If a 40% change in price results in a 25% change in quantity supplied, then the price elasticity of supply is about
a. 0.63, and supply is elastic.
b. 0.63, and supply is inelastic.
c. 1.60, and supply is elastic.
d. 1.60, and supply is inelastic.
The correct answer and explanation is :
The correct answer is:
b. 0.63, and supply is inelastic.
Explanation:
Price Elasticity of Supply (PES) measures how much the quantity supplied of a good responds to a change in its price. It is calculated using the formula:
$$
\text{Price Elasticity of Supply (PES)} = \frac{\%\text{ change in quantity supplied}}{\%\text{ change in price}}
$$
From the question:
- Percentage change in quantity supplied = 25%
- Percentage change in price = 40%
$$
PES = \frac{25\%}{40\%} = 0.625 \approx 0.63
$$
Now let’s interpret the value:
- If PES > 1, supply is elastic – producers are highly responsive to price changes.
- If PES = 1, supply is unit elastic – responsiveness is proportional.
- If PES < 1, supply is inelastic – producers are less responsive to price changes.
Since 0.63 < 1, the supply is considered inelastic.
Why is this important?
Understanding elasticity of supply helps businesses and policymakers anticipate how producers will respond to price changes. For example:
- If supply is inelastic, a large price increase results in only a small increase in the quantity supplied. This might occur due to limited resources, long production times, or capacity constraints.
- In contrast, when supply is elastic, producers can quickly adjust output, often due to available raw materials, flexible production, or shorter time horizons.
In this case, a 40% increase in price only resulted in a 25% increase in quantity supplied, showing that producers are not highly responsive. This might reflect short-term rigidity in production processes.
Final Answer:
b. 0.63, and supply is inelastic.