Perfectly elastic supply can be difficult to understand because it is a technical impossibility. That’s right, a perfectly elastic supply refers to one in which the supply curve is perfectly horizontal, i.e. perfectly infinite. Needless to say, infinite supply is simply impossible.
But as it turns out, understanding perfectly elastic supply is not that difficult at all, as long as you’re ready to use your imagination. Below we’ll look at the formula for perfectly elastic supply and plug in some truly hypothetical examples. Then you can create scenarios relative to your own business with this awesome course on how to build and test supply chain models in Microsoft Excel.
Perfectly Elastic Supply By Definition
Perfectly elastic supply exists when any decrease in product price, no matter how minuscule, causes the supply for the product to immediately fall to zero. This occurs when the manufacturer or producer of the product is willing to produce a constant supply of the product (at least, for the foreseeable future) at a certain price (or, of course, a price higher than the certain price).
Perfectly Elastic Supply By Formula
It is not necessary to discuss the other theories of supply to understand perfectly elastic supply, but because the formula for price elasticity relates to all of them, it is somewhat necessary to mention them. But first, the formula for price elasticity:
Elasticity = % Change In Quantity / % Change In Price
Very simple. Now, when the elasticity equals different values, these values correspond to a certain type of price elasticity:
- Inelastic: When elasticity is equal to a value less than 1, it is said to be inelastic. In others words, a change in price does not really affect consumer demand or supply of the good. What kinds of products behave this way? Necessities. Necessities are inelastic because we need them: water, food, shelter, etc.
- Elastic: When elasticity is equal to a value greater than 1, it is said to be elastic. In this case, an increase in price could have a very profound affect on demand. Elastic products, then, are those that we can live without. They can be luxuries, accessories, non-essential clothing, etc. If the price of iPads suddenly doubled, the demand would respond in the opposite manner and likely to an even greater degree.
Both inelastic and elastic supply can be “perfect.” When the elasticity is equal to zero (the supply curve is vertical), then the supply is perfectly inelastic. When the elasticity is equal to infinity (the supply curve is horizontal), then the supply is perfectly elastic. This probably doesn’t make any sense at the moment, but the example below will make everything clear. You can further increase your understanding with this great post on the different types of elasticity of demand.
Perfectly Elastic Supply By Example
So how would it be possible for a product to have perfectly elastic supply? What would have to happen, according to our formula, is the % change in price would have to approach zero. The reason is this: as the denominator of a fraction approaches zero, the value of the fraction approaches infinity. This means that a very, very, very small % change in price could completely throw off the demand. In fact, when perfectly elastic supply occurs, any decrease in price immediately causes the supply to become zero. What kind of product even behaves this way?
Some people believe that it is impossible for a real product to be truly, perfectly elastic. Others say it has happened occasionally. In either case, let’s look at a hypothetical situation.
Competition: In order for perfectly elastic supply to exist, you need to have several competitors who make, essentially, the exact same product and who, through competition, have more or less hit the lowest price for which they can possibly sell the product. Because it is elastic, the supply tends to be of something non-essential, even though agricultural items have historically been the perfect perfectly elastic example.
Turning A Profit: So if you have several companies in Florida who all grow oranges, and if you add up all the costs involved – land, seeds, fertilizer, labor, etc. – and if it costs exactly $100 to produce a crate or oranges, then the price cannot drop below $100. If consumers refuse to pay $100 per crate, then the supply will end (% change will be infinite) because it is not a viable product. Even if the new price is $99.99, then the supply will end because it is not possible to produce the product for that price. Thus, the product is an example of perfectly elastic supply.
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