Cigarrette

Supply Elasticity

Suppliers make a profit by selling goods and services at higher prices than their cost to produce. How much of a profit suppliers make is determined by the cost of the factors of production to produce the product and on the suppliers' efficiency in producing the product. Since higher prices make it easier to earn a profit, and since the amount of profit is also dependent on the quantity sold, if increased demand raises prices, then suppliers will respond by increasing their supply, since that will allow them to earn a higher profit. Of course, this is merely the law of supply, but it does not state how much supply will change when prices change. The elasticity of supply measures the percentage change in the quantity of supply compared to the percentage change in a supply determinant. Although the elasticity of supply can be measured against several supply determinants, the most important is the price. The price elasticity of supply measures the percentage change in supply quantity compared to the percentage change in the price, which, in turn, determines the change in total revenue.

Price Elasticity of Supply | = | Quantity Change PercentagePrice Change Percentage |

There is a wide variation in the price elasticity of supply, which depends not only on the product or service, but also whether the price change occurs in a short time or over a long time. If the supply changes little with a change in price, then supplies are considered inelastic. Supply is elastic if there are large changes in supply for a small change in price. If the percentage change in price is equal, though opposite, to the percentage change in quantity, then the supplies considered unit elastic.

For instance, the supply of land is generally inelastic, because, as Will Rogers once quipped, they're not making any more of the stuff. By contrast, the supply of software is almost perfectly elastic since it costs very little to make and distribute copies of software.

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