How does price elasticity affect supply?

There are two types of price elasticity: price elasticity of supply and price elasticity of demand. The price elasticity of supply measures the responsiveness to the supply of a good or service after a change in its market price. According to basic economic theory, the supply of a good increases when its price rises. Conversely, the supply of a good decreases when its price decreases. Price elasticity of supply measures the percentage change in supply divided by the percentage change in price.

In a free market, producers compete with each other for profits. Since profits are never constant across time or across different goods, entrepreneurs shift resources and labor efforts towards those goods that are more profitable and away from goods that are less profitable. This causes an increase in supply of highly valued goods and a decrease in supply for less-valued goods. Economists refer to the tendency for price and quantity supplied to be positively related as the law of supply.

To illustrate, suppose that consumers begin demanding more oranges and fewer apples. There are more dollars bidding for oranges and fewer for apples, which causes orange prices to rise and apple prices to drop. Producers of fruit, seeing the shift in demand, decide to grow more oranges and fewer apples because it can result in higher profits.

How much will the supply of oranges increase or the supply of apples decrease? These answers depend on each fruit's price elasticity of supply. If oranges have a very high price elasticity of supply, then their supply increases dramatically. Apples, on the other hand, might have a lower price elasticity of demand, which means their supply won't drop as dramatically.

Price elasticity of supply can be calculated using the following formula: (% change in quantity supplied) / (% change in price)

There are many factors that can influence the sensitivity of supply to price changes. Some kinds of goods have zero price elasticity of supply, which means that the supply never changes along with price. Original paintings of Leonardo da Vinci would be an example; no more can be produced.

The availability of natural resources or substitute goods has a large impact on elasticity of supply. Even though the demand for gold spiked from 2008-2012, the supply of gold did not rise very much; gold is relatively uncommon, and it takes a long time to mine new gold reserves. It is likely that both apples and oranges have relatively high elasticity of supply, because it is easy to either plant more or fewer fruit-bearing trees.

Producers also need time to respond to price changes. When the price of oil drops for two days before rising back up to previous levels, oil producers are unlikely to shift production processes and change output because the price drop was short-lived.