Price Elasticity of Supply (PES) measures how responsive the quantity of a good or service supplied by producers is to a change in its price. Think of it as a producer's “willingness-to-sell” rubber band. If a small price increase causes producers to flood the market with their goods, supply is considered elastic (a very stretchy rubber band). Conversely, if the price can double and producers can barely offer any more product than before, supply is inelastic (a stiff, unyielding band). The concept is calculated with a simple formula: (% Change in Quantity Supplied) / (% Change in Price). For a value investor, this isn't just dry economics. Understanding whether a company operates in an industry with stretchy or stiff supply is a critical clue to its long-term profitability and its ability to fend off competitors. It’s a key piece of the puzzle when assessing a company's Economic Moat.
Elasticity isn't just an on/off switch; it’s a spectrum. The result of the PES formula tells you exactly where a product's supply sits.
This is the extreme case where the quantity supplied doesn't change at all, no matter what happens to the price. The supply is fixed. Think of a one-of-a-kind painting like the Mona Lisa or the number of seats in a sold-out stadium. No matter how high the price goes, you can't create more.
Here, a change in price leads to a proportionally smaller change in the quantity supplied. For example, if the price of aged Scotch whiskey increases by 20%, producers can't magically create more 18-year-old stock. They might increase production for the future, but in the short term, supply is very stiff. This often applies to goods that require a long lead time, specialized skills, or rare components to produce.
This is a theoretical benchmark where the percentage change in quantity supplied is exactly equal to the percentage change in price. If the price goes up by 10%, producers supply exactly 10% more. It’s a perfect one-to-one response.
This occurs when the quantity supplied changes by a larger percentage than the price change. Think of products that are easy and cheap to produce, like plain t-shirts or digital goods like e-books. If the price for a popular e-book rises by 10%, the publisher can supply 50% more, 100% more, or even 1,000% more copies instantly for virtually no extra cost. The supply is very stretchy.
Another theoretical extreme, this happens when suppliers will offer any quantity of a good at a certain price, but none at all at a price even a penny lower. This scenario helps economists model markets with intense competition where producers are price-takers.
Understanding supply elasticity helps you peek behind the curtain of a company's business model and its competitive standing. A business that sells a product with inelastic supply often has a powerful Competitive Advantage. If a company makes something that is difficult, time-consuming, or protected by patents (like a new life-saving drug), competitors can't easily jump in and ramp up production. When demand for that product soars, the company can raise prices significantly without triggering a flood of new supply. This is a recipe for high Profit Margins and sustainable returns, a hallmark of a great long-term investment. On the other hand, a business in an industry with elastic supply often lives on a knife's edge. Think of a company that makes generic coffee mugs. If demand rises and the company tries to increase its prices, dozens of other factories can quickly switch their machines to produce more mugs, flooding the market. This new supply immediately pushes prices back down. These businesses are often commodity-like, constantly battling for razor-thin margins and possessing little to no pricing power. As a value investor, you are hunting for businesses with stiff, inelastic supply dynamics, as they are far more likely to build and maintain a durable economic moat.
Several factors determine whether a product's supply is more like a steel rod or a rubber band: