Price elasticity of supply

Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in the good's own price (%ΔQs ÷ %ΔP). How elastic supply is depends on several factors.

The most important is the time period. In the short run, at least one factor of production (usually capital) is fixed, so firms can only change output by varying the variable factors; supply is therefore relatively inelastic. In the long run, all factors are variable — firms can build new capacity and new firms can enter — so supply becomes elastic.

A second factor is spare capacity. A firm with idle machines and underused workers can raise output quickly and cheaply when price rises, making supply more elastic. A firm operating at full capacity cannot easily expand, so its supply is inelastic.

A third is the level of stocks. Firms that hold large stocks of finished goods can release them quickly in response to a price rise, giving elastic supply; goods that are perishable (and so cannot be stored) tend to have inelastic supply.

Finally, the mobility and substitutability of factors of production matters: if resources can be switched easily into producing the good, supply is more elastic. The availability of raw materials has a similar effect.

These factors together explain why, for example, the supply of fresh agricultural produce is inelastic in the short run but the supply of a manufactured good with spare capacity and large stocks can be quite elastic.

The price doubled, which is a +100% change, while quantity supplied rose by less than 5% (say +5% at most).

Approximate PES = %ΔQs ÷ %ΔP = +5% ÷ +100% = +0.05 (and possibly lower). Since PES is far below 1, cocoa supply is highly inelastic in this period.

This reveals that cocoa producers cannot respond quickly to a higher price. Cocoa is grown on trees that take several years to mature, so in the short run the area in production is essentially fixed — farmers cannot grow significantly more cocoa within a year however attractive the price. There is also little spare capacity and limited ability to store extra output.

The practical implication is that a surge in demand for cocoa leads mostly to a large rise in price rather than a rise in quantity, because supply is so inelastic in the short run. Only over the long run, as new trees mature and more land is planted, would supply become more elastic and output expand.

The volatility of commodity prices comes mainly from the elasticities of supply and demand and from frequent supply shocks.

Inelastic supply. Agricultural goods have price-inelastic supply in the short run: crops take a growing season (or, for tree crops, years) to produce, output cannot be increased quickly when price rises, and many products are perishable and cannot be stored to smooth supply. Manufactured goods, by contrast, usually have more elastic supply — firms hold stocks and have spare capacity, so they can adjust output quickly.

Inelastic demand. Demand for basic foodstuffs is also price-inelastic, because food is a necessity with few substitutes. When both curves are steep (inelastic), any shift in supply causes a large change in price but only a small change in quantity.

Frequent supply shocks. Agricultural supply is repeatedly hit by weather, pests and disease, which shift the supply curve sharply from year to year. Because supply (and demand) are inelastic, each shift produces a big price swing. Manufactured goods are far less exposed to such natural shocks.

Qualifications. Not all commodity volatility is identical: buffer stock schemes or government intervention can dampen swings, and storable commodities (e.g. grain) are less volatile than perishables. Some manufactured goods can also be volatile if they depend on a volatile input (e.g. oil). Demand-side shocks (e.g. a global boom) also matter, not only supply shocks.

Judgement. The greater volatility of commodity prices is primarily explained by the combination of inelastic supply and inelastic demand together with frequent supply shocks, which means shocks fall mainly on price rather than quantity. Manufactured goods are more stable chiefly because their supply is more elastic (stocks and spare capacity). The most defensible conclusion is that low elasticities are the key reason, but the degree of volatility also depends on storability and on whether stabilisation schemes are used — so the contrast, while real, is not absolute.

Both PES and PED help a government understand how a market responds to change, but they capture different sides of the market, and their relative importance depends on the policy problem.

Why PES matters. PES tells the government how quickly producers can adjust output. In markets with inelastic supply (e.g. agriculture, housing), demand shocks cause large price swings, so stabilising prices may require boosting supply flexibility — for example, buffer stocks to add supply when prices spike, or supply-side measures (irrigation, infrastructure) to raise long-run PES. If the instability comes from the supply side, PES is the more directly relevant elasticity.

Why PED matters. PED tells the government how consumers respond to price. It is crucial when the policy works through price — for instance, knowing demand is inelastic explains why taxing a demerit good raises revenue but cuts consumption little, and why subsidising a necessity mainly benefits consumers. If the goal is to influence consumption or revenue, PED is the more relevant elasticity.

They interact. Price volatility depends on both elasticities together: large swings occur when supply and demand are inelastic. So a government usually needs both to predict the size of price and quantity changes after a shock — neither alone is sufficient.

Judgement. Neither elasticity is universally 'more important'; their importance is problem-specific. For stabilising prices in a market subject to supply shocks, PES is often the more important focus, because the instability and the available remedies (stocks, supply-side policy) act on the supply side. But the government still needs PED to anticipate how consumers and revenue will respond, and because volatility depends on both. The most defensible conclusion is that PES tends to be the primary concern for price stabilisation against supply shocks, but it must be used alongside PED, since the two jointly determine the market outcome.