Supply
Supply
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Supply is a whole list: how many units a firm is willing and able to sell at each possible price.
Mirelo Tiles is a tile maker in the town of Ostel. It fires its tiles in one kiln, an oven that hardens clay into tiles. How many tiles will Mirelo sell in a week? That depends on the price it can get for each one.
Supply: the quantity of a good or service that producers are willing and able to sell at each price over a given period of time: the whole schedule is supply, and one point on it is the quantity supplied.
Put simply, supply answers one question at every price: "How many will you sell at this price?" Both conditions must hold. A firm with no tiles is not able to supply them. A firm that has tiles but will not sell them at that price is not willing.
Supply is always measured over a period, such as tiles a week. It is not the number of tiles in Mirelo's store at one moment. Here is Mirelo's supply schedule:
The whole table is Mirelo's supply. One row, such as 1,000 tiles at $5, is the quantity supplied at that price. Plot each row on a diagram, with price on the vertical axis and quantity supplied on the horizontal axis, and join the points: the line is Mirelo's supply curve, S.
Market supply: the total of every firm's supply: the quantity of a good that all producers are willing and able to sell at each price over a given period.
Put simply, to find market supply at $5, add Mirelo's 1,000 tiles to the tiles every other maker in Ostel is willing and able to sell at $5. Then do the same at every other price.
On Mirelo's schedule, each $1 rise in the price brings 100 more tiles a week. This pattern is called the law of supply.
Law of supply: as the price of a good rises, the quantity supplied rises, and as the price falls, the quantity supplied falls, ceteris paribus (all other things being equal).
Put simply, a higher price brings a higher quantity supplied, as long as nothing else changes. This is what the upward slope of the supply curve shows.
Real Example: In early 2024, after the price of robusta coffee had risen, some farmers in Vietnam kept their beans in store, waiting for even higher prices. They were able to sell, because they had the beans, but at that price they were not willing to. This does not break the law of supply, which holds only when nothing else changes: here something else had changed, because the farmers now hoped for a higher price later.
Exam Matters: To define supply, give both conditions: willing and able. Then add the two details that make it a schedule: at each price, and over a period of time.
Each extra tile costs more to make than the ones before, so Mirelo needs a higher price to make more.
Mirelo's supply curve slopes upward: the higher the price, the higher the quantity supplied. Why does Mirelo need a higher price before it will make more tiles? The answer lies in what each extra tile costs to make.
Mirelo makes its cheapest tiles first: in normal working hours, with its regular staff and its usual clay. To make more tiles, it must use resources that cost more. It may pay its workers overtime, use an older and slower press (the machine that shapes the tiles), or buy clay from a more expensive supplier.
Take the tiles beyond 1,000 a week. To fire them, Mirelo needs a weekend shift, and the overtime pay raises the cost of each of those tiles. Each of these extra 100 tiles costs more than $5 to make. At a price of $5 they would lose money, so Mirelo supplies only 1,000. At $6 the price covers their cost, so they are worth making, and the quantity supplied rises to 1,100.
Read the other way round, this explains the law of supply. A higher price covers the cost of tiles that were not worth making before, so the quantity supplied rises as the price rises.
A change in the good's own price moves the firm along its supply curve, and the curve itself does not move.
Mirelo's supply curve already answers one question: how many tiles will Mirelo sell at each price? Price is measured on its vertical axis. So when the price of a tile changes and nothing else does, the answer is already on the curve: Mirelo moves to another point on the same curve.
Say the price of a tile rises from $5 to $6. On the diagram, A is the point on S at $5 and 1,000 tiles a week, and B is the point on S at $6 and 1,100 tiles. Mirelo moves up the curve from A to B. The quantity supplied rises by 100 tiles a week, but S stays where it was.
Extension of supply: a rise in the quantity supplied caused by a rise in the good's own price, shown by a movement up along the supply curve.
Contraction of supply: a fall in the quantity supplied caused by a fall in the good's own price, shown by a movement down along the supply curve.
Put simply, an extension is a move up the curve the firm is already on, caused by a higher price. A contraction is the same kind of move downwards. If the price falls from $6 back to $5, Mirelo moves down from B to A, and the quantity supplied falls from 1,100 to 1,000 tiles a week.
In a movement, the quantity supplied changes, but supply does not. Supply is the whole schedule, and every row of Mirelo's schedule is the same as before. So the name "extension of supply" can mislead: what extends is the quantity supplied, not supply itself. A rise in the price causes an extension of supply, not a shift of the curve.
Exam Matters: To show an extension, draw one supply curve and mark two points on it, with both prices and both quantities read off to the axes.
When something other than the good's own price changes, the quantity supplied changes at every price, and the whole curve shifts.
A change in the price of a tile moves Mirelo along its curve. Other changes alter the quantity Mirelo supplies at every price. Suppose a rise in Mirelo's costs means it now supplies 200 fewer tiles a week at every price: 800 at $5 instead of 1,000, and 900 at $6 instead of 1,100. Every row of the schedule has changed, so the whole curve moves.
Increase in supply: a rise in the quantity supplied at every price, caused by a change in a factor other than the good's own price, shown by a shift of the supply curve to the right.
Decrease in supply: a fall in the quantity supplied at every price, caused by a change in a factor other than the good's own price, shown by a shift of the supply curve to the left.
Put simply, an increase in supply gives a new schedule with more in every row, and a decrease gives one with less in every row.
To tell which has happened, hold one price still and compare. At $5, Mirelo used to supply 1,000 tiles a week. If it now supplies 800 at $5, supply has decreased. Quantity is on the horizontal axis, so a smaller quantity at the same price lies to the left: the curve has shifted left. If it now supplies 1,200 at $5, supply has increased and the curve has shifted right.
In the exam, say whether the curve has shifted right or left, because that names the change in supply. "Up" and "down" can mislead. After the rise in costs, Mirelo supplies 200 fewer tiles at every price, so at $7 it now supplies 1,000 tiles, not 1,200. Before, those 1,000 tiles needed only $5. So a curve that shifts left also lies above the old one: each quantity now needs a higher price. A shift "up" is therefore a decrease in supply, and a shift "down" is an increase.
Real Example: In 2018-19, a severe drought in New South Wales and Queensland cut Australia's wheat harvest to 17.3 million tonnes, from 21.24 million the year before. Farmers had less wheat to sell. The cause was the weather, not a change in the price of wheat, so this is a decrease in supply: the curve shifts to the left.
When the cost of making each unit rises, a firm supplies less at every price, so its supply curve shifts left.
To make its tiles, Mirelo pays for workers, clay, fuel for the kiln and rent for its workshop. Together these are its costs of production.
Costs of production: the payments a firm makes for the factors of production and other inputs it uses, such as wages, raw materials, energy and rent.
Put simply, costs of production are everything Mirelo pays to turn clay into finished tiles. For supply, what matters is the cost of making each tile.
Now the price of clay rises, so each tile costs more to make. Follow what happens at one price, $5:
At $6, Mirelo now supplies 900 tiles, not 1,100, and at $7, 1,000, not 1,200. The quantity supplied is 200 lower at every price. This is a decrease in supply.
Read upwards, the shift says the same thing. Before, Mirelo needed $5 to supply 1,000 tiles. Each of those tiles now costs more to make, so Mirelo needs a higher price for them: the new schedule shows 1,000 tiles only at $7. Each quantity now needs a higher price, so the new curve lies above Mirelo's original supply curve, S, as well as to its left.
A fall in costs reverses each step. If the price of clay fell back, each tile would cost less to make. At $5, the 200 tiles that stopped being worth making would cover their cost again, so Mirelo would supply 1,000 once more. More at every price is an increase in supply, and S would shift back to the right.
New technology lets a firm make more from the same inputs, so each unit costs less and supply increases.
New technology is a better way of turning inputs into output: a faster machine, a better process, or a method that wastes less.
Start again from Mirelo's first schedule, S. Mirelo starts to use a new firing method that needs less fuel and less time for each tile, so its one kiln can also fire more tiles a week. Each tile now costs less to make, so, as with any fall in costs, tiles that were not worth making at $5 now are. At $5, Mirelo supplies 1,200 tiles a week instead of 1,000, and 200 more at every other price. Supply has increased, and S shifts to the right.
Two things make technology different from a fall in the price of an input:
Over time, other tile makers in Ostel may copy the method. As each one does, its own supply increases, so market supply in Ostel increases too.
A specific tax adds the same amount to the price a firm needs for every unit, so the supply curve shifts up.
Governments tax spending as well as income. A tax on spending is collected through the seller.
Indirect tax: a tax on spending on goods and services, paid to the government by the seller, who can charge buyers some or all of it in a higher price.
Put simply, part of the price you pay for the good is tax, and the seller sends that part to the government.
Specific tax: a fixed amount of tax on each unit of a good sold, whatever its price.
Put simply, a specific tax is a fixed sum on every unit, such as $1 a tile, whether the tile sells for $3 or for $7.
Each point on a supply curve shows the price Mirelo needs to receive to supply that quantity. Now the national government puts a specific tax of $1 on every tile. The tax is a cost of selling each tile, like a rise in the cost of clay. Before the tax, Mirelo needed $5 a tile to supply 1,000 tiles a week. It still needs to keep $5, but now $1 of each tile's price goes to the government. So buyers must pay $6 for Mirelo to supply those 1,000 tiles.
The tax is the same $1 on every tile, so the same happens at every quantity:
Every point on Mirelo's supply curve, S, moves up by exactly $1, so the new curve, S + tax, is parallel to S. Two prices now matter: the price buyers pay, and the price Mirelo keeps after paying the tax. The gap between them is always $1.
This upward shift is also a decrease in supply. To see why, hold the price buyers pay at $6. Before the tax, Mirelo kept all $6, and at $6 it supplied 1,100 tiles. After the tax, Mirelo keeps only $6 − $1 = $5.
The price Mirelo keeps decides which tiles are worth making, so it now supplies what it used to supply at $5: 1,000 tiles. The same happens at every price buyers pay: the quantity supplied is 100 tiles lower, so the curve has also shifted left.
Exam Matters: Label the new curve S + tax and show the vertical gap between S and S + tax. For a specific tax, the gap is the same at every quantity.
An ad valorem tax is a percentage of the price, so the tax on each unit grows as the price rises.
Many countries tax goods as a percentage of their price.
Ad valorem tax: a tax charged as a percentage of the price of a good, so the tax on each unit is larger when the price is higher.
Put simply, the government takes the same share of every price, not the same sum, so a more expensive unit pays more tax.
Suppose the national government taxes tiles at 20% of the price Mirelo needs. To find S + tax, add the tax at each quantity to the price Mirelo needs there.
The tax grows from $0.60 to $1 to $1.40 as the price Mirelo needs rises. So the gap between S and S + tax widens as the quantity rises. S + tax does not move parallel to S: it pivots, turning away from S so that it is steeper.
The key difference from a specific tax is what happens as the price rises. Compare the tax each one adds to a tile:
With a specific tax, the tax on each unit stays the same; with an ad valorem tax, it changes with the price.
Both taxes decrease supply: at any price buyers pay, Mirelo keeps less, so it supplies fewer tiles. For example, when buyers pay $6, Mirelo keeps $5: the tax is 20% of the $5 Mirelo needs, which is $1. So Mirelo supplies 1,000 tiles, 100 fewer than it supplied at $6 before the tax.
Real Example: Saudi Arabia charges value added tax (VAT) at 15% of the price, a rate it set in July 2020. So an item priced at 200 riyals before tax carries 30 riyals of tax, ten times the tax on a 20-riyal item. The tax on each item follows its price, as it does for any tax charged as a percentage of the price.
A subsidy lowers the price a firm needs for every unit, so the supply curve shifts down and supply increases.
A government sometimes wants more of a good than the market would supply on its own, such as a basic food or a vaccine. One way to get more is to pay producers for each unit.
Subsidy: a payment by the government to producers for each unit of a good they produce or sell, which lowers their costs and increases supply.
Put simply, a subsidy is the opposite of a specific tax: the government pays the firm on each unit, instead of the firm paying the government.
Suppose the national government pays Mirelo $1 for every tile it sells. Without the subsidy, Mirelo needs $5 a tile to supply 1,000 tiles a week. With it, $1 of each tile's $5 comes from the government. So Mirelo needs only $5 − $1 = $4 from the buyer to supply the same number of tiles.
The subsidy is the same $1 on every tile, so every point on S moves down by $1, and the new curve is parallel to S. This downward shift is also an increase in supply, a shift to the right.
Hold the price buyers pay at $5. Mirelo now receives $6 a tile, $5 from the buyer and $1 from the government, and at $6 it supplies 1,100 tiles. At every price buyers pay, the quantity supplied is 100 tiles higher.
Ending a tax or a subsidy reverses its shift: every point moves back by the amount of the tax or subsidy. Each step of the subsidy mirrors the $1 specific tax:
A natural disaster destroys output or the means to make it, so less can be supplied at every price.
Floods, droughts, earthquakes and storms can destroy crops, damage factories and cut the roads that take goods to market. Firms are then less able to supply, whatever the price.
Suppose heavy rain floods Mirelo's clay pit. Until the water is pumped out, Mirelo cannot dig clay there, so it can fire fewer tiles. At $5 it now supplies 600 tiles a week, not 1,000, and 400 fewer at every other price. This is a decrease in supply: S shifts to the left.
The flood changes what Mirelo is able to supply, not what it is willing to supply. At $5, Mirelo is still willing to sell 1,000 tiles, but without its clay it is able to make only 600. A disaster can raise costs as well. Clay bought from a pit further away costs more, and that reduces supply in the same way as any rise in costs.
How long the shift lasts depends on how quickly the damage is repaired. A flooded pit may be pumped dry in weeks. A destroyed factory can take years to rebuild. Once the damage is repaired, supply increases again, and S shifts back to the right.
Real Example: In October 2011, floods in Thailand forced thousands of factories to close, including makers of computer hard drives. In the last three months of 2011, global hard-drive shipments were 26% lower than a year before. The floods cut the industry's ability to make drives. The fall in shipments was a fall in the quantity supplied, and it counts as a decrease in supply because its cause was the floods, not the price of drives.
The law of supply gives the direction of the response to a price rise; price elasticity of supply gives its size.
Mirelo Tiles makes tiles in the town of Ostel and fires them in one kiln, an oven that hardens clay into tiles. Every Mirelo figure here comes from its first supply schedule, S: 1,000 tiles a week at $5, and 1,100 at $6.
The law of supply tells you the direction: when the price rises, the quantity supplied rises. It does not tell you the size. Will a higher price bring a few more tiles, or a great many more? Price elasticity of supply answers that question.
Price elasticity of supply (PES): the responsiveness of the quantity supplied of a good to a change in its own price.
Put simply, PES measures how strongly producers react when the price of their good changes. The higher the PES, the larger the percentage rise in the quantity supplied after the same percentage rise in price.
Why does the formula use percentages, not the number of extra units? Tiles are counted one by one and oil in barrels, so their extra units cannot be compared. A $1 price rise is also large on a $5 tile but tiny on a $500 machine. A percentage measures each change against the value it started from: $1 on $5 is 20%. Percentages have no units, so the PES of tiles can be compared with the PES of oil.
PES is positive along an upward-sloping supply curve. There, the price and the quantity supplied move in the same direction. Both percentage changes therefore have the same sign, so their ratio is positive.
Exam Matters: To define PES, say it is the responsiveness of the quantity supplied to a change in the good's own price, then give the formula with the quantity supplied on top.
To calculate PES, divide the percentage change in quantity supplied by the percentage change in price, each measured from its own starting value.
PES is worked out in three steps. First find the percentage change in the quantity supplied. Then find the percentage change in price. Then divide the first by the second.
Each percentage change is the change divided by the original value, the value before the change, then multiplied by 100. Why the original value? A percentage change says how large a change is compared with where it started. Dividing by the new value would give a different answer for the same change: 100 tiles on 1,100 is not 10%. So the base is always the value before the change.
What does 0.5 mean? For every 1% rise in the price of a tile, Mirelo's quantity supplied rose by 0.5%. The quantity supplied did respond, but by a smaller percentage than the price.
If the price falls, the method is the same, and the original value is the value before the fall. If Mirelo's price falls from $5 to $4, its quantity supplied falls from 1,000 to 900 tiles a week: a fall of 10% after a fall of 20% in the price. Both changes are negative, so PES is still positive: 0.5.
Exam Matters: Show each step on its own line: the two percentage changes, then the division. Then add one sentence on what the value means for this producer.
Whether PES is above or below 1 tells you if the quantity supplied changes by a larger or smaller percentage than the price.
A PES value is read by comparing it with 1. Above 1, the quantity supplied changes by a larger percentage than the price. Below 1, it changes by a smaller one. These two cases have names.
Price elastic supply: supply for which the percentage change in quantity supplied is greater than the percentage change in price, so PES is greater than 1.
Price inelastic supply: supply for which the percentage change in quantity supplied is smaller than the percentage change in price, so PES is between 0 and 1.
Put simply, with elastic supply a 10% rise in price brings a rise of more than 10% in the quantity supplied. With inelastic supply, the same 10% rise in price brings a rise of less than 10%.
Mirelo's PES of 0.5 is inelastic. Compare it with a second producer whose quantity supplied rises by 30% after the same 20% price rise:
The price rise is the same for both. The difference is how far each producer can raise its quantity supplied in response.
On a diagram, compare two supply curves that pass through the same point. For the same price rise, the flatter curve gives the larger rise in the quantity supplied, so it is the more elastic of the two. This comparison holds only for curves that pass through the same point.
Exam Matters: To interpret a PES value, compare it with 1, name the type of supply, and say what it means for this producer, for example what a 10% price rise does to its quantity supplied.
Supply is unitary elastic when the quantity supplied changes by exactly the same percentage as the price.
Unitary elastic supply: supply for which the percentage change in quantity supplied equals the percentage change in price, so PES is exactly 1.
Put simply, the quantity supplied changes by the same percentage as the price. A 10% rise in price brings a 10% rise in the quantity supplied.
Any straight supply curve that starts at the origin, where price and quantity are both zero, has a PES of 1 all along it, whatever its slope. Why? On such a line, the quantity is always the same multiple of the price: a line through $2 and 100 units also passes through $4 and 200 units. So a 100% rise in price brings a 100% rise in quantity.
A straight supply curve that does not start at the origin is different. Extend it down to an axis. If it meets the price axis, the quantity is zero while the price is still above zero, so, compared with a line from the origin, the quantity is small for its price. Any rise in it is then a larger percentage than the rise in price: supply is elastic all along. If it meets the quantity axis, there is some quantity even at a price of zero, so the quantity is large for its price. Any rise in it is a smaller percentage: supply is inelastic all along.
Mirelo's curve S is one of these: extended down, it meets the quantity axis at 500 tiles, so its supply is inelastic at every price.
At the two extremes of PES, the supply curve is a vertical line or a horizontal line.
PES can take any value from 0 upward. At the two ends of that range, the supply curve does not slope at all.
Perfectly inelastic supply: supply for which the quantity supplied does not change when the price changes, so PES is zero.
Put simply, the quantity is fixed for now, whatever the price. Think of the seats in a stadium for one match on Saturday. However high the ticket price goes, no extra seats can appear before that match, so the percentage change in the quantity supplied is 0. Supply for that match is a vertical line at the number of seats. Over a few years, though, a larger stand could be built, so the line is vertical only for that match.
Perfectly elastic supply: supply for which producers will supply any quantity at one price but nothing at a lower price, so PES is infinite.
Put simply, at one price the producer will supply any quantity, and below that price it supplies none. Supply is a horizontal line at that price. Along it, the quantity can change by any amount while the price does not change at all, so PES is infinite.
Why horizontal? Take one small farm selling a standard grade of maize into a large market. Over several seasons, it can plant more land. Each extra sack then costs about the same to grow as the last one, and the market price just covers that cost. So at the market price every sack is worth growing, and the farm will supply any quantity. At any lower price, no sack covers its cost, so it supplies none.
Real markets are rarely exactly like this. Perfectly elastic supply is a model of a very small producer among very many.
The more time producers have after a price rise, the more ways they have to raise the quantity supplied.
Suppose the price of a tile rises from $5 to $6 and stays there. What can Mirelo do to supply more tiles? It has several ways to respond, and each one needs a different amount of time to arrange.
Each step adds to the ones before it. Today Mirelo can only sell what it has in store. By the end of the week, it can also fire more tiles in the kiln it has. Within months it can add workers, and in about two years it can add a whole kiln.
So the longer the period after the price rise, the more responses are open to Mirelo. Each new response adds more tiles, so the same price rise, $1 on $5 or 20%, brings a larger percentage rise in the quantity supplied. This is why time is a determinant of PES: the longer the period, the more price elastic supply is. A PES value always belongs to a period, so always say which one.
Real Example: Oil production in the US Gulf of Mexico responds less to short-term price changes than oil production on land in the Lower 48 states, the US states other than Alaska and Hawaii. The reason is time: large offshore projects take a long time to discover and develop. So over a short period, the supply of offshore oil is less price elastic than the supply of oil on land.
Exam Matters: When a question gives a period, such as "over the next month", say which responses fit inside it before you judge whether supply is elastic.
A firm that can store its good can respond to a price rise by selling stock, so its supply is more price elastic than that of a firm that cannot.
The quickest response to a price rise is to sell goods that are already made. Whether a firm can do this depends on two things: whether it holds stock, and whether its good can be stored at all.
Stock: goods that a firm has already produced and holds, ready to sell.
Put simply, stock is output made earlier and stored, like tiles stacked in Mirelo's store. When the price rises, Mirelo can sell more tiles this week without firing a single extra one. Stock lets the quantity supplied rise before production does, so supply is more price elastic.
Perishable good: a good that decays or loses its value quickly, so it cannot be stored for long.
Put simply, a perishable good must be sold soon after it is made, whatever the price that day. Fresh milk, fresh bread and ripe fruit are examples.
Perishability affects PES because a perishable good cannot be stored. There is no stock to release when the price rises, and none can be made ahead for a later price rise. So its quantity supplied can rise only as fast as production can, and its supply is less price elastic than the supply of a good that keeps. A good that keeps, such as tiles or tinned food, can be stored and then released, so its supply is more price elastic.
Storage is not free. A warehouse, refrigeration and goods that sit unsold all cost money. So a firm holds stock only when being able to respond to a price rise is worth that cost.
Exam Matters: Apply this factor to the good in the question: say whether it spoils, how long it keeps and what storing it costs.
Supply is more price elastic when the workers and machines needed can easily move into making the good.
To raise output after a price rise, a firm needs more factors of production: more workers, more machines, more land. Can it get them quickly? That depends on how easily those factors can move into this use.
Occupational mobility: the ease with which a factor of production can move from one use or job to another.
Geographical mobility: the ease with which a factor of production can move from one area to another.
Put simply, occupational mobility asks whether a worker or a machine can switch to new work. Geographical mobility asks whether it can move to a new place. A packer can learn to pack tiles in a day, and a van can carry tiles as easily as fruit. A skilled glassblower may need years of training, and a machine built for one product may be useless for another.
Why does this change PES? When the price of a good rises, making more of it becomes worthwhile, so the firm needs more factors. If the factors are mobile, the firm can attract them from other work or other towns. Then the quantity supplied rises quickly, and supply is more price elastic. If the factors are specialised, a higher price cannot attract them quickly. Then the quantity supplied rises slowly, and supply is more price inelastic.
Distance matters too. Workers may be unable to move to the town where the work is, because housing there is expensive or their families live elsewhere. This is low geographical mobility, and it makes supply more price inelastic than if workers could move, even when the right skills exist.
When a law limits how much may be produced, a higher price cannot raise output beyond that limit.
Some limits on output are set by law, not by cost. A firm may be able to make more, and a higher price may make more worth making, but the law does not allow it.
Quota: a legal limit on the quantity of a good that may be produced or sold in a given period.
Put simply, a quota is a ceiling written into law. A fishing boat with a quota of 50 tonnes this season must stop at 50 tonnes, even if the price of fish doubles.
Other legal constraints work in the same way:
Why does a legal limit make supply inelastic? A higher cost can be covered by a higher price: if making more costs more, a high enough price makes it worthwhile. A legal limit is different. Once output reaches the limit, no price brings any more, so the supply curve becomes vertical there. The closer output is to the limit, the less the quantity supplied can respond to the price.
Over time, a rule can change. A government can raise a quota or issue more licences, and then the quantity supplied can rise again.
Real Example: A law of 1937 created New York City's system of taxi licences, called medallions, which the city regulates. The right to run a licensed taxi became very valuable: in 2013–2014 a medallion sold for over $1 million. While the number of licences is limited, the number of licensed taxis cannot rise just because running one becomes worth more.
A firm with spare capacity can raise output quickly, so its supply is more price elastic than a firm working at its limit.
Mirelo fires its tiles in one kiln, and one kiln can fire at most 1,200 tiles a week. That limit has a name.
Capacity: the maximum output a firm can produce with its existing resources in a given period.
Put simply, capacity is the most a firm can make with the buildings and machines it has now.
Spare capacity: the difference between a firm's capacity and the output it is producing now.
Put simply, spare capacity is room to grow without building anything. At $5, Mirelo fires 1,000 tiles a week, so it has 200 tiles a week of spare capacity.
Why does spare capacity make supply more price elastic? A firm with spare capacity can raise output with what it already has, such as longer hours in the kiln and more clay. So when the price rises, its quantity supplied can rise quickly. A firm at full capacity cannot do this. To make more, it must first add capacity by building or buying more, and that takes time. Until then its output cannot rise, so, with no stock to sell, its supply is price inelastic.
Spare capacity makes supply more price elastic, not always elastic. Mirelo's 200 tiles of spare capacity let its quantity supplied rise by 10% when the price rises by 20%, so its supply is still price inelastic. At $7 it reaches 1,200 tiles a week, its full capacity. At any higher price, one kiln cannot fire a single extra tile until Mirelo adds a second kiln.
Capacity is the last of five factors that decide how price elastic supply is: the time period, stock, the mobility of factors, legal limits and capacity. Each one asks how quickly, and how far, the quantity supplied can rise when the price does.
Exam Matters: When you examine the factors behind PES, find the evidence for each one in the case, then judge which one limits the response most, and over what period.
In economics, the short run is not a set length of time: it lasts while at least one factor stays fixed.
Mirelo can raise its output in many ways: more clay, more hours, more workers. But it cannot add a kiln quickly, because a second kiln takes about two years to build. For now, the kiln is a fixed factor of production: its quantity cannot be changed.
Short run: the period in which at least one factor of production is fixed.
Put simply, the short run is the time a firm must work with something it cannot yet change. Mirelo's short run lasts as long as a second kiln would take to build: about two years.
In the short run, Mirelo can still vary its other factors. When the price rises from $5 to $6, it buys more clay and pays for a weekend shift, and its quantity supplied rises from 1,000 to 1,100 tiles a week. But every tile must be fired in the one kiln, so output can rise only up to the kiln's capacity of 1,200 tiles a week.
The short run is defined by what is fixed, not by a number of months, so its length differs between industries. For a market stall it may be a day. For a power station it may be ten years, because that is how long a new one can take to build.
In the long run every factor can change, so a firm can choose its capacity, not only how much of it to use.
Given enough time, Mirelo's kiln stops being fixed. In about two years it could build a second kiln, or move to a larger site. At that point no factor is fixed any more.
Long run: the period in which all factors of production can be varied.
Put simply, the long run is a period long enough for a firm to change everything, including its buildings and machines. For Mirelo, it begins once a second kiln could be built and working.
The key difference from the short run is what the firm chooses. In the short run, Mirelo chooses how much of its one kiln to use, up to its capacity of 1,200 tiles a week. In the long run, it chooses the capacity itself: one kiln or two, this site or a larger one.
Across a whole market, the long run also allows new firms to join, adding their capacity too.
In the long run the limits on output loosen, so the same price rise brings a larger response than in the short run.
The longer the period, the more responses a firm has to a price rise. In the long run every factor of production can change. Over that much time, each of the limits on supply can loosen:
Each loosened limit adds to the response a firm can make to the same price rise. So the quantity supplied rises by a larger percentage, and supply is more price elastic in the long run.
On the diagram, S is Mirelo's supply curve with one kiln, and S long run is its supply curve with two kilns. A is the point where S and S long run cross, at $5 and 1,000 tiles. B is the point on S at $6 and 1,100 tiles. C is the point on S long run at $6 and 1,400 tiles.
The firm and the price rise are the same. Only the period differs. With two kilns, the extra tiles are no longer limited to what one kiln can fire. So a PES value is always stated for a period: Mirelo's PES is 0.5 with one kiln, and 2 once it can have two.
Supply is a whole list: how many units a firm is willing and able to sell at each possible price.
Each extra tile costs more to make than the ones before, so Mirelo needs a higher price to make more.