Price Elasticity of Supply and the Relative Importance of factors Which Influence the Elasticity of Supply of Electricity
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In a competitive market, price plays an important role in measuring the demand and supply of goods and services. Price is an important principle of microeconomics that is encapsulated in the analyses of demand and supply in order to achieve equilibrium in the quantity of any good or service. The concept of price corresponds with the market’s desire and adjusts in accordance with the market change.
In simple words, price is the significant economic function providing an economic mechanism through which the distribution of goods and services indicates the strength of demand. Price, demand, and supply are interrelated and affect each other in the market. If the supply of the product is high, it will ultimately lead to low prices and hence the production will also be low. On the contrary, if the supply is low this will have resulted in an increase in price and an increase in production.
The price elasticity of demand and supply differs from product to product for instance the supply of electricity is done through the network of cables and various power stations. The growing importance of electricity in both the domestic and industrial sectors has inclined the producers to manage the supply and demand of electricity with regard to its price.
Thus, this essay will give a brief explanation of the price elasticity of supply and evaluate the importance of the factors which influence the price elasticity of the supply of electricity.
Price elasticity is an economic measure that determines the change in price with regard to the supply of goods and services (Rios, McConnell, and Brue 2013). This elasticity also alters the demand for goods and services in the market. The price elasticity of supply is a percentage measure that determines the change in supply with the change in another factor.
The responsiveness of the supplied quantity to the change in price is the ultimate focus of price elasticity of supply. It is a major factor of economics that all the firms are required to assess in order to perform effectively in the market. The market conditions are dynamic and the demand and supply of the products alter the price mechanism drastically. So the price elasticity of supply can be determined as:
Figure 1: Formula of Price Elasticity of Supply
The value of the coefficient might be ranging from 0 showing the perfect inelastic and to infinite which is perfectly elastic. For instance, if the market price of any product increases £2 to £2.10 and the increase in supply is noted from 5m to7.5.m then the PES will be:
= (+) 2.5
According to the above example, the positive sign indicates that the high prices will be the major reason behind the incentive of supplying more due to the coefficient greater than one. The price elasticity of supply will then be elastic and the response of the firm will be positive towards the change in price. This notion will give a competitive advantage to the company in the market over its other rivals.
Figure 2: Elastic and Inelastic Supply Curves (Geoff Riley 2016)
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There are three main causes of price elasticity namely, perfectly elastic, perfectly inelastic, and unit elastic (Armstrong and Vickers 2010: 30). Perfectly elastic is a situation where at one price of any product or service the supply is infinite. The perfectly inelastic is defined as a scenario in which one quantity of the product is supplied. Lastly, the unit elasticity can be graphically shown in which the linear supply enters from the origin.
Figure 3: Cases of PES Economics Online 2016
The formula of price elasticity of supply could be identical to the formula of demand elasticity (Bohi 2013). As the price elasticity in demand is usually negative but the case is different in price elasticity of supply. In price elasticity of supply, the price is normally positive. The adjustment of price elasticity of supply can be determined by the length of time. It has been identified that if a longer time is given for adjustment, the greater elasticity of supply is achieved. The reason behind this is that if the firms are given more time for adjustment the ways to enhance production can be figured out.
Figure 4: Short Run and Long Run Elasticity
In the above diagram, it is determined that in a short-run period of time there is a vertical supply curve “SS” with the price indicating by “Pe” and the quantity supplied by “Qe”. The increase in price in the short-run indicates no change in quantity supplied. In the given time for adjustment, the curve of supply is rotating at price Pe to S1S1. Thus the new quantity is supplied which is shifted out at P1. On the contrary, the long-run supply is being shown by S2S2 due to which there is an increase in quantity supplied to Q2 at P1. The main reason for the longevity of time is that the firms will be able to expand their industry and the flow of resources can be made possible. Therefore, the elasticity of supply which is short run and long run can be adjusted accordingly. The short-run is the amount of time in which the full adjustment cannot be taken place. On the contrary, the long run is the amount of time in which the firms are able to fully adjust the elasticity within the change in price.
The price elasticity of supply is an important factor due to fluctuations in prices in different industries of the world (Pigou 2016). Due to the growing importance of industrialization, the use of energy has also been increased. The electricity supply in the United Kingdom is generated in different ways. There has been a constant supply of electricity in the region and the demand for fuel sources as well as technological advancement has increased in the past few years. Electricity is known to be a new product that cannot be preserved which is the main reason why the supply and demand of electricity must be balanced in the UK. The United Kingdom has been engaged in bilateral exchange of electricity in order to meet the demand. The energy is being imported and exported through interconnectors and currently, the UK has formed these interconnectors between Netherlands, Ireland, and France.
Figure 5: UK Electricity Supply (Euro Means 2015)
According to the statistics, the total electricity supply in the UK shows a peak in annual cycles especially in winter (Ward, Evans and Grimmond 2013: 4645). However, the supply and demand of UK electricity were decreasing in 2015. Amongst the many reasons for the low consumption of electricity in the UK is technological innovation, high energy prices, substitutes for energy creation, and offshoring of various heavy industries. All of the factors reduced demand and hence the supply of electricity also decreases. In 2015 UK consumed 2830,092,000 MWh of total electricity at the price of £167/MWh (Foxon 2013:10). A survey was conducted to estimate the total national value of the UK’s electricity according to which £47 billion worth of energy has been used in the UK per year.
Figure 6: UK Electricity Supply (Euro Means 2015)
According to the empirical analyses conducted by Martin and Anderson (2011: 105) the price elasticity of supply can be influenced by a number of factors. The main factors are the nature of the industry, availability of resources, technological innovation, and cost of production. The elasticity of supply of electricity in the UK can be affected by the nature of the industry. The electricity market has no domain where it can be saved or preserved for mater usage. Due to this reason, the production capacity of the industry has to be increasing day by day in order to meet the demands of the consumers. If there is no way of preserving electricity the price elasticity of supply will be low because it does not have any shelf life like other products. This is also known as a condition in price inelasticity of supply. According to DECC stated that UK has generated up to 81 GW capacity in 2016 and 70.1 of dispatched capacity due to the high demand in winter (Lawton 2010). The green movement in the UK narrates that the production of electricity through wind power plants can be helpful for storing the surplus of production and can be stored for future uses. According to this, it has been expected that the price elasticity of the supply of electricity can be high due to the high demand for electricity in the UK.
Figure 7: UK Electricity Supply (Euro Means 2015)
The availability of resources is also one of the important factors which affect the price elasticity of supply. If an industry has a large number of available resources the price elasticity will be high and vice versa. In the electricity industry of UK, the electricity is generated through a number of resources. The main resources of producing electricity in the UK are solar planes, wind turbines, wood-burning, hydraulic plants, and nuclear reactors (Akorede, Hizam, and Pouresmaeil 2010: 724). According to one survey, the low carbon policy of the UK’s government has the main focus on climate change which generated 50% of electricity. The available resources have shown that the price elasticity of the UK electricity supply has been high. These resources have lower down the prices which ultimately increased demand and hence the supply of electricity as well.
Figure 8: Percentage of Electricity Generation
Another main factor that influences price elasticity of supply is the technological innovation in the production and distribution of the products or services. Some industries such as the electricity industry in order to reach the equilibrium at price incorporate technological advancements which further affect their price elasticity (Allcott 2011: 820). These advancements lead to more efficient production and better machinery due to which the output automatically increases along with the increase in price. The electricity market of the UK uses many latest methods of producing electricity in which the solar and wind power energy are noteworthy. These energy transmissions have been connected to the power grid which further taking the initiation of low carbon power. In this respect, the total amount spent on electricity is estimated at up to £90 million per year showing that the low carbon initiative has proven to be the technology due to which more amount had to be spent and hence the price has gone up. In this regard, the price elasticity is considered low.
Figure 9: UK Electricity Supply (Euro Means 2016)
According to one study conducted by Verbruggen et al. (2010: 850) the price elasticity of supply can be affected by the cost of the production of goods and services. The supply of electricity has been high in the UK due to the low cost of production. It has been identified that the surge in UK’s solar energy reforms has driven down the prices of cost of production. The electricity generator paid up to £30 megawatt per hour. Moreover, wind power plants have been producing electricity at the cheapest prices in the UK. This is due to the rise of renewables and efficiency in power storage. It has been identified that the cost of producing electricity through means such as solar, wind, and renewable power sources is significantly low. The reason is that electricity generation is achieved through natural resources which are cheaper in the UK.
Figure 10: UK Electricity Supply Trends (A2o People 2015)
All the factors which affect the price elasticity of supply are considered important due to their influence on the supply and demand of the product. As the price elasticity is the measure that shows the quantity of supply in accordance with its price (Fischer 2010: 101). The changes in price further affect the demand for the products or services by the consumers. In the UK there are high technological advancements and the cost of production is low. These prospects have further led towards more supply of the energy and hence the prices have also been altered. For instance, the supply of electricity has been high due to the green movement which further decreased the prices by one megawatt per hour.
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The price elasticity of the supply of electricity can be influenced by various factors. These factors determine if the price elasticity would be high or low. The aforementioned analyses show that in the UK the supply of electricity has been increased due to a number of factors such as high demand, low cost of production, and resource availability. All the factors have significant importance in the stability of price and the quantity supplied. Hence, the total quantity of electricity supplied in the UK has been altered and in retrospect, it also affected the demand for electricity in the region: both in domestic and industrial sectors.
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