How to Measure the Elasticity of Supply. Overview and Explanation.

The elasticity of supply is a measure of how responsive the quantity supplied of a certain good is if there's a change in the price of that good. So if the price of oil goes up by 5% what happens to the percentage change in the quantity supplied of oil, how do oil producers respond to that? We take a percentage change in the quantity supplied and we divide it by the percentage change in the price of the good and similar to price elasticity of demand if it's greater than one we would say the elasticity of supply is elastic. If it's between zero and one, so if it's less than 1 then we would say that the elasticity of supply is inelastic.

I want to give you an example and we'll show you how to calculate the elasticity of supply. So let's say that we're talking about the market for natural gas and that the price of natural gas increases by 10% and then firms in response that let's say that they increase production of fracking or whatever they're doing, they increased production to get more natural gas and as a result the quantity of natural gas supplied increases by 15%.

So now let's calculate the elasticity to supply using those figures. So again we're going to take the percentage change your quantity supplied which is going to be 15% and then we're going to divide it by the change in the price so the price of natural gas increased by 10%. So when we divide those we get 1.5. So we would say that the elasticity of supply is elastic because it's greater than one.

That means that a 1% change in the price leads to more than a 1% change in the quantity supplied. Now the elasticity of supply is going to depend on a couple of things. One is the substitution of resources, how easy it is for firms when they see that increase in the price to turn around and say "Let's now produce more natural gas" or they might not have the resources to do so or it might be really difficult, they might have to switch resources from something else they were doing in order to produce more natural gas. So it depends on the goods in the question how easy it is to substitute resources.

It's also going to talk not just about the substitution of resources as an issue but also thinking about the time frame and whether we're talking about the short-run or the long-run and so forth. It's not necessarily easy if we see that the price goes up 10% to immediately the next day we're going to increase natural gas production by 15%. Maybe that's something that takes a huge investment of resources and machinery and so forth and maybe in the long run maybe it would be more elastic than it would be in the short run. So again it depends on the good or service and we have to think about how easy it is to shift resources to change the production of that good or service in response to the price change and then how easy it is to do that in the short-run versus the long run.

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