Supply is price inelastic if a change in price causes a smaller percentage change in supply. (PES of less than one)
Example of inelastic supply –
Price of rents falls by 20%; Q.Supply declines by 1%. PES = 0.05
Diagram of inelastic supply
In this case, an increase in price from £30 to £40 has led to an increase in quantity supplied from 15 to 16.
- % change in price = 10/30 = 33.3%
- % change in supply = 1/15 = 6.66%
- Therefore price elasticity of supply (PES) = 6.6/33.3 = 0.2
With a PES of 0.2, it is inelastic because PES is less than one.
Supply curve on right – perfectly inelastic
Supply on left PES = 0.2 (inelastic
Perfectly inelastic supply
Perfectly inelastic supply occurs when a change in price does not affect the quantity supplied.
Factors that make supply inelastic
Usually if the price increases, the firm would like to supply more. The good becomes more profitable. However, there may be several factors which make it difficult for the firm to supply more. Therefore supply is price inelastic.
- Firm operating close to full capacity. If a firm is operating close to full capacity, then it has limited ability to increase the supply. It may be able to get workers to do some overtime, but at some point, it will meet capital limits, and it cannot increase supply without long-term capital investment.
- Running out of raw materials. There will come a time when we run out of raw materials – oil, natural gas. When this occurs, the supply will be inelastic because it is physically impossible to increase supply.
- Short term. Supply will be more inelastic in the short-term. In the short-term capital is fixed. It takes time to invest and increase the size of a factory. However, in the long-term, farmers can cultivate more land or firms can increase the size of their factory and supply will become more responsive.
- Limited factors of production. Some firms may come across labour constraints, especially if the work requires highly skilled labour. For example, the supply of extra maths lessons may be limited by the ability to employ sufficiently skilled maths teachers.
- Low levels of stocks. If firms can stockpile goods, then they can respond to increases in demand and price. However, some goods cannot be stored, e.g. intangible services or food with short shelf-life like tomatoes and bananas.
- Planning restrictions. Homes are often supply inelastic because in certain areas it is hard to find suitable land or get planning permission to build more houses.
Importance of inelastic supply
This shows the UK housing market between 1998 and 2005. House prices more than doubled because supply was price inelastic. Despite rising demand and rising prices, there was only a moderate increase in supply.
- High prices. If supply is inelastic, it may be easier for firms to put up prices. For example, the supply of rented accommodation in London is inelastic because it is hard to find new places to build property. But, with inelastic supply and rising demand, this has pushed up the price of housing and rented accommodation.
- Planning. Supply is usually inelastic in the short-term. Therefore, it requires forward planning by the firm to increase supply in anticipation of future demand. However, this can be difficult to do, and there is a risk that a firm invests, but the demand fails to materialise.
- Volatile prices. In markets where supply and demand are inelastic, we are likely to see more volatile prices. This may require government intervention to stabilise prices, through a scheme, such as buffer stocks. See: Volatile prices.