The Price Elasticity of Supply

In the wake of the flu vaccine shortfall of 2004, attempts by vaccine distributors to drive up the price of vaccines would have been much less effective if a higher price had induced a large increase in the output of flu vaccines by flu vaccine manufacturers other than Chiron. In fact, if the rise in price had precipitated a significant increase in flu vaccine production, the price would have been pushed back down. But that didn’t happen because, as we mentioned earlier, it would have been far too costly and technically difficult to produce more vaccine for the 2004–2005 flu season. (In reality, the production of flu vaccine begins a year before distribution.)

This was another critical element in the ability of some flu vaccine distributors, like Med-Stat, to get significantly higher prices by restricting supply of their product: a low responsiveness in the quantity of output supplied to the higher price of flu vaccine by flu vaccine producers. To measure the response of producers to price changes, we need a measure parallel to the price elasticity of demand—the price elasticity of supply.

Measuring the Price Elasticity of Supply

The price elasticity of supply is defined the same way as the price elasticity of demand (although there is no minus sign to be eliminated here):

The only difference is that here we consider movements along the supply curve rather than movements along the demand curve.

Suppose that the price of tomatoes rises by 10%. If the quantity of tomatoes supplied also increases by 10% in response, the price elasticity of supply of tomatoes is 1 (10%/10%) and supply is unit-elastic. If the quantity supplied increases by 5%, the price elasticity of supply is 0.5 and supply is inelastic; if the quantity increases by 20%, the price elasticity of supply is 2 and supply is elastic.

As in the case of demand, the extreme values of the price elasticity of supply have a simple graphical representation. Panel (a) of Figure 5-6 shows the supply of cell phone frequencies, the portion of the radio spectrum that is suitable for sending and receiving cell phone signals. Governments own the right to sell the use of this part of the radio spectrum to cell phone operators inside their borders. But governments can’t increase or decrease the number of cell phone frequencies that they have to offer—for technical reasons, the quantity of frequencies suitable for cell phone operation is a fixed quantity.

Panel (a) shows a perfectly inelastic supply curve, which is a vertical line. The price elasticity of supply is zero: the quantity supplied is always the same, regardless of price. Panel (b) shows a perfectly elastic supply curve, which is a horizontal line. At a price of $12, producers will supply any quantity, but they will supply none at a price below $12. If price rises above $12, they will supply an extremely large quantity.

So the supply curve for cell phone frequencies is a vertical line, which we have assumed is set at the quantity of 100 frequencies. As you move up and down that curve, the change in the quantity supplied by the government is zero, whatever the change in price. So panel (a) illustrates a case in which the price elasticity of supply is zero. This is a case of perfectly inelastic supply.

Panel (b) shows the supply curve for pizza. We suppose that it costs $12 to produce a pizza, including all opportunity costs. At any price below $12, it would be unprofitable to produce pizza and all the pizza parlors in America would go out of business. Alternatively, there are many producers who could operate pizza parlors if they were profitable. The ingredients—flour, tomatoes, cheese—are plentiful. And if necessary, more tomatoes could be grown, more milk could be produced to make mozzarella, and so on. So any price above $12 would elicit an extremely large quantity of pizzas supplied. The implied supply curve is therefore a horizontal line at $12.

Since even a tiny increase in the price would lead to a huge increase in the quantity supplied, the price elasticity of supply would be more or less infinite. This is a case of perfectly elastic supply.

As our cell phone frequencies and pizza examples suggest, real-world instances of both perfectly inelastic and perfectly elastic supply are easy to find—much easier than their counterparts in demand.

What Factors Determine the Price Elasticity of Supply?

Our examples tell us the main determinant of the price elasticity of supply: the availability of inputs. In addition, as with the price elasticity of demand, time may also play a role in the price elasticity of supply. Here we briefly summarize the two factors.

The Availability of Inputs The price elasticity of supply tends to be large when inputs are readily available and can be shifted into and out of production at a relatively low cost. It tends to be small when inputs are difficult to obtain—and can be shifted into and out of production only at a relatively high cost.

Time The price elasticity of supply tends to grow larger as producers have more time to respond to a price change. This means that the long-run price elasticity of supply is often higher than the short-run elasticity. (In the case of the flu vaccine shortfall, time was the crucial element because flu vaccine must be grown in cultures over many months.)

The price elasticity of pizza supply is very high because the inputs needed to expand the industry are readily available. The price elasticity of cell phone frequencies is zero because an essential input—the radio spectrum—cannot be increased at all.

Many industries are like pizza production and have large price elasticities of supply: they can be readily expanded because they don’t require any special or unique resources. In contrast, the price elasticity of supply is usually substantially less than perfectly elastic for goods that involve limited natural resources: minerals like gold or copper, agricultural products like coffee that flourish only on certain types of land, and renewable resources like ocean fish that can only be exploited up to a point without destroying the resource.

But given enough time, producers are often able to significantly change the amount they produce in response to a price change, even when production involves a limited natural resource. For example, consider again the effects of a surge in flu vaccine prices, but this time focus on the supply response. If the price were to rise to $90 per vaccination and stay there for a number of years, there would almost certainly be a substantial increase in flu vaccine production. Producers such as Chiron would eventually respond by increasing the size of their manufacturing plants, hiring more lab technicians, and so on. But significantly enlarging the capacity of a biotech manufacturing lab takes several years, not weeks or months or even a single year.

For this reason, economists often make a distinction between the short-run elasticity of supply, usually referring to a few weeks or months, and the long-run elasticity of supply, usually referring to several years. In most industries, the long-run elasticity of supply is larger than the short-run elasticity.