- Derivation of Short-Run and Long-Run Supply Curves for an Industry
- How does 'Supply' Differ from 'Stock'? And What are the Factors Determining the Supply of a Commodity?
Supply is responsive to price changes. The extent to which supply extends for a given price rise is known as elasticity of supply. Prof. Boulding uses a beautiful analogy to explain the relationship between price and supply, “The relation between price and the quantity supplied is rather like the relation between a whistle and a dog – the louder the whistle, the faster comes the dog; raise the price and the quantity supplied increases. If the dog is responsive – in economic terminology, “elastic” – quite a small crescendo in the whistle will send him bounding along. If the dog is unresponsive or “inelastic”, we may have to whistle very loudly before he comes along at all.”
Elasticity of supply may also be defined as the ratio of the percentage change or the proportionate change in quantity supplied to the percentage or proportionate change in price.
Es = proportionate change in supply/Proportionate change in price
= (change in quantity supplied/Original quantity supplied) × (Change in price/Original price)
Let Q = Original supply
ΔQ = Change of supply
P = Original price and
ΔP = Change of price, then
Es = (ΔQ/Q) / (ΔP/P) = (ΔQ/Q) × (P/ΔP) = (ΔQ/ΔP) × (P/Q)
Suppose that the price of an article rises from $4 to $5 and as a result, supply rises from 200 to 300. Then
Es = (100/1) × (4/200) = 2.
Since both price and quantity move in the same direction, Es has a positive sign.
Types of Supply Elasticity
There are two limiting cases of elasticity of supply, which are of economic significance.
- Elasticity of supply equal to infinity
- Absolutely inelastic supply
Another way of expressing the range of elasticity is that elasticity of supply is greater than one, less than one or equal to one.
Table 1: Types of Elasticity of Supply
Supply elasticity = α
Supply elasticity = 0
Supply elasticity = 1
Supply elasticity > 1
Supply elasticity < 1
The following figure 1 illustrates the various types of elasticity clearly.
1. Perfectly Elastic Supply (S1S1 curve)
Perfectly or infinitely elastic supply signifies that a fall in price will completely cut off supply and a rise in price will cause an infinite expansion of supply.
2. Perfectly Inelastic Supply (S2S2)
Perfectly inelastic supply means that changes in price will not bring about any change in supply.
3. Unitary Elastic Supply (S3S3)
When elasticity of supply is unitary, a change in price will cause a proportionate change in quantity supplied. Any straight-line supply curve passing through the origin has a unitary elasticity throughout its length regardless of its slope.
4. Relatively Elastic Supply (S4S4)
When the proportionate change in quantity is greater than the proportionate change in price the supply is relatively elastic. Any straight-line supply curve that intersects the vertical axis has an elasticity greater than one throughout its length.
5. Relatively Inelastic Supply (S5S5)
When the proportionate change in quantity is less than the proportionate change in price, the supply is relatively inelastic. Any straight line that cuts the horizontal axis has an elasticity less than one.
Generally, elasticity of supply can vary from one price range to another.
At a low price and for small quantities, supply is perfectly elastic. However, as quantity continues to increase, supply becomes less and less elastic. At higher supply prices, supply is perfectly inelastic. This is shown in figure 2.
Measurement of Elasticity of Supply
Elasticity of supply can be measured by using two methods:
- The point method and
- The ratio method
The Point Method
On the given supply curve the price elasticity at a point is measured by the distance along a tangent to the horizontal axis divided by the distance along it to the vertical axis.
The elasticity of supply at point T is measured as RT/OT
In panel (a) RT > OT, therefore Es > 1
In panel (b) RT = OT, therefore Es = 1
In panel (c) RT < OT, therefore Es < 1
The Ratio method
The co-efficient of elasticity of supply is obtained by using the ratio method as follows:
Es = (ΔQ/Q) × (P/ΔP)
The co-efficient of elasticity of supply varies from zero to infinity.
Factors Determining Elasticity of Supply
Elasticity of supply is determined by the following factors:
1. The nature of commodities
Based on nature, commodities are divided into perishable goods and durable goods. In the case of perishable goods like fish, vegetables etc., the supply is less elastic, whereas in the case of durable goods the supply tends to be more elastic.
The element of time exercises an important influence on the elasticity of supply. In almost every industry, supply will be more elastic in the long-run than in the short-run.
3. Mobility of Factors
Availability of factors of production and mobility of factors of production also affect the elasticity of supply. Mobility of factors causes elasticity of supply and vice versa.
4. Technique of production
The adoption of advanced technology or replacement of capital-intensive techniques, in the place of traditional or labor intensive techniques makes the supply more elastic.
5. Number of Markets and the Number of Products Produced
If a firm sells its product in different markets, then its supply will be elastic. This is because of the fact that a fall in price in any one market will induce the firm to sell in other markets. Again, when it produces a variety of products, it can easily transfer resources from production of one product to the others, so that each of his products will be elastic in supply.
6. Scale of Production
Goods can be produced either on a large-scale or on a small-scale. Goods produced on a large-scale are elastic while goods produced on a small-scale are inelastic.
7. Natural Factors
The supply of agricultural goods are inelastic by nature. The influence of nature is more pronounced in agricultural production. That is why it is said that ‘Nature does the business and man is merely a manager.’ The presence of external factors beyond man’s control tends to make the supply of agricultural products inelastic.
Significance of Elasticity of Supply
1. The elasticity of supply of a good is a major factor in determining as to how much of its price will alter when there is a change in the conditions of demand. Let us explain this with the help of supply of and demand for sugarcane as shown in figure 4.
In figure 4, DD is the demand curve and SS is the supply curve. OP is the price. If demand for sugar increases to D1S1 in the short-run it is inelastic, for its supply can be expanded only by adding labor, fertilizers etc. therefore, the supply increases only by a small amount (MM1). However, in the long period more land can be put under sugarcane. Supply is, therefore more elastic and is represented by the curve S1S1. The long-run price falls to OP2 and quantity increases to OM2.
2. The elasticity of supply is significant in determining the extent of taxation.
Where the supply of a good is inelastic the government can impose a tax on the producer without having a great effect on the amount of the goods offered for sale. For example, a man owns a mineral well for which a maximum rent of $100 can be got. The owner gives it on rent for $1000 per month. Suppose the government levies a tax of $500 a year on this mineral well. This means that the owner will have to pay the tax from out of his own pocket, since he cannot get it from the user. If the tax amount is increased to $1000, the owner of the mineral well will stop letting it on rent because the net income from the mineral well becomes zero.
Venkatachari M from Hyderabad, India on December 18, 2014:
Very intelligent article. Voted up.