Determinants of price elasticity of supply. This article will explain what determines the price elasticity of supply of a good and how time can affect the price elasticity of supply.
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DETERMINANTS OF PRICE ELASTICITY OF SUPPLY:
- Ease of entry into an industry – If there is high competition or a lot of regulations in an industry, it makes it difficult for new companies to enter. This would cause supply to be inelastic as producers have more control over the market price than the consumer. An example of this is the diamond market where the supply of diamonds is extremely limited as producers hold back most of the diamonds produced and release them very slowly. In addition to this, most of the world’s diamond mines are controlled by a handful of companies which makes it very difficult for new firms to enter the market. This means that these companies can control the price of diamonds which causes supply to be elastic.
- Amount of spare capacity – If a firm has a high amount of spare capacity, it means the firm can quickly raise the production the good in order to respond to price changes. This means a firm with a high amount of spare capacity usually has elastic supply. However, if a firm is working near or at full capacity, supply tends to be inelastic as the firm cannot increase production of a good in order to react to a change in the price of the good.
- Stage of the economic cycle – The elasticity of supply depends on the stage of the economic cycle a country is at. For example, if a country is going through a recession, supply would be elastic as firms have a will have a high amount of spare capacity which means they will be able to increase supply when the price increases. However, if an economy is experiencing high levels of growth i.e. it is going through a ‘boom phase’, firms will not have as much spare capacity and therefore supply will be inelastic as firms will not be able to increase their production of the good.
- Length of a product’s lifetime – If a product has a long lifetime, it can be stored for a later date. This would mean the supply for these products is elastic as the product can be stockpiled to meet future surges in the demand of a good. These goods tend to be manufactured such as toasters, kettles, etc. However, if a good has a short lifetime, it means it cannot be stored for a later date. This would mean that supply for such a good is inelastic as it cannot be stockpiled to meet future surges in the demand of a good. An example of goods includes fruits and vegetables.
- Time period – The most important factor influencing the elasticity of supply is the time period. In the short run, it is hard for firms to raise supply if it is functioning at full capacity because at least one factor of production is fixed (labour, capital, land and entrepreneurs). This means in the short-term supply is not responsive to a change in price which means supply tends to be inelastic in the short term. However, in the long run, firms have the ability to increase their capacity which enables them to increase production in the long run. This means that supply is elastic in the long run as it is responsive to price.
In conclusion, there are many factors that influence the elasticity of supply. However, the most important factor is time. This because in the long run forms can adapt to changes in the price of the good by expanding or contracting the production and supply of their good which leads to supply being elastic in the long run and inelastic in the short run.
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