What is Price Elasticity of Supply and how to calculate it

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Price Elasticity of Supply (PES) is an indicator that reveals how the supply of a product or service varies due to price changes. A simple example is the property market. In times of crisis, housing prices plummet, construction companies stop building houses, supply falls. On the contrary, when prices rise, it is time to continue building, as there is a greater profit margin. Thus, there is a directly proportional relationship between the selling price, and the quantities of products that are manufactured, and made available to consumers. This indicator shows that not only can the demand vary when prices change, but the entire market can respond to these changes if they are drastic. Therefore, you should also consider the price elasticity of supply when defining your pricing strategy. We explain how to calculate it and its determining factors.


How to calculate Price Elasticity of Supply 

To calculate the price elasticity of supply, the percentage change in the quantity supplied of a product is divided by the percentage change in the price of that item.

        Percentage change in the quantity supplied 

PES = ___________________________________________

Percentage change in price 
 

The result from this equation can be 1, less than 1, or more than 1. From this data, the supply can be classified into three groups. 

Classification of elasticity of supply 

  • Unitary Elastic Supply: When the result of the equation equals 1. In this scenario, the price change causes a proportional change in the product supply
  • Elastic Supply: When the result of the equation is greater than 1. In these cases, any change in the product’s price, however small, will result in a greater variation in the quantity of items supplied. This situation is often the case in small businesses where prices condition the profit margin and production capacity. 
  • Inelastic Supply: Values below 1. This occurs when, unlike in the previous cases, price changes hardly affect the volume of items supplied by the brands or e-commerce businesses.

Determining factors in the price elasticity of supply 

Certain conditions may affect the price elasticity of supply. Among those which stand out most are: 

  • The company’s ability to increase its production based on:
    • Availability of inputs or raw materials. 
    • Technological capacity. 
  • Production costs. 
  • The time available to respond to price changes. 

All these factors come into play if the company is considering increasing its supply to increase its profit margin as well. If, on the other hand, the price forces the business to reduce its production and product supply, to survive it will be crucial to check the balance between costs and profits to avoid going into the red. In this respect, as mentioned above, when a company’s profit margin is very low, any change in prices can have a great impact, for the better or worse. 

An effective way to keep adequate control of e-commerce prices and changes, both for your own and your competitor’s prices, is to have a pricing suite that stores all the key information for the business. This software provides an overview of the company’s price trend and market position to optimise strategic decision-making. It is an invaluable tool to complete the digitisation of both business and price management.

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