What is Inelastic Supply?
Definition: Inelastic supply is one of the concepts within the law of supply and demand. Inelastic supply refers to an economic situation where price changes do not affect the amount of products that producers are able and willing to produce.
What does it mean to have inelastic supply?
The elasticity of demand lends itself to the law of supply which basically states that the quantity of goods supplied increases when there is an increase in the market price while an increase in the market price leads to a decrease in the demand for the same product in the market. In other words, the rate at which producers make products remains constant regardless of changes in the prices that consumers are willing to pay.
Time is a key factor when determining the elasticity of demand. For example, supply is usually considered elastic over long-term periods and inelastic during short-term periods. The reason for this is that firms are limited in their capacity to produce goods of a higher quantity within a limited duration of time. They are therefore not able to adjust their operations to ramp up supply fast enough. This also explains why price changes over short-term durations do not usually affect the quantity of goods supplied. Meanwhile, firms can adjust their production capacity over the long-term, therefore allowing them to react fast enough to the price changes.
The above chart represents inelastic supply. It demonstrates that there is little change in the quantity of products that the producers in the market are willing to produce despite a significant increase in market price. The red line represents the price elasticity of supply.
Factors that Cause Inelastic Supply
Limited Inputs
Having a limited supply of inputs. Sometimes a company barely has enough raw materials to rump up its production measures to take advantage of higher prices in the market.
Short-term duration
Companies may go through a stage of inelastic supply if there are signs of inelastic short supply during the short-term duration.
Plant Capacity
A company operating near its full capacity might not have enough capacity to ramp up its supply enough for it to boost its production activities to match its intended supplying capacity. A company might also not have enough financial resources to employ additional labor that might otherwise help to boost production.
Market Prices
The producer might not have enough stock to boost its supply in the market to take advantage of the higher market prices. Sometimes companies produce a higher capacity of products than the units they can move through the market. The extra produce might help the company to ramp up supply without having to boost their production capacity.
Production Constraints
Production constraints may prevent a producer from keeping up with the demand in the market or even not being able to take advantage of price increments in the market.
Planning Restrictions
Planning restrictions may also come in the way. For example, the planning rules of the location where the company’s manufacturing activities are located might demand that the firm should seek regulatory approval for any expansion plans. This means that it would take some time for the company to secure approval for the construction of additional production facilities, thus preventing it from taking ramping up supply to match the higher prices in the market. Consequently, this would lead to inelastic supply.
Why is the Inelasticity of Supply Important?
Inelastic supply does not necessarily mean bad news for the firms or players involved. There are instances where the inelasticity of supply might come in handy.
Inelastic supply in the housing or property market might be of benefit to the owners of the houses in a location. For example, rental space in London is quite inelastic because there is scarce space on which new property can be built. This results in a situation where the tenants or rental property owners in the area can increase their rental prices so that they can earn more rental income.
Planning delays allow the company to know how the demand outlook in the market. A situation where the company might be unable to ramp up supply in the short-term despite higher market prices might be a blessing in disguise for the company. Demand might fail to yield, thus not justifying any investments to boost production and therefore supply.