What this lesson teaches
I can calculate PES, say what the value means, and draw supply curves with different elasticities.
Syllabus K343, 2.7.2. Calculation of PES: calculation of PES using the formula; interpretation of the significance of the PES value: perfectly inelastic, inelastic, unitary, elastic, perfectly elastic; drawing and interpretation of supply curve diagrams to show different PES
Make a guess
Within one COE bidding exercise, the number of COEs is fixed. More people want cars. What happens?
- The premium rises; the number of COEs is unchanged.
- The premium stays put, because a vertical supply curve fixes the price.
- More COEs are issued to meet the demand.
Show the answer
The premium rises; the number of COEs is unchanged.
Supply is perfectly inelastic, a vertical line. A rise in demand cannot raise quantity, so it all shows up in the price.
Perfectly inelastic supply (PES = 0) is a vertical line. Perfectly elastic supply (PES infinite) is a horizontal line.
Supply has the same two extremes as demand, and you may be asked to draw either one.
Perfectly inelastic supply has a PES of 0. Sellers cannot change the quantity they offer, whatever the price, so the supply curve is a vertical line. Seats in a concert hall on one night are an example: a higher ticket price cannot create more seats. When demand rises, only the price can rise.
Perfectly elastic supply has an infinite PES. Sellers will supply any quantity at one price, but nothing below it, so the supply curve is a horizontal line. This fits a seller who can make more copies at the same cost per unit, such as an app store selling a game download. When demand rises, the quantity sold rises and the price stays the same.
Unitary supply (PES = 1) is a straight line from the origin. Real supply curves sit between the extremes. Supply is often close to perfectly inelastic in the very short run, because firms need time to hire workers and buy machines, and it becomes more elastic over time.
- Perfectly inelastic supply
- PES = 0. Vertical supply curve: a rise in demand raises only the price.
- Perfectly elastic supply
- PES infinite. Horizontal supply curve: a rise in demand raises only the quantity.
- COE example
- COE supply in one bidding exercise is fixed by LTA, so it is perfectly inelastic.
Worked example: Why certificate of entitlement premiums jump
In Singapore, the Land Transport Authority (LTA) sets how many certificates of entitlement (COEs) are offered in each bidding exercise. A COE is needed to own a car.
- Within one bidding exercise the number of COEs is fixed, so a higher premium cannot bring out more of them: supply is perfectly inelastic.
- Draw supply as a vertical line at the quota. Suppose more people want cars, so demand for COEs shifts right.
- Quantity cannot rise, so the whole increase in demand pushes up the premium (the price of a COE).
- Compare a game download: supply is close to perfectly elastic, so more demand raises the number sold, not the price.
Watch out for this
A vertical supply curve means the price can never change.
It means the quantity supplied cannot change. The price still changes when demand shifts; in fact all of the change in demand shows up in the price.
Check your understanding
The supply of a good is perfectly elastic. Demand for it increases. What happens?
- Quantity rises and the price stays the same
- Price rises and quantity stays the same
- Price and quantity both rise by large amounts
Show the answer
Quantity rises and the price stays the same
Right. A horizontal supply curve means sellers supply any amount at that price, so the new demand is met without a price rise.
Check your understanding
Which good is most likely to have a price elasticity of supply close to zero?
- Bottled water from a plant with full warehouses
- Paintings by an artist who has died
- Downloads of a music album
- T-shirts from a factory with spare machines
Show the answer
Paintings by an artist who has died
Right. No more can ever be made, so quantity supplied cannot respond to price.