Calculation, Determinants & Significance of PES (CIE IGCSE Economics)

• The law of supply states that when there is an increase in price (ceteris paribus), producers will increase the quantity supplied & vice versa
  • Economists are interested in how much the quantity supplied will increase

• Price elasticity of supply (PES) reveals how responsive the change in quantity supplied is to a change in price
  • The responsiveness is different for different types of products
    
    

Calculation of PES

• PES can be calculated using the following formula
  
  

• To calculate a % change, use the following formula
  
  

Step 1:  Calculate the % change in QS

Step 2: Calculate the % change in P

Step 3: Insert the above values in the PES formula

Step 4: Explain one reason for the value

The PES value of 0.15 indicates that avocados are very price inelastic in supply. Even with a significant increase in price, suppliers are unable to supply more likely due to the time it takes to grow additional avocados

 
Interpreting PES Values

The Values of PES Vary From 0 To Infinity (∞) & They Are Classified As Follows

Value	Name	Explanation	Diagram
0	Perfectly Inelastic	The QS is completely unresponsive to a change in P (e.g. fixed number of seats in a theatre)
0→1	Relatively Inelastic	The %∆ in QS is less than proportional to the %∆ in P (e.g agricultural products)
1→ ∞	Relatively Elastic	The %∆ in QS is more than proportional to the %∆ in P (e.g t-shirts)
∞	Perfectly Elastic	The %∆ in QS will fall to zero with any %∆ in P. However, supply is unlimited at a particular price. This is a very theoretical scenario
1	Unitary Elasticity	Any supply curve that starts at the origin (e.g. S1, S2 or S3) has a PES value equal to 1. The %∆ in P = %∆ in QS

• Some products are more responsive to changes in prices than other products
  
  
• The factors that determine the responsiveness are called the determinants of PES & include:
  • Mobility of the factors of production: if producers can quickly switch their resources between products, then the PES will be more elastic. For example, if prices of hiking boots increase & shoe manufacturers can switch resources from producing trainers to boots, then boots will be price elastic in supply
  • Availability of raw materials: if raw materials are scarce then PES will be low (inelastic). If they are abundant, PES will be higher (elastic)
  • Ability to store goods: if products can be easily stored then PES will be higher (elastic) as producers can quickly increase supply (for example, tinned food products). An inability to store products results in lower PES (inelastic)
  • Spare capacity: if prices increase for a product & there is capacity to produce more in the factories that make those products, then supply will be elastic. If there is no spare capacity to increase production, then supply will be inelastic
  • Time period: In the short run, producers may find it harder to respond to an increase in prices as it takes time to produce the product (e.g., avocados). However, in the long run they can change any of their factors of production so as to produce more

• If producers have a high PES (elastic) then they are able to respond to increases in price very quickly
  • This is desirable as it means producers can increase revenues & profits if they can supply more
  • Firms can increase their PES by:
    • Creating more spare capacity on their production lines
    • Maintaining larger inventories
    • Using more modern technology
      
      
• If producers have a low PES (inelastic) then they are less able to respond to increases in price
  • This shortage in supply will mean that prices continue to rise, possibly causing inflation in the economy
    
    
• Governments are very interested in the PES of key markets in the economy as they want to ensure that these markets can respond quickly to rising demand
  • One e.g is the housing market. If the PES of housing is low (inelastic), property prices will become unaffordable with any increase in demand
  • Another e.g. is the labour market. If the PES of labour is low (inelastic) then production costs of firms will rise quickly during periods of increasing demand when firms need to hire additional workers