The elasticity of supply basically means that how many products a supplier can supply as price changes. It can be represented by the equation below.
Percentage change in quantity supplied
Percentage change in price
Normally, the answer for the percentage change in supply will be positive. This is because according to the law of supply, the relationship between price and quantity supplied must be positive related, ceteris paribus. As price of the good goes up, quantity supply will increase vice-versa. And the shape of a supply curve is upward sloping as shown below.
Supplier normally depends on this elasticity to determine and to do research on how good is the product to a consumer.
The determinant of price elasticity of supply is the time period. It can be seen in two points of view, the short run or the long run time period. A short run business normally has a fixed productive capacity. For example, if a man has a land where he grows cabbage, because it is all he knows, it is fixed of what he grows, and the amount he grows. He will supply the same thing for a short run and have a fixed income. And in conclusion, the supply will considered as inelastic.
For long run, it is a bit different from short run. It basically means that the supplier can decide what he wants to do with what he has. He or she will have sufficient time to do what he or she wants to do. For example, if a person knows that there is a trend that people are eating more tomatoes than cabbage, the producer can plant tomatoes more that cabbage in his plantation. The supplier will supply more tomatoes and it will be elastic.
Businesses normally use the concept of price elasticity to determine their price. Normally take a look from a consumer's point of view, which means that using price elasticity of demand. According to Slavin 2009, it says that when demand is elastic, if we were to raise price, total revenue would fall. Sellers determine the price of a good by calculating the total revenue. Let's see a simple example. If a saloon normally gives 20 haircuts for the price of $15 each, how much would the revenue be? And if the price per hair cut increases to $20, and the number of haircuts can she can give is only 10, how much is the total revenue?
Table 2.1: Hypothetical Revenue Schedule
As you can see, the total revenue when the price is $15 is $300 whereas the total revenue of $20 is only $200. We know that it is elastic in by calculating the price elasticity of demand. In other cases, when price is elastic, the total revenue can increase too. It really depends on the product. For example, a packet of tissue cost $0.30 in a supermarket, whereas the price of a packet tissue cost $0.50 in a 24 hours mini market. The packet tissue in the supermarket can be considered as elastic in the supply point of view for consumers. Price is cheaper, consumer are more responsive during the day time. But if it is compared during midnight or early in the morning, the packet tissue in the 24 hours mini market is elastic also. People have no choice but to go to that mini market to get the tissue. But if the price of the packet tissues increases in the supermarket, it could be considered as inelastic already. The reaction of a consumer will be less responsive. Because it follows the law of demand, when price increase, quantity demanded for a good decrease.
Supply can be defined as the schedule of quantity of a good or services that people are willing and able to sell at various prices. (Slavin 2009). According to the law of supply, the relationship between price and quantity demanded are positively related. Which means that it is the opposite compared to the law of demand. As price of a good increase, the quantity supplied will increase vice-versa. The supply curve can be drawn and the shape of the curve is an upward sloping curve as shown.
Figure 3.1: Supply Curve
Price of Good A
Quantity supplied of Good A
There will be an increase and decrease of supply due to several reasons. But I specifically want to talk about what are the reasons or determinants that increase the supply of a product here.
One of the reasons that there will be an increase of product is because the changes in the cost of production. This determinant is the most important and most effected determinants. This is because the price of raw materials, labour or even capital has decreased. For example, if a company that produces pillow found out that the price of cotton, a raw material of pillow, has decreased, they are willing to produce more pillows because of the capital that they have can buy extra cotton and eventually producing more pillows. They supplier are willing to produce more and this will be an advantage to the company. Because it will increase the profit of the company with the same amount of money that they are willing to supply even before the price of cotton drops.
Secondly, the introduction of new technology will cause the supply of a product increases. Throughout these years, we've seen many advanced technology have been introduced to industries and that have helped them because these technology will decrease the cost of production and it speeds up the production. For example, more people are depending on computers rather than men anymore. Because computer are faster and won't make mistakes as often as human do. It also reduces the cost of a production because no salaries are involved when computers are using. It is just a fixed cost when it is bought. Many factories in this era are using at least a few computers to run their business. A company or factory without a computer will take a long time to produce goods, and eventually will allow substitutes to take over their consumers' demand.
Next, the expectations of future price changes also play a part in the supply of a product. If the price of a good is expected to drop in the future, there will be an increase in supply of product. Let's put it in an example, if price of corn are expected to drop in the future, supplier will increase their product now because when price drops, there will be less supply according to the law of supply.
Price ceilings and price floors are introduced mainly by government.
Equilibrium price and quantity
Government introduce price floors and ceiling to control the situation in the country. If the government introduce price ceiling, it basically means that it is a good thing to a consumer as the maximum price of the product that a supply can sell. Consumers attracted to the low price. But there is a problem over here. There are shortages of supply. This is where the government have to do their job. A shortage in supply will create an allocation of resource and consumer will feel unfair as some people can afford it and buy many at a time. So the government introduces rationing function or people might call it waiting list.
Price ceiling is the opposite of price floors. It introduces a minimum price for a product. This time, the favour is on the supplier's side. Supplier will gain more than consumer in the sense that they earn more. But in this case there is a surplus of supply which means that there supplier supplies more than consumers demand.
All in all, price floors and ceilings can stifle the rationing function where it really creates many problems between people over a product. This price floors and ceilings are really creating unfairness among consumers without affecting the suppliers. That is why economists say it in this way. Another thing is that price floors and ceilings do distort resource allocation. Meaning that it creates unfairness and it really change the natural feel of a normal human where both supplier and consumer get benefits. This is a really terrible situation if it is not controlled properly. A good government of a country must know how to face these problems.
Demand can be defined as the schedule of quantities of a good or services that people are willing and able to buy at different prices. (Slavin 2009). According to the law of demand, it states that the relationship between the price and the quantity demanded is negatively related, ceteris paribus. As the price goes up, quantity demanded goes down vice-versa. It basically applies to every consumer. If the price of a good is expensive, we wouldn't consider buying it. But if it is cheap, the demand for the good is higher. The graph that represents demand curve is a downwards sloping curve.
Price of good A
Quantity demanded of good A
A decrease in the price of good A will cause an increase in quantity demanded for good A. It will cause a movement downwards from point B to point C. And the relationship that is negative between price and quantity demanded has been proven also. The only determinant that changes the quantity demand is the price of a good.
Change in quantity demand will cause a shift of the whole demand curve. In this case, demand curve is shifting leftward; it means that there is less demand of a good. Unlike change in quantity demanded, there are several effects that change the demand curve. Examples of effects are income and wealth, prices of other goods and services, tastes and preferences, expectations, and many more. These determinants can either shift the demand curve leftward or rightward depending on the effects on price. There are also some situations where demand curve are forced to shift such as natural disaster occurs.
According to Slavin (2009), income elasticity of demand measures how the consumption of various goods and services response to change in income. It can be represented by the equation below:
Percentage change in quantity demanded
Percentage change in income
There are three main degrees of income elasticity of demand. By calculating the elasticity of income, we can know those degrees. There are normal goods, luxury goods and necessity goods. If we found out that the answer for the income elasticity is between zero to one (0<EI<1), for example, 0.43 or 0.99, it can be concluded and consider as a normal good. Normal good can be things that we need it but don't really care about the quality of it for example a family needs a car just to travel around rather than to show other people what they have. If the answer calculated for the elasticity of income is more than 1 (1<EI), for example, 2.54 or 5.78, it can be considered as a luxury good where people can afford to buy branded and better quality of goods. For instance, consumers choose to buy Mini Cooper rather than Proton Wira because of the income that made them buys luxury goods. Last but not least, if the answer found is equals to zero (EI=0), it is a necessity good. For example like rice, electricity and other necessities. These are the goods that everybody needs it. No matter the consumer have higher income level; they still have to pay the same amount, which benefits them.
Consumer surplus can be defined as the difference between what you pay for some good or service and what you have been willing to pay. (Slavin 2009). And the definition of producer surplus can be defined as the relationship between the price in the market in the current situation and the total cost of production for the firm. (Karl E. Case, Ray C. Fair 2004).
As we can see from the figure above, consumer surplus is above the equilibrium whereas producer surplus is below the equilibrium of demand and supply. The reason why consumer surplus is above the equilibrium is because consumers are willing to pay that amount of money more than the current market value as long as it is above the equilibrium point. But fewer consumers will pay for the product as price increases. As for producer surplus, it is below the equilibrium which means that they are willing to produce their goods in order to cover their costs or the opportunity cost of production. This will give just enough of profit to continue their business. They are willing to supply at any amount as long as it is below the equilibrium point.
Production possibilities frontier shows that all the goods and services which are combined together can produced if every society's resources are used efficiently all in a graph. (Karl E. Case, Ray C. Fair 2004). The three concepts use in the production possibilities frontier is choice, opportunity cost, and scarcity. Economics also can be defined as a study of how to make use fully on what they have with scare resources playing a part in it. They want to have what they want but they only have limited resources to fulfil their wish or wants. That's why in economics, we have choice, opportunity cost, and scarcity to try to make use of everything that we have.
As we can see from the graph, when a company wants to produce 10 units of Good A, they only can produce 20 units of Good B. If the company wants to produce 25 units of Good B, they only can produce 8 units of Good A. This is what we call opportunity cost. There are many possibilities of combination of both goods. As you can see in the graph, the area under the graph is where all the possibilities are. If there is an increase in either one of the good, there will be a decrease in the other good. Scarcity can also be seen in this graph. There is only limited capital of a company to produce both goods. And it is up to their choice on what is more important and can get more profit from the goods. It also really depends on how consumers will react on the goods, whether they prefer Good A or Good B. It is the best for them to produce using fully of the opportunity cost, which means along the curve. This is because it will give them the maximum profit that they can get when they choose what they produce.
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