Elasticity of the Offer: Types, Factors That Influence and How It Is Calculated (With Example)

The supply elasticity is an indicator used in economics to express the responsiveness or flexibility of the quantity offered of a product or service in the face of a change in its price. It is necessary for a company to know how quickly and effectively it can respond to changing market conditions, especially changes in prices.

The elasticity is represented in numerical form and is defined as the percentage variation in the quantity that is offered, divided by the percentage variation in the price. It is desirable for a company to be highly receptive to variations in price and other market conditions.

A high supply elasticity makes the company more competitive than its rivals and allows the company to generate more income and profits. In the short term, the quantity of products offered may be different from the quantity manufactured, because companies have inventories that they can accumulate or consume.

Types

The offer of the product can be described as inelastic when the coefficient is less than one; It is difficult for companies to change production in a given period of time. For example, the offer of hotel rooms is inelastic.

On the other hand, supply can be described as elastic when the coefficient is greater than one; Companies can easily increase production without increasing cost or time delays. The offer of books is elastic.

For any given supply curve, it is likely that supply elasticity varies across the curve. There are three extreme cases of supply elasticity.

Perfectly elastic

A percentage change of almost zero in the price produces a very large percentage change in the quantity offered.

Perfectly inelastic

Only one quantity can be offered, regardless of the price. An elasticity of zero indicates that the quantity offered does not respond to a price change, the quantity offered is fixed. The offer of lots of land in front of the beach is perfectly inelastic.

Unitary elasticity

The percentage change in the quantity offered is equal to the percentage change in the price. The fish offer has unit elasticity.

Graphically, it is shown as a linear curve that starts from the origin:

Influential factors

Complexity of production

The elasticity of supply depends very much on the complexity of the production process. For example, textile production is relatively simple. Labor is largely unqualified and no special structures are needed as production facilities. Therefore, the elasticity of the offer for textiles is high.

On the other hand, the elasticity of supply for certain types of motor vehicles is relatively low. Its manufacture is a multi-stage process that requires specialized equipment, skilled labor, a large network of suppliers and large research and development costs.

Mobility of production components

If the components associated with the production (labor, machinery, capital, etc.) of a company that manufactures a product are readily available and the company can change its resources to make them produce another required product, then it can be said that its Supply elasticity is high.

If the opposite is applied, then its elasticity is low. For example, a print shop that can easily switch from printing magazines to greeting cards has an elastic offer.

Response time

The offer is normally more elastic in the long term than in the short term for the goods produced.

It is assumed that all components of production can be used in the long term to increase supply. In the short term only labor can be increased, and even then changes can be prohibitively expensive.

For example, a cotton farmer can not respond in the short term to an increase in the price of soy, due to the time it would take to get the necessary land. In contrast, the offer of milk is elastic due to the short period of time that exists since the cows produce the milk until the products reach the market.

Availability of inventories

If the stocks of raw materials and finished products are at a high level, then a company can respond to a change in the price: its offer will be elastic.

On the other hand, when stocks are low, the decrease in supplies forces prices to increase due to shortages.

Additional production capacity

A producer with unused capacity can respond quickly to price changes in the market, assuming that production components are readily available.

The excess capacity within a company is indicative of a more proportional response in the quantity offered to the changes in the price, which suggests an elasticity of supply. Indicates that the producer could respond appropriately to changes in the price to match the offer.

The greater the additional production capacity, the companies can respond faster to price changes. Therefore, the more elastic the offer, the better the product or service.

The supply of products and services is more elastic during a recession, when a large amount of labor and capital resources are available.

How is it calculated?

Several research methods are used to calculate real-life supply elasticities, including the analysis of historical sales data and the use of surveys on customer preferences, in order to build test markets capable of modeling the elasticity of those changes.

Alternatively, a joint analysis can be used, classifying the preferences of the users and then analyzing them statistically.

The following equation calculates the Elasticity of the Offer (EO):

Percentage Change in the Quantity Offered / Percentage Change in Price

The Percentage Change in the Quantity Offered (CPCO) is calculated as:

((Quantity offered2 - quantity supplied1) / quantity offered1) x 100

In the same way, the Percentage Change in Price (CPP) is calculated:

((Price2 - price1) / price1) x 100

Example

The market price of a company increases from a, 10, thus increasing its quantity offered from 10,000 to 12,500.

Applying the above formulas, the elasticity of the offer is:

CPCO = ((12,500 - 10,000) / 10,000) x 100 = +25

CPP = ((1,1 - 1) / 1) x 100 = +10

EO = +25 / + 10 = +2.5

The positive sign reflects the fact that the increase in prices will act as an incentive to bid more. Because the coefficient is greater than one, the offer is elastic, with the company responding to price changes. This will give you a competitive advantage over your rivals.

References

1. Wikipedia, the free encyclopedia (2018). Price elasticity of supply. Taken from: en.wikipedia.org.
2. Economics Online (2018). Price elasticity of supply. Taken from: economicsonline.co.uk.
3. Geoff Riley (2018). Explaining Price Elasticity of Supply. Taken from: tutor2u.net.
4. Tejvan Pettinge (2016). Price Elasticity of Supply. Economics Help. Taken from: economicshelp.org.
5. Earle C. Traynham (2018). Chapter 5, Elasticities of Demand and Supply. University of North Florida. Taken from: unf.edu.