Question

In each of the following cases, do you think the price elasticity of supply is (i) perfectly elastic; (ii) perfectly inelastic; (iii) elastic, but not perfectly elastic; or (iv) inelastic, but not perfectly inelastic? Explain using a diagram. a. An increase in demand this summer for luxury cruises leads to a huge jump in the sales price of a cabin on the Queen Mary 2 . b. The price of a kilowatt of electricity is the same during periods of high electricity demand as during periods of low electricity demand. c. Fewer people want to fly during February than during any other month. The airlines cancel about \(10 \%\) of their flights as ticket prices fall about \(20 \%\) during this month. d. Owners of vacation homes in Maine rent them out during the summer. Due to the soft economy this year, a \(30 \%\) decline in the price of a vacation rental leads more than half of homeowners to occupy their vacation homes themselves during the summer.

Short answer

a. Luxury cruises b. Electricity price c. Airline ticket prices in February d. Vacation home rentals a. In the case of luxury cruises, the price elasticity of supply is perfectly inelastic. b. For electricity price, the price elasticity of supply is perfectly inelastic. c. With airline ticket prices in February, the price elasticity of supply is inelastic but not perfectly inelastic. d. In the case of vacation home rentals, the price elasticity of supply is elastic but not perfectly elastic.

Step-by-step solution

a. Luxury cruises

In this case, the increase in demand for luxury cruises leads to a huge jump in the sales price of a cabin. Since the price increases significantly and the supply of cabins on Queen Mary 2 is fixed (there cannot be new cabins added immediately), we can conclude that the price elasticity of supply is perfectly inelastic. The supply curve would be a vertical line in this case, as the quantity remains constant regardless of price changes.

b. Electricity price

The price of electricity remains the same during both high and low demand periods, indicating that the amount of electricity supplied is not affected by the price. This suggests that the price elasticity of supply for electricity is perfectly inelastic. The supply curve would be a vertical line, as the supply remains constant irrespective of price changes.

c. Airline ticket prices in February

In February, as the demand for flights decreases, the price of tickets drops by \(20 \%\) and the airlines cancel about \(10 \%\) of their flights. The reduction in quantity supplied is less than the decrease in price, which indicates that the supply is inelastic, but not perfectly inelastic. The supply curve would be steep but not vertical.

d. Vacation home rentals

A \(30 \%\) decline in the price of a vacation rental leads more than half of homeowners to occupy their vacation homes themselves during the summer. As the reduction in price causes a relatively larger reduction in the quantity supplied, the supply is elastic but not perfectly elastic. The supply curve would be a flatter curve, as the quantity supplied adjusts more than proportionately to price changes.

Key concepts

Perfectly Inelastic Supply

In a perfectly inelastic supply situation, the quantity of a good supplied remains constant, no matter how its price changes. This occurs when suppliers are unable to adjust the amount they supply in response to price shifts.
One classic example is luxury cruises. If an increase in demand raises the sales price of a cabin, but no additional cabins can be added to cruise ships in the short term, the supply is perfectly inelastic.
This is depicted in a supply curve as a vertical line, indicating that the quantity remains static irrespective of the price fluctuations.

Elastic Supply

Elastic supply occurs when the quantity supplied changes significantly in response to price changes. This flexibility means that suppliers can easily adjust their production levels.
For example, in the rental market for vacation homes, if there is a soft economy, a drop in the rental price can lead many homeowners to decide against renting and instead occupy their properties themselves.

• If a decrease in rent price by 30% results in more than half of vacation homeowners using the homes themselves, this indicates an elastic response.
• The supply curve here is flatter, showing that quantity supplied changes more than price changes.

Inelastic Supply

Inelastic supply is where the quantity supplied is relatively unresponsive to price changes. Unlike perfectly inelastic supply, some degree of response exists.
Airline ticket pricing in February serves as an illustration of this. Even if ticket prices drop by 20% due to decreased demand, airlines only reduce their flights by about 10%.
In this case, the supply curve is steep, demonstrating some, but limited, responsiveness to price changes.

Perfectly Elastic Supply

Perfectly elastic supply represents a situation where the supply quantity can change infinitely at a given price level. This is not featured in the provided scenarios, as perfect elasticity would imply readiness to supply any quantity demanded at the current price.

• If the price changes, suppliers would adjust the quantity supplied extensively to match the new price.
• On a graph, this would appear as a horizontal supply curve, reflecting infinite responsiveness to price adjustments.

Such circumstances are rare but can occur in highly competitive markets where producers can ramp up or decrease supply instantly.