Economics – Price elasticity of supply | e-Consult

Answer: The price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in price. The coefficient of PES represents the percentage change in quantity supplied divided by the percentage change in price. The size and sign of this coefficient have significant implications for a firm's decision-making regarding production levels and profitability.

Interpretation of the Coefficient:

• |Coefficient | Interpretation | Implications for Firm

• > 1 (Elastic) | Quantity supplied changes by a larger percentage than the price change. | Firms are relatively responsive to price changes. They can easily adjust production in response to changes in market prices. If price falls, firms can significantly reduce output to avoid losses. If price rises, firms can significantly increase output to maximize profits.
• = 1 (Unit Elastic) | Quantity supplied changes by the same percentage as the price change. | The firm's responsiveness to price changes is proportional. The firm will adjust its output to maintain the same level of revenue.

Implications for Production Levels and Profitability:

• Elastic Supply: Firms with elastic supply are more likely to adjust their production levels in response to market price changes. This allows them to maximize profits by exploiting price fluctuations. They are also less vulnerable to price shocks.
• Inelastic Supply: Firms with inelastic supply have less flexibility in adjusting their production levels. They may be forced to accept lower profits if prices fall, or miss out on potential profits if prices rise. They are more vulnerable to price shocks. They may need to consider long-term adjustments to capacity to improve supply elasticity.

Conclusion: The size and sign of the PES coefficient are crucial for firms to make informed decisions about production levels. A high (positive) coefficient indicates responsiveness to price changes, offering flexibility and potential for profit maximization. A low (positive) coefficient indicates limited responsiveness, potentially leading to difficulties in adjusting to market fluctuations and impacting profitability.