Price Elasticity of Supply in Microeconomics

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  • 0:04 Calculating Price Elasticity
  • 0:48 Elastic Supply
  • 1:56 Inelastic Supply
  • 3:07 What Determines Elasticity?
  • 4:17 Long-Run Elasticity
  • 4:42 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

Price elasticity of supply is similar to elasticity of demand, but there are differences too. Let's explore them by looking at some real-life examples of elastic and inelastic supply.

Calculating Price Elasticity

Elasticity is simply a measure of how responsive the quantity demanded or supplied is to changes in price. The elasticity of demand is just common sense. When the price of normal products go down, we will buy more, and vice versa when the price goes up. The simple mathematical calculation is elasticity = % change in quantity demanded or supplied / % change in price. When the price drops by 5% and we buy 10% more, then demand is elastic, since 10% / 5% = 2.0. The key number here is 1.0. If the elasticity calculation is greater than 1.0, demand or supply is elastic. Below 1.0 and it is inelastic.

Elastic Supply

Let's meet Joan. She's the manager of a large bottling plant for one of the big cola companies. We are very flexible at this plant, she tells us. When people started living healthier lifestyles, there was a big change in demand for our products. Everyone wanted the no-cal version cola instead of regular. We were able to meet the change in demand quickly and easily by going to 75% no-cal cola here, instead of 50%. It was just a matter of switching to the no-cal syrup during our second shift. Our costs didn't go up at all. Soon the trucks full of no-cal were rumbling out to all of the grocery stores and vending machines in our region of the country. The corporate people raised the price a little, but they know it's a war selling cola in grocery stores with all of the competition, so they kept our price hike small. She then showed us a few numbers. When the quantity of no-cal we supplied went up by 25% and the price only went up 5%, that meant our supply elasticity was 25% / 5%, or 5.0. That is quite a bit more than 1.0, so the company economist said we have very elastic demand. We like to think we have healthier customers too.

Inelastic Supply

Now let's pay a visit to Gus. Gus runs a chain of gas stations in a northern state. He goes on to tell us how supply works in his business. He says that the demand for gas at the pump is very seasonal. People love to travel in the summer. The road trip with the vehicle on the open highway, with the driver's elbow hanging out of one window and the dog's head hanging out another, is a common sight in the summer. We love the freedom of the open road. The demand curve for gas shifts outward every summer and, unless the supply curve shifts along with it, the price goes up. The problem is that we can't shift the supply curve very much. The refineries that we buy our gas from are already running at close to capacity anyway, so they can't supply us with much more gas, and the oil companies won't spend the millions to build new ones if it's just for seasonal demand, since the new refining capacity won't be needed in the winter months when people are snug in their homes instead of driving somewhere. So what happens in the summer is my supply of gas only goes up about 10%, while the demand shift raised the price 20%. So my elasticity of supply is 10% / 20% = 0.5, and since that is below 1.0, it's inelastic.

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