Like the Price Elasticity of Demand, we can also calculate and analyze a Price Elasticity of Supply to understand production and supply decisions in reaction to changes in market price. This concept can be applied to a wide variety of market types: output markets, labor and capital markets, and financial markets
This numerical measure is a similar ratio between the market price of a good, service or factor input to the quantity supplied:
ηS = %ΔQS / %ΔP
The interpretation is similar. If the value of ηS is equal to 0.5 then:
%ΔQS = ηS x %ΔP
%ΔQS = 0.5p x %ΔP
A 1.0% change in market price leads to a 0.5% change in quantity supplied.
Unlike, what we observe with a downward sloping demand curve; with supply, as price increases quantity supplied increases -- except in the most atypical cases. Thus an increase in market price will always be matched with an increase in Revenue for the firm.
Given the ratio: %ΔQS / %Δ P:
if (%ΔQ) > %(ΔP) then ηS > 1.0 and supply is price elastic or price sensitive.
if the opposite is true then:
ηS < 1.0 and supply is price inelastic or not very sensitive to change in price.
The wage rate (w) represents the price of labor. We can use this price to calculate the price elasticity of labor supply:
ηL = %ΔLS / %Δw
and note that if this value is less than one, labor supply is somewhat insensitive to changes in the wage rate. That is, rising wages may not be providing a strong incentive to workers to join the labor force or to work longer hours. The opposite may also be true. In a later section (Labor Supply Decisions) we examine the forces that may lead to labor supply being sensitive or insensitive to change in wages.
Interest rates (r) represent the price of current spending -- a household can spend today or defer spending, save and with the additional interest income, spend more in the future. Stated differently, the opportunity cost of spending today is foregoing the interest earned on any accumulating savings.
ηSavings = %ΔQSavings / %Δr
Like with labor markets, savings can be highly sensititive or highly insensitive to changes in interest rates. This is discussed in a later section as well (Savings Decisions).