Question

What is the price elasticity of supply? Can you explain it in your own words?

Short answer

The price elasticity of supply (PES) is a measure of how sensitive the quantity supplied of a specific product is to changes in the product's price. It is calculated using the formula: \( PES = \frac{\% \hspace{2px} change \hspace{2px} in \hspace{2px} quantity \hspace{2px} supplied}{\% \hspace{2px} change \hspace{2px} in \hspace{2px} price} \). PES can be classified into categories based on its value: perfectly inelastic (PES = 0), inelastic (0 < PES < 1), unit elastic (PES = 1), and elastic (PES > 1). Understanding PES helps businesses and policymakers predict and manage market behavior in response to price changes.

Step-by-step solution

Definition of Price Elasticity of Supply

Price elasticity of supply (PES) is a measure of how sensitive the quantity supplied of a specific product is to changes in the product's price. In other words, it tells us how much more or less of a product firms, in general, are willing to produce and supply to the market when the price of that product changes. Understanding the PES helps businesses and policymakers to predict and manage market behavior in response to changes in prices.

Formula for Calculating Price Elasticity of Supply

Price Elasticity of Supply is calculated using the following formula: \( PES = \frac{\% \hspace{2px} change \hspace{2px} in \hspace{2px} quantity \hspace{2px} supplied}{\% \hspace{2px} change \hspace{2px} in \hspace{2px} price} \) To calculate the percentage change in quantity supplied and price, we can use the following formulas: \( \% \hspace{2px} change \hspace{2px} in \hspace{2px} quantity \hspace{2px} supplied = \frac{New \hspace{2px} quantity \hspace{2px} supplied - Old \hspace{2px} quantity \hspace{2px} supplied}{Old \hspace{2px} quantity\hspace{2px} supplied} \times 100 \) \( \% \hspace{2px} change \hspace{2px} in \hspace{2px} price = \frac{New \hspace{2px} price - Old \hspace{2px} price}{Old \hspace{2px} price} \times 100 \) After calculating the percentage change in quantity supplied and price, plug the values into the PES formula to get the price elasticity of supply.

Examples and Interpretation

Let's consider an example to better understand the concept. Suppose a company produces smartphones. When the price is \(500, the company produces 10,000 smartphones. If the price increases to \)550, the company produces 11,000 smartphones. First, calculate the percentage change in quantity supplied and price: \( \% \hspace{2px} change \hspace{2px} in \hspace{2px} quantity \hspace{2px} supplied = \frac{(11,000 - 10,000)}{10,000} \times 100 = 10 \% \) \( \% \hspace{2px} change \hspace{2px} in \hspace{2px} price = \frac{(550 - 500)}{500} \times 100 = 10 \% \) Now plug these values into the PES formula: \( PES = \frac{10 \%}{10 \%} = 1 \) A PES of 1 means the supply is unitary elastic, meaning the percentage change in price led to an equal percentage change in quantity supplied. PES can be classified into categories based on its value: - If PES = 0, the supply is perfectly inelastic (i.e., quantity supplied does not change with a change in price) - If 0 < PES < 1, the supply is inelastic (i.e., less responsive to price changes) - If PES = 1, the supply is unit elastic (i.e., the percentage change in price results in an equal percentage change in quantity supplied) - If PES > 1, the supply is elastic (i.e., very responsive to price changes) Understanding the price elasticity of supply can help businesses and policymakers make better decisions related to pricing, production levels, and market interventions for specific products.