand
   • b) Increased production capacity
   • c) Fixed production factors
   • d) Decreased storage capability

Answers:

1. a
2. c
3. b
4. a
5. b

9. Essay-Style Questions

1. Discuss the factors that determine the price elasticity of supply for a product.
2. Explain why the price elasticity of supply for agricultural products tends to be low.
3. Analyze how unused capacity and the mobility of factors of production influence the price elasticity of supply.
4. Compare the price elasticity of supply between primary commodities and manufactured goods, providing real-world examples.
5. Evaluate the implications of price elasticity of supply for government policy-making.

10. Model Answer

Question: Discuss the factors that determine the price elasticity of supply for a product.

Model Answer:

The price elasticity of supply (PES) measures the responsiveness of the quantity supplied of a good to a change in its price. Several key factors determine PES, including time, the mobility of factors of production, unused capacity, and the ability to store stocks.

Time: The time period considered is crucial. In the short run, supply is generally more inelastic because firms cannot quickly adjust all production factors. For example, in agriculture, crops need time to grow, making short-term supply inelastic. However, in the long run, firms can alter production processes, invest in new technology, and enter or exit industries, making supply more elastic.

Mobility of Factors of Production: The ease with which labor, capital, and other resources can be reallocated affects PES. If factors of production can be easily shifted between uses, supply is more elastic. For instance, in the technology sector, skilled workers and capital can be quickly redirected to produce different products, leading to a higher PES.

Unused Capacity: Firms with significant unused production capacity can respond more flexibly to price changes. For example, a factory operating at 70% capacity can increase output more easily if prices rise, compared to one already at full capacity. Thus, high unused capacity leads to a more elastic supply.

Ability to Store Stocks: The capability to store goods allows firms to adjust supply more effectively. If a company can stockpile products, it can release more goods when prices increase, enhancing supply elasticity. For example, manufacturers of non-perishable goods like electronics often have higher PES due to better storage options.

Real-world examples illustrate these concepts. In Brazil, coffee supply is inelastic due to long growth periods and climatic dependencies, reflecting low PES. Conversely, China’s electronics industry, with rapid technological advancements and flexible manufacturing, demonstrates high PES.

In conclusion, understanding the determinants of PES, such as time, mobility of factors, unused capacity, and storage capabilities, is essential for analyzing supply responsiveness in different markets. This knowledge helps firms and policymakers anticipate and manage changes in supply dynamics effectively.