ECONOMIC ANALYSIS (MBSA 1313)

CASE STUDY:

SUPPLY ELASTICITY (CONCEPT & THEORY)

25th APRIL 2018

Group 5 Members:

Wong Kon Ping (MBS171055)

Mohd Tirmidzy Bin Che Mat (MBS 171180)

Aizuddin Bin Azizan (MBS 171051)

Mohd Ashraf Bin Kamarul Zaman (MBS171 045)

Shahrizan Bin Khairudin (MBS 171 072)

Reza Doshvarpasand (MBS 171 080)

Rosnadi bin Majid (MBS171057)

Khalid Aswad Bin Abdul Wahab (MBS 171 178)

Section :03

Lecturer:Prof. Dr. Ali Golam Hassan

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NAME Wong Kon Ping

MATRIX NO MBS 171 055

EMAIL konping@hotmail.com

CONTACT 016 – 2632 202

NAME Mohd Tirmidzy Bin Che Mat

MATRIX NO MBS 171180

EMAIL mdtirmidzy@gmail.com

CONTACT 019 – 7148449

NAME Aizuddin Bin Azizan

MATRIX NO MBS 171 051

EMAIL aizuddinazizan666@gmail.com

CONTACT 016 – 6947 234

NAME Mohd Ashraf Bin Kamarul Zaman

MATRIX NO MBS 171045

EMAIL phormia.regina@gmail.com

CONTACT 019 – 9814097

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NAME Shahrizan Bin Khairudin

MATRIX NO MBS 171 072

EMAIL shahokt@yahoo.com

CONTACT 012 – 9126 844

NAME Reza Doshvarpasand

MATRIX NO MBS 171 080

EMAIL pasand393@gmail.com

CONTACT 017 – 3992 412

NAME Rosnadi bin Majid

MATRIX NO MBS 171 057

EMAIL idan1276@gmail.com

CONTACT 013 – 5549 654

NAME Khalid Aswad Bin Abdul Wahab

MATRIX NO MBS 171178

EMAIL khalid.aswad@gmail.com

CONTACT 012 – 9121160

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 TABLE OF CONTENTS
1.0 Introduction ………………………………………………………………………… 5
1.1 Differentiation Between Elasticity Demand and Elasticity Supply ………... 7
2.0 Types of Supply Elasticity …………………………………………………………. 8
2.1 Perfectly Elastic Supply ….…………………………………………………
2.2 Perfectly Inelastic Supply ….………………………………………………
2.3 Relatively Elastic Supply ….……………………………….………………
2.4 Relatively Inelastic Supply ….……………………………….………………
2.5 Unit Elastic Supply ……….…………………………………………………
3.0 Factors That Effect Elasticity of Supply …………………………………………… 3
3.1 Spare Production Capacity ………………………………………………… 4
3.2 Stock of Finish Products Components .…..………………………………… 5
3.3 Internal Analysis …………………………………………………………….
3.4 Ease & Cost of Factor Substitution / Mobility ……………………………...
4.0 Determinants of Elasticity of Supply ………………………………………………
4.1 Change in Per Unit Costs with Increased Production …...………………….
4.2 Time Horizon ……..…………………………………………………………
4.3 Share of Market For Inputs …..……………………………………………..
4.4 Geographic Scope …………………………………………………………...
5.0 Conclusion …………………………………………………………………………..

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1.0 Introduction

The law of supply states that if the price of a product increases, quantity supply will also
increase as the supplier will be willing to supply so that they could earn more profit. This law
shows that there is a positive relationship between price and quantity supply.

Graph 1: Law of Supply

Graph 1 shows that when the price of product is at P1, then the quantity supply will be at
Q1, whereas if the price increases to P2, then the quantity supply will also increase to Q2. This
shows that as the prices increases, the producers are willing to supply more to earn more profit.

Price elasticity of supply (PES) is method used in economics term to show how the
responsiveness (elasticity) of quantity supplied (goods or services) will react towards the changes
in its price. In other words, the quantity of supply is elastic when changes in price effects drastically
the quantity of supply (supply increase or decrease a lot). On the other hand, inelastic supply occurs
when the same increase in price either no effect or a little increase or decrease the quantity of
supply. The elasticity is represented in numerical form and is defined as the percentage change in
the quantity supplied divided by the percentage of change in price (See Figure 1).

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 % ∆𝑄𝑆
𝑆𝑢𝑝𝑝𝑙𝑦 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑡𝑦(𝑃𝐸𝑆) =
%∆ 𝑝
Figure 1: Elasticity Supply Formula

Elasticity can be divided into two (2) main characteristics; Elastic and Inelastic. A supply
curve is said to be ELASTIC when an increase in price will increases the quantity supplied in a
big sum. Whereas the same increase in price, will also increases the quantity supplied but only
involved a little sum, then it is said to be INELASTIC. Graph 2 and Graph 3 is an example of
inelastic supply and elastic supply.

Graph 2: Example of Inelastic Supply

Graph 3: Example of Elastic Supply

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 Basically there are four (4) types of situation to determine whether the price is elastic or
inelastic. It will be discussed thoroughly in the next chapter and they are:-
i. When PES > 1, then supply is elastic;
ii. When PES < 1, then supply is inelastic;
iii. When PES = 0, then supply is perfectly inelastic;
iv. When PES = infinity, then supply is perfectly elastic, by following a change in demand.

1.1 Differentiation between Elasticity Demand and Elasticity Supply

There are three (3) characteristics of differentiation between Elasticity Demand and
Elasticity Supply. The characteristic are shown on table 1.
Elasticity Demand Elasticity Supply
- Consumer’s responsiveness to a change - Producer’s responsiveness to a change in
in price price
- Percentage change in quantity demand - Percentage change in quantity supplied
divided by percentage change in price divided by percentage change in price.
% ∆𝑄𝐷 % ∆𝑄𝑆
𝐷𝑒𝑚𝑎𝑛𝑑 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑡𝑦(𝑃𝐸𝐷) = 𝑆𝑢𝑝𝑝𝑙𝑦 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑡𝑦(𝑃𝐸𝑆) =
%∆ 𝑝 %∆ 𝑝

Table 1: Differentiation between Elasticity Demand and Elasticity Supply

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2.0 Types of Elasticity

This is the degree of change in the quantity supplied with respect to change in the price of
product varies in different situation. There are five (5) types of elasticity:
i. Perfectly Elastic Supply
ii. Perfectly Inelastic Supply
iii. Relatively Elastic Supply
iv. Relatively Inelastic Supply
v. Unit Elastic Supply

2.1 Perfectly Elastic Supply

Elastic supply equal to infinity. It means that the price is constant at a certain level and the
quantity of supply is infinite. If the price increase or decrease, it will cause quantity supply to
decrease from the infinite amount to zero with respect to proportionate change in the price of
product. The numerical value of elasticity of supply ranges from zero to infinity (oo). The price
remain constant as the price of product does not effect the quantity supplied. Refer to graph 4 for
an example Perfectly Elastic Supply.

Graph 4: Example graph of Perfectly Elastic Supply

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 The situation in Perfectly Elastic Supply is imaginary as there is no suitable situation that
can replicate the real scenario, as the price remains constant as the price of a product does not
affect the quantity supplied. Let us understand the concept of perfectly elastic supply with an
example by using table 2 and graph 5 below.

Price (RM Per Kg) Quantity Supplied (Kgs. in thousands)

100 50
100 70
100 90

Table 2: The Supply Schedule of Price for Product X

Graph 5: Supply Curve for Product X

Graph 5 shows that the price of product x remains constant at RM 100 per kg. However
the quantity supplied changes from 50,000 kgs to 90,000 kgs at the same price rate. Therefore the
supply of product X is perfectly elastic (PES = oo).

2.2 Perfectly Inelastic Supply

The supply is said to be perfectly inelastic if the price change of an item will not affect the
quantity offered for the item. This means that even if the price of an item goes up or down, the
quantity offered on the item remains the same or unchanged.

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 One of the example of goods that have a perfectly inelastic supply are the output of
agricultural products, such as vegetables in the short term. Although market prices for vegetables
rise in a short period of time, vegetable production cannot be added until new planted plants
produce the output, and this takes quite a while.

The numerical value of elasticity of supply is equal to zero (PES=0). The example as in
Table 3 and the curve for perfectly inelastic supply is vertical or parallel to the price axis as shown
in the Graph 6 below.

Price (RM-Per Kg.) Quantity Supplied (Kgs)

3.00 50
3.50 50
4.00 50
Table 3 : The quantity supplied and the price for product Y

Price S
(RM)

P2
P1
P0

0 Q0 Quantity (Kg)

Graph 6 : Supply curve for Product Y

Graph 6 shows that the supply of product Y remains constant at 50 Kgs. However, the price
changes from RM 3.00 to RM 4.00 at the same supply rate. Therefore, the supply of product Y is
perfectly inelastic (e = 0).

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2.3 Relatively Elastic Supply

Supply is said to be elastic if the percentage change in quantities supplied is greater than
the percentage change in the price of the goods. This means that when the price of an item increases
by 10%, the quantity offered will increase by more than 10%, and on the contrary, when the price
of an item drops by 10%, the quantity offered will decrease by more than 10%. Examples of goods
with elastic supply are manufactured goods that can be added in the short term.

In such a case, the numerical value of elasticity of supply is greater than one (eS>1). For
example, if the quantity supplied increases by 30% with respect to 10% change in the price of a
product, it is called relatively elastic supply. The concept of relatively elastic supply is explained
with the help of an example in Table 4 and Graph 7 below.

Price (RM-Per item) Quantity Supplied (‘000)

40 30
41 35
42 40

Table 4 : The quantity supplied and price for product Z

Price (RM) S

42
41
40

0 30 35 40 (‘000)
Quantity supplied

Graph 7: Supply curve for product Z

In Graph 7, when the price of product Z is RM 40, the quantity supplied is 30,000 units. However,
when the price increases to RM 41, supply reaches to 35,000 units. Similarly, when the price
further increases to RM 42, the supply increases to 40,000 units.

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This shows that the change in price is only RM1 while the change in supply is 5,000. In other
words, the proportionate change in quantity supplied is more than the proportionate change in the
price of product Z. Therefore, the supply of product Z is highly elastic (ES >1).

Based on the above sample , the calculation for the elasticity of supply is as follows:

Es = Q1-Qo X Po
P1-Po Qo

= 35 – 30 X 40
41-40 30

= 5 X 4
1 3
= 20
3

= 6.67 i. e > 1 (Elastic)

2.4 Relatively Inelastic Supply

Good Markets are markets for the output of production. Talking on the economic
perspective firms, which ultimately are owned by individuals either singly or in some corporate
form, are organizations that buy the services of those f

2.5 Unit Elastic Supply

Good Markets are markets for the output of production. Talking on the economic
perspective firms, which ultimately are owned by individuals either singly or in some corporate
form, are organizations that buy the services of those f

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3.0 Factors That Effect Elasticity of Supply

One of the Founding Fathers of economics, Adam Smith, described the price mechanism.
To describe that mechanism, he used a term called “Invisible Hand”. This Invisible Hand, plays a

3.1 Spare Production Capacity

One of the Founding Fathers of economics, Adam Smith, described the price mechanism.
To describe that mechanism, he used a term called “Invisible Hand”. This Invisible Hand, plays a

3.2 Stock of Finish Products Components

One of the Founding Fathers of economics, Adam Smith, described the price mechanism.
To describe that mechanism, he used a term called “Invisible Hand”. This Invisible Hand, plays a

3.3 Internal Analysis

One of the Founding Fathers of economics, Adam Smith, described the price mechanism.
To describe that mechanism, he used a term called “Invisible Hand”. This Invisible Hand, plays a

3.4 Ease & Cost of Factor Substitution / Mobility

One of the Founding Fathers of economics, Adam Smith, described the price mechanism.
To describe that mechanism, he used a term called “Invisible Hand”. This Invisible Hand, plays a

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4.0 Determinants of Elasticity of Supply

Inelastic Elastic
- Difficult to increase production at - Ease to increase production at constant
constant unit cost. unit cost.
- Short run. - Long run.
- Large share of market for inputs. - Small share of market for inputs.
- Global supply. - Local supply.

Table 2 : Summary Determinants of Elastically Supply

4.1 Change in Per Unit Costs with Increased Production

This function motivates producer or consumer to follow a course of action or to change
behaviour. When the price of good increase, the quantity of supply will increase. The increase in
price, provide an incentive to the existing producer to supply more because they provide the
possibility or more revenue and increase profit.

4.2 Time Horizon

This function motivates producer or consumer to follow a course of action or to change
behaviour. When the price of good increase, the quantity of supply will increase. The increase in
price, provide an incentive to the existing producer to supply more because they provide the
possibility or more revenue and increase profit.

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4.3 Share of Market For Inputs
This function motivates producer or consumer to follow a course of action or to change
behaviour. When the price of good increase, the quantity of supply will increase. The increase in
price, provide an incentive to the existing producer to supply more because they provide the
possibility or more revenue and increase profit.

4.4 Geographic Scope

This function motivates producer or consumer to follow a course of action or to change
behaviour. When the price of good increase, the quantity of supply will increase. The increase in
price, provide an incentive to the existing producer to supply more because they provide the
possibility or more revenue and increase profit.

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5.0 Conclusion
This function motivates producer or consumer to follow a course of action or to change
behaviour. When the price of good increase, the quantity of supply will increase. The increase in
price, provide an incentive to the exi

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References

Gale, D. (1955). The Law of Supply and Demand. Mathematica Scandinavica.

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