Supply elasticity is a measure of the responsiveness of an industry or a producer to changes in demand for its product. The availability of critical resources, technology innovation, and the number of competitors producing a product or service also are factors.
- The flexibility of production levels affects supply elasticity.
- Availability of critical resources is a factor.
- The number of competitors in an industry affects its supply elasticity.
Understanding Elasticity of Supply
Elasticity of supply is a measure of a producer’s ability to cope effectively with changes in demand. A number of factors can affect it.
- Availability of resources is a factor. If a company depends on an increasingly scarce resource to produce its product, it may be unable to step up production when demand increases. Moreover, the resource will become increasingly expensive, forcing a corresponding increase in the producer’s price or decrease in its production, or both.
- Technology innovation is a factor in many industries. More efficient production reduces costs and allows for larger production numbers at lower prices.
- The number of competitors is a factor. An increase in the number of suppliers makes the price of a product or service more elastic. If one supplier can’t meet demand, others will rush to fill the gap.
- Flexibility is a big factor. If a resource becomes scarce, can another resource be substituted? Can production be ramped up quickly in response to greater demand? Efficient producers can respond more quickly to increased demand.
Factoring in Price Elasticity
The price of any product or service also is elastic or inelastic in relation to its supply. This is determined by measuring the percentage change in its supply and the percentage change in its price over a period of time. Dividing the change in supply by the change in price results in a numerical value. If that number is more than one, the product shows price elasticity. If it is less than one, the product is inelastic.
Technology innovation can reduce supply elasticity. More efficient production reduces costs and allows for expanded production.
If supply is elastic, so is price. A greater supply of a product or service reduces its cost. A scarcer supply forces prices up.
The most notorious example of price elasticity may be seen in the price of gasoline at the pump. In 2008, demand for fuel soared worldwide, with big increases in developing nations like China. A government chart shows that the price of crude increased to above $3 per gallon, while the price to American consumers increased to more than $4 per gallon. With increases in production and inventories, prices fell off a cliff. By early 2009, the price of crude was below $1 per gallon and the price to consumers was under $1.75.
The price of gasoline is elastic. That is, consumers must buy it no matter what the price is. Its supply is also elastic. If demand increases, the industry will increase production to meet it.