Supply also can be determined by price elasticity. If producers are responsive to a change in price then supply is elastic. If they are insensitive to price change then the supply is inelastic.
In economics elasticity of supply is denoted by Es, but there is a change in our elasticity of demand formula:
Like Ed, if Es is smaller than one, then the supply is inelastic. However, if Es is smaller than one then the supply is inelastic.
The main determinant of elasticity of supply is time they have to respond to an increase in demand. Shifting resources takes time, more time available- greater ability to shift resources. The impact that time can have on elasticity of supply is distinguished among the immediate market period, short run, and the long run.
Market Period
Market period is that amount of time in which suppliers are unable to respond to an increase in demand and in price of a good. Suppose an owner of a small goat farm has 100 liter produced in the whole week and he bring all this quantity of milk to the market to sell. The supply curve is perfectly inelastic (vertical). This farmer will sell all his milk whether the price is high or low. Why? Because the farmer can offer only this quantity of milk in this milk even if the price is very high. Another week in needed to collect more milk, so he needs some time to respond to the increase in demand. Also, because the product is perishable he can’t keep it away for some time from the market. If the price is smaller than anticipated this farmer also has to sell all this quantity of milk.
As we can see farmer’s cost of production, won’t enter into decision to sell, because he has to sell all his production in order to avoid total loss. During market period our farmer’s quantity of supplied milk is fixed, no matter how high or low the price can be.
However, not all supply curves are perfectly inelastic immediately after a price change. If the good is not perishable and price rises, then the producers may choose to increase quantity supplied by drawing down their inventory unsold, stored goods causing market supply to get more quantity of that good.
For our farmer this market period can be one week, however, for producers of some goods that can be inexpensively stored, there may be no market period at all.
The Short Run
In short run, the plant capacity of some producers or of the entire industry is fixed. In the short run, our farmer’s farm is fixed, but he may give more food and more nutrients for his goats which may result in a somewhat higher output. In this case, an increase in demand is met with an increase in supply, which results in a smaller price adjustment than in the market period.
The Long Run
The long Run is period long enough for firms to adjust their plant size and new firms to enter the industry. In milk industry for example our farmer can buy more land, more goats and more labor force. Moreover, other farmers may be attracted by high revenue possible to get in milk industry and to enter it. Such adjustments make a higher supply in response to an increase in demand.
Cross Elasticity of Demand
The cross elasticity of demand measures how sensitive consumer purchases of the products let’s say “A” are to a change in price of the good “B”.
This formula helps us understand easier the concepts of complementary and supplementary goods.
Substitute Goods
If cross-elasticity of demand is positive, meaning that sales of A move in the same direction as a change of B, then A and B are substitute goods. Example: An increase in price of X causes consumers to purchase more Y.
Complementary Goods
When cross-elasticity is negative, we know that X and Y are complementary, an increase in price of one cause demand for another to decrease.
Independent Good
A zero or near-zero cross elasticity shows that two products are unrelated also called independent good. Example: wristwatches and apples, glasses and walnuts.
Income elasticity Demand
Income elasticity demand measures how demand of a product is affected by an increase of income. The coefficient of income elasticity demand, Ei , can be found by following formula:
Normal goods
For most goods, the income elasticity coefficient Ei is positive, meaning more of them are demanded as income increases. Such goods are called normal or superior goods.
Inferior goods
Negative income elasticity shows an inferior good. Ex: used clothes, long-distance bus tickets.
Table at Cross and Income Elasticity of Demand:
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