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Calculating Price Elasticity of Supply: Definition, Formula & Examples

Instructor: Greg Hanichak

Greg has a Bachelor of Business Administration degree from the University of Scranton and is an operations manager with a leading logistics provider.

This lesson covers the concept of price elasticity of supply by defining the concept, providing a formula for calculating the supply elasticity, and discussing the classifications of supply elasticity.

What is Price Elasticity of Supply?

According to the law of supply and demand, when prices increase, so too should supply, and vice versa. But, how much supply will increase or decrease because of a change in price is determined by an item's supply elasticity. Price elasticity of supply, also referred to as supply elasticity, measures the degree to which a change in the price of an item or commodity affects the quantity of the item supplied. In other words, supply elasticity measures the likelihood more or less of an item will be supplied due to an increase or decrease in the price of the item. Supply elasticity is calculated by using this formula:

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Types of Elasticity

Using the ratio, we classify an item's elasticity as either elastic, inelastic, or unit elastic. If the elasticity ratio is less than one, the item is referred to as inelastic, meaning the change in price has little effect on supply. Inelastic goods are typically necessities such as food, water, or medications. If the ratio is greater than one, we classify it as elastic. Unit elastic items have a ratio exactly equal to one and are exceedingly rare.

Extremes

There are extreme elasticity classifications, known as perfect elasticity and perfect inelasticity. Perfect elasticity means the supply of it is completely dependent on price, while perfectly inelastic items will have the same supply regardless of price changes. Perfectly elastic items are theoretical due to the impossibility of infinite supply. There is a classic example of perfect inelasticity, land. Regardless of what the price of land is, the supply is constant as there will always be the same amount of acreage on the face of the earth.

Calculating Elasticity

Now that we know a bit about supply elasticity, let's look at a few examples using the formula. As a reminder, the formula for calculating elasticity is:

% change in supply/ % change in price

Example 1:

The current market price for coffee mugs is $18.00 with 5,000,000 coffee mugs supplied. A reduction in demand causes the price to fall to $15.00 and supply drops to 4,000,000 mugs.

% change in supply = (5,000,000-4,000,000)/5,000,000 = 1,000,000/5,000,000 = 1/5 = 20%

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