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Unit 1 Micro: Revision on Price Elasticity of Supply

Thursday, April 05, 2012
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Here is a planned answer to an exam question

“Discuss how the price elasticity of supply of coffee might differ in the short run and long run.”

The command word “discuss” tells us that this is an example of a Unit 1 micro question that requires both analysis and evaluation to score full marks.

As always look for precise definitions, clear chains of reasoning, accurate diagrams and some evaluative comments.

Dfinition: Price elasticity of supply (Pes) measures the relationship between change in quantity supplied and a change in price.

The formula for price elasticity of supply is: Percentage change in quantity supplied divided by the percentage change in price

When Pes > 1, then supply is price elastic, when Pes

< 1, then supply is price inelastic. When Pes = 0, supply is perfectly inelastic and when Pes = infinity, supply is perfectly elastic following a change in demand.

Many factors affect the price elasticity of supply for a product, in this answer we will focus on the market supply of coffee. The question asks us to focus first of all on the link between time and price elasticity of supply.

Supply is usually more price elastic the longer the time period that a supplier is allowed to adjust its production levels.

In some agricultural markets the momentary supply is fixed and is determined mainly by planting decisions made months before, and also climatic conditions, which affect the production yield. This means that the price elasticity of supply in the momentary period is zero (a vertical supply curve)

Coffee Supply Elasticity

Supply is likely to be price inelastic in the short run because it may be difficult for coffee farmers to expand output and to increase their use of factors of production such as land and capital. In the short run at least one factor input is assumed to be fixed, for example the available stock of capital equipment.

Coffee Supply Elasticity

In the long run all factor inputs are assumed to be variable and therefore short-term supply constraints can usually be resolved and we expect to see a more elastic supply curve. Producers are better able to respond to a higher level of market demand.

Coffee Supply Elasticity

Evaluation:

Other factors affect price elasticity of supply

(1) Spare production capacity: If there is plenty of spare capacity then coffee growers can increase output without a rise in costs and supply will be elastic in response to a change in demand.

(2) Stocks of finished products and components: If stocks of coffee beans in storage are at a high level then growers are able to respond to a change in demand - supply will be elastic.

(3) The ease and cost of factor substitution: This factor might be relevant if a change in world coffee prices persuades some farmers either to switch their crops and increase the amount of land under cultivation for coffee, or conversely take coffee production out of the market by switching to more profitable crops.

 

 




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