CONTINUATION NOTES ON SUPPLY - III (PRICE ELASTICITY OF SUPPLY)

PRICE ELASTICITY OF SUPPLY

Definition of es

It refers to a degree of responsiveness or change in quantity supplied of a commodity due to change in its price. OR it is defined as the proportionate change in quantity supplied of a commodity divided by a given proportionate change in its price. Thus:

CATEGORIES (DEGREES) OF PRICE ELASTICITY OF SUPPLY

ü  There are FIVE categories of es:

1.      Perfectly Elastic Supply

2.      Perfectly Inelastic Supply

3.      Unitary Elastic Supply

4.      Elastic Supply

5.      Inelastic Supply

1.      Perfectly Elastic Supply

ü  If a small change in the price leads to an infinite change in quantity supplied. Thus, es = α   

2.      Perfectly Inelastic Supply

ü  If the quantity supplied does not change with the change in price. Thus, es = 0                                    

              

3.      Unitary Elastic Supply

ü  When the percentage change in the quantity supplied is equal to the percentage change in its price. Thus, es = 1

4.      Elastic Supply

ü  When the percentage change in the quantity supplied is greater than the percentage change in its price. Thus, es > 1    

5.      Inelastic Supply

ü  When the percentage change in the quantity supplied is less than the percentage change in its price. Thus, es < 1  

                                                                                                    

MEASUREMENT OF ELASTICITY OF SUPPLY

ü  The Elasticity of Supply can be measured by TWO methods:

1.      Percentage / Proportionate Method.

2.      Geometric / Point Method.

1.      Percentage / Proportionate Method.

ü  The percentage / proportionate method is the ratio of proportionate change in quantity supply of a commodity to the proportionate change in its price. Thus;

Where;

ü  P – Initial Price.

ü  Q – Initial Quantity.

ü  ∆P – Change in Price.

ü  ∆Q – Change in Quantity Supplied.

Example 1: An increase in the price of the commodity from Nu. 10 to Nu. 15 increases the quantity supplied from 500 to 750 units. Calculate the elasticity of supply and comment on the type of elasticity. [Note: Leave space for Solution]

Example 2:  A producer supplies 200 units of a good at Nu. 10 per unit. Price elasticity of supply is 2. How many units will the producer supply at Nu. 11 per unit.  [Leave space for Solution]  

2.      Geometric / Point Method.

The elasticity of supply at different points on the supply curve can be measured by geometric / point method as:       1. On a Straight Line Supply Curve

2.      On the Non-Linear Supply Curve

CONTINUATION NOTES ON SUPPLY - II

EXCEPTIONAL SUPPLY CURVES – EXCEPTIONS TO THE LAW OF SUPPLY

1.      Vertical Supply Curve

ü  The supply of certain commodities cannot be change due to change in its price. For example, the rare goods such as classical paintings, old manuscripts, a rare postage stamp, old coins etc. the supply is fixed. In some cases, the supply may be fixed in the long run. In such cases, the supply curve will be a vertical line parallel to OY.

1.      Backward Sloping Supply Curve

ü  A backward supply curve shows a smaller quantity would be supplied at higher prices. For example, the wages of the labour is Nu. 150 per day and he is willing to work 5 days to earn Nu. 750. Due to an increase in his wage rate to Nu. 200, he is willing to work only four days. 

MOVEMENT ALONG THE SUPPLY CURVE (Change in Quantity Supplied)

ü  When the quantity supplied changes as a result of change in price while other factors remaining same or constant, it is known as change in quantity supplied. It is of TWO types:

1.      Extension of Supply.

2.      Contraction of Supply.

1.      Extension of Supply

When the quantity supplied rises due to rise in the price. It is known as extension of supply. It is the upward movement (A to A₁) along the same supply curve.

2.      Contraction of Supply

When the quantity supplied falls due to fall in the price. It is known as contraction of supply. It is the downward movement (A to A₂) along the same supply curve.

SHIFT OF THE SUPPLY CURVE (Change in Supply)

ü  When the quantity supplied of a commodity changes due to changes in any other factors except the price of the commodity is called change in supply. It is of TWO types:

1.      Increase in Supply.

2.      Decrease in Supply.

 Home Work (Students’ Activity)

1. Write THREE distinctions between Extension of Supply and Increase in Supply.

2.  Give THREE differences between Contraction of Supply and Decrease in Supply.

3. Why does Supply Curve Slope upward from Left to Right?

4. Give TWO factors each for Increase in Supply and Decrease in Supply.

CONTINUATION OF NOTES ON SUPPLY - I

TIME PERIOD AND SUPPLY

Q. Explain the various time periods in relation to the supply of a commodity.

1.      Market Period

ü  It is a very short period in which the supply of a commodity is fixed. For example, once the vegetables are grown and brought to the market, there cannot be change in the supply of vegetables. 

1.      Short – Run

ü  It is the period in which the supply of a commodity can be increase to some extent. For example, in case of factories, if the producers want to increase production by running the existing plant (machines) for longer hours like two shifts instead of one.

1.      Long – Run

ü  It is the period during which the supply of a commodity can be increased to any extent. For example, if the producer wants to increase the supply of a commodity by a huge amount, he may set up a new factories or plants. 

NOTES ON SUPPLY

CHAPTER – 05

SUPPLY – LAW OF SUPPLY AND PRICE ELASTICITY OF SUPPLY

Definition of Supply

ü  Supply of a commodity refers to the quantity of a commodity which producers or sellers are willing to produce and offer for sale at a particular price during a particular period of time.

TYPES OF SUPPLY

1.      Individual Supply

It refers to a quantity of a commodity which a single producer is willing to produce and offer for sale at a particular price during a particular period of time.

2.      Market Supply / Industry’s Supply

It refers to a quantity of a commodity which all the producers are willing to produce and offer for sale at a particular price during a particular period of time.

DIFFERENCES BETWEEN STOCK AND SUPPLY

Stock	Supply
ü  Stock is the total amount of the commodity available with the producers. ü  It is unsold goods. ü  It has no time dimensions.	ü  Supply is the amount that producers are willing to bring into the market. ü  It is the part of stock which is offer for sale. ü  It has a time dimensions.

FACTORS AFFECTING SUPPLY (DETERMINANTS)

1.      Price of a Product / Commodity

There is a direct relationship between the price of a commodity and its supply. If the price of a product increases, then the supply of the product also increases and vice-versa.

2.      Goals of the Producers / Firms

Generally, supply of a commodity increases only at higher prices as it fulfills the objective of profit maximization. However, some firms are willing to supply more to capture extensive markets and to enhance their status and prestige, thereby fulfilling the objective of sales maximization. Similarly, if the firms aim at minimizing the risk, they will play safe, produce less and supply less.

3.      Input Prices / Factor Prices

The inputs such as raw materials, labour, equipment, machines etc. are available in sufficient quantity at lower price, and then there would be increase in production and supply and vice- versa.

4.      Prices of Related Commodities

The prices of substitutes and complementary goods also affect the supply of a product. For example, if the price of beans increases, then the farmers would tend to grow more beans than other vegetables. This would decrease the supply of other vegetables in the market.

5.      Technology

A better and advanced technology increases the production which results in the increase in the supply of product. For example, the production of fertilizers and good quality seeds increased the production of crops. This further increase the supply of food grains in the market.

6.      Nature of the Commodity

The supply is more on the goods produced by the competitive firms compared to the monopolized industry.

7.      Government’s Policies

The different policies of the government like taxation and subsidy policies have a greater impact on the supply of a product. For example, increase in the taxes (excise duty, sales tax etc.) would decrease the supply of a product and vice-versa.

8.      Expectations of Future Prices

In case producers expect an increase in the price of a commodity in future, then they will supply less today and if price is expected to fall in future, supply will naturally increase in the present period.

9.      Natural Factors

The climate conditions directly affect the supply of certain products. For example, the supply of agricultural products increases when monsoon comes on time. However, the supply of these products decreases at the time of drought, flood, etc.

10.  Agreement Among Producers

Sometimes producers may form a group and make some agreement to restrict the supply of a commodity to earn large profits. They will create artificial scarcity of the commodities, as a result supply decrease.

11.  Availability of Transport and Communication Facilities

A better transport and communication facilities will expand the size of the market. This will motivate the producers to produce and supply more.

SUPPLY FUNCTION

It states the relationship between the quantity supplied of a commodity and its determinants.

Thus:

Sn = f (Pn, P1…. Pn-1, Gf , Fi…Fm, T, E, Gt, N, Mt…)

 Where;

ü  S_n – Quantity supplied of a commodity ‘n’.

ü  f – Functional relation between supply and its determinants.

ü  P_n – Price of commodity ‘n’.

ü  P₁…. P_n-1 – Prices of all other commodities.

ü  G_f – Goal of the firm.

ü  F_i…F_m – Prices of different factors of production.

ü  T – Technique of production.

ü  E – Expectation of future prices.

ü  G_t – Taxation policy of the Government.

ü  N – Natural factors.

ü  M_t – Means of transportation.

LAW OF SUPPLY

The law of supply states that, other things remaining same, the quantity supplied increase with the increase in price and decrease with the decrease in price.

Assumptions of the Law

1.      There should be no change in the prices of related goods.

2.      No change in the taxation policy.

3.      The cost of production should remain unchanged.

4.      No change in the state of technology.

5.      The input prices should not change.

ü  The Law of Supply can be illustrated with the help of Supply Schedule and Supply Curve.

SUPPLY SCHEDULE

ü  It is a table showing various quantity of a commodity which producers / sellers are willing to produce and sell at different prices during a given period of time OR it is the tabular presentation of law of supply. It is of TWO types:

1.      Individual Supply Schedule

2.      Market Supply Schedule

Individual Supply Schedule

ü  It is a table showing various quantity of a commodity that an individual producer is willing to produce and sell at different prices during a given period of time.

Individual Supply Schedule for Potatoes

Price of Potatoes (Nu. Per kg)	Quantity Supplied (kg per Month)
Nu. 60 Nu. 50 Nu. 40 Nu. 30 Nu. 20	50 40 30 20 10

Market Supply Schedule

ü  It is a table showing various quantity of a commodity that all the producers / firm are willing to produce and sell at different prices during a given period of time.

Market Supply Schedule for Potatoes

Price (Nu. Per kg)	Quantity Supplied by Firm A (kg per Month)	Quantity Supplied by Firm B (kg per Month)	Market Supply (A+B) (kg per Month)
20 30 40 50 60	10 20 30 40 50	5 10 15 20 25	15 30 45 60 75

SUPPLY CURVE

ü  It is a curve showing various quantity of a commodity which producers / sellers are willing to produce and sell at different prices during a given period of time OR it is the diagrammatic presentation of the law of supply. It is of TWO types:

1.      Individual Supply Curve

2.      Market Supply Curve

Individual Supply Curve

ü  It is a curve showing various quantity of a commodity that an individual producer is willing to produce and sell at different prices during a given period of time OR it is the graphic presentation of individual supply schedule.

Market Supply Curve

ü  It is a curve showing various quantity of a commodity that all the producers are willing to produce and sell at different prices during a given period of time OR it is the graphic presentation of market supply schedule.