Intro to Supply
Supply: The quantity of a g/s which a producer is willing and able to produce and sell at a given price.
Market supply: The sum of all producers’ individual supply.
The Law of Supply: As the selling price of a product increases (↑), quantity supplied increase too (↑); conversely, as the price of a good decreases (↓), quantity supplied decreases too (↓).
The Supply Curve
The Supply Curve: a graph depicting the relationship between the price of a certain commodity (the y-axis) and the quantity of that commodity that is supplied at that price (the x-axis)
Supply curves are upward sloping due to the law of supply
Supply as a function: Quantity supplied can be thought of as a function of price, as well as several other factors.
Qs = f(P, K1, K2, …)
The supply curve is a graphical representation of this function.
Changes in Price: Correspond to movements along the supply curve.
Every point on the price axis corresponds to a given point on the quantity axis.
Changes to any other determining factor: Correspond to a shift of the supply curve.
If another factor changes, the quantity supply at all given prices will change, the only way to show this is by moving the curve.
E.g. When the harvest of strawberries fails, firms will make less strawberry ice cream at each price.
Why is the Supply Curve Upward Sloping?
Key Question: Why do firms sell more at higher prices, less at lower prices (the law of supply)?
The Profit Motive: When the market price rises following an increase in demand, it becomes more profitable for businesses to increase their output.
Production and Costs: When output expands, a firm’s production costs tend to rise, therefore a higher price is needed to cover these extra costs of production.
This may be due to the effects of diminishing returns as more factor inputs are added to production.
New entrants coming into the market: Higher prices may create an incentive for other businesses to enter the market leading to an increase in total supply.
Determinants of Supply
Recap: Supply/the supply curve can be thought of as a function.
Quantity supplied is a function of price, as well as several other factors.
Qs = f(P, K1, K2, …)
Question: What are these factors?
1. The price of the good (p)
If the price of an ordinary G/S increases, supply for that product will increase too.
If the price of an ordinary G/S decreases, supply for that product will decrease too.
2. Costs of production
Costs of production: the costs associated with making output, mainly made up of the costs of hiring and using the necessary factors of production (C.E.L.L.).
If the factor input prices increase, a greater price of the final product is required for firms to maintain their profit for each unit. The firm has passed on some of the increased costs to consumers.
This means that a lower quantity is supplied at any given price.
A fall in supply – an inward shift.
E.g. If a firm has to pay its worker’s higher wages, the firm won’t be able to produce as much for the same price.
3. Level of Technology
Improvements in technology means that we can get more output from a given amount of inputs.
This means that the production costs for each unit will fall.
Firms will produce more for a given price as more units now become profitable to make.
An increase in supply – an outward shift.
4. Government Policy (taxes and subsidies and regulations)
Indirect taxes: government imposed levies on the sale of an item that entitle the government to a proportion of the sales price.
They artificially increase production costs, decreasing supply – an inward shift.
E.g. Cigarettes and Alcohol are highly taxed to make them more expensive and reduce the amount consumed.
Subsidies: sums of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low.
They artificially bring about a fall in cost of production, as they cover part of the firms supply costs, increasing supply – an outward shift.
E.g. Farmers are subsidised so as to ensure sufficient food is available and affordable for UK citizens.
Regulations: a set of rules, normally imposed by government, that seeks to modify or determine the behaviour of firms.
They increase production costs as it can be expensive for firms to meet more standards, decreasing supply – an inward shift.
E.g. Increased health and safety regulations mean firms must spend more on PPE.
5. Prices of Substitutes in Production
Substitute in Production: A different product that could have been supplied using the same resources.
A rise in the price of a substitute in production might lead some producers to switch to producing the substitute product.
E.g. If coffee farmers see cocoa prices rise, this may cause some farmers to switch from coffee to cocoa.
Less coffee is produced at each given price meaning a decrease in supply – an inward shift.
6. The entry of new producers into the market
With more producers, there will be more people who can produce output and more people willing to sell for a given price.
An increase in supply – an outward shift.
(Arguably though, the number of producers would only increase as a result of changes to one of the other factors leading to an attractive new price).
7. Shocks to factors of production
If there is a marked reduction in the quantity of a factor of production, there will be fewer available resources.
With less inputs, firms will have to cut the quantity they produce at each given price level.
A decrease in supply – an inward shift
E.g. If an earthquake destroys all the sewing machines in a garment factory, that firm can no longer make clothes, meaning fewer clothes can be produced at any given price
8. Other factors
A variety of other factors will have an impact on the quantity supply of a good or service including:
- Expectations
- Population changes
Full Supply function: Qs = f(price of the good, costs of production, level of technology, government policies, prices of substitutes in production, no. of firms in the market, stock of factor of production, …)
Joint Supply
Definition: when two goods are produced together from the same origin / raw material.
A change in the level of production of one good, effects the supply of the other.
Analysis: Joint supply usually arises because producing a good, creates a by-product.
E.g. Increasing the quantity of beef will mean more cows have to be killed. This will mean that more cow hides can be produced as a by-product, and the supply of hides increases.
