Economic
ECONOMICS 1 (ECON101)
Supply
MODULE 4 : Textbook Chapter 2 and 3
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Supply
It is the total amount or quantity of a good or product that producers are willing and able to sell at various price levels (Schiller, 1986)
It is the total amount of output of goods and services in an economy (Sloman, 2006)
The amount of goods and services that firms can supply depends on the available resources and technology.
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The relationship between supply and price
When the price of good rises, the quantity supplied will also rise.
This can be explained with help of an example.
Now imagine that a farmer is deciding what to do with his land. Part of his land is fertile and part of it is having poor soil.
The farmer will think of growing vegetables in the fertile part and keeping sheep on the unfertile part.
The vegetable farmer will choose depends on the price of it. Say if the price of tomatoes is high, the farmer will use a lot of the fertile part for growing tomatoes.
If the price of potatoes is still increasing, then the farmer would use the unfertile land also to grow tomatoes, even though the yield is much lower there.
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He prices
3
Law of Supply
As price rises, firms supply more quantity.
It is worth incurring the extra unit costs.
They switch from less profitable goods.
In the long run, new firms will be encouraged to enter the market.
As price decreases, firms supply less quantity.
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The supply Curve
Supply Schedule
The supply schedule is a table that shows the different quantities of good that producers are willing and able to supply at various prices over a given time period. Below is an example :
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| Table 2.2 : The supply of tomatoes (monthly) | |||
| Price (SR per kg) | Rudy’s supply (tonnes) | TOTAL market supply (tonnes : 000s) | |
| a | 20 | 50 | 100 |
| b | 40 | 70 | 200 |
| c | 60 | 100 | 350 |
| d | 80 | 120 | 530 |
| e | 100 | 130 | 700 |
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The supply curve
The supply schedule can be represented graphically as a supply curve.
Supply curve
A graph showing the relationship between the price of a good and the quantity of the good supplied over a given period of time. Supply curve is upward sloping (positively sloped).
A supply curve can be for an individual firm’s supply curve or for a market curve ( that of the whole industry).
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Market supply of tomatoes (monthly)
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a
a
b
c
d
e
P
20
40
60
80
100
Q
100
200
350
530
700
b
c
d
e
Price (SR per kg)
Quantity (tonnes: 000s)
Supply
Prepared by: Ms.Farha Zeba Ibrahim
Determinants of supply
Price
The costs of production due to :
Change in input prices e.g. raw materials
Change in technology e.g. high capacity machine
Organizational change e.g. flat organization
Government policies e.g. subsidy, tax
The profitability of alternative products
The profitability of goods in joint supply
Calamities e.g. Typhoon, earthquake, war
Expectations of future price changes
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Movement along and shift in the supply curve:
To distinguish between movement along the supply curve and the shift in the supply curve, we need to understand the difference between a change in supply and a change in the quantity supplied.
A shift in the supply curve is referred to as a change in supply.
A movement along the supply curves as a result of a change in price is referred to as a change in the quantity supply.
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Movements along the supply curve
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Price of Pepsi
Quantity of Pepsi
0
SR1.00
SR3.00
1
5
S
A
C
SR3.00
A rise in the price of Pepsi results in a movement along the supply curve or called as “A change in the quantity supplied”.
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Shift in supply curve
A supply curve is constructed on the assumption that other factors (other determinants of demand) remains constant. But when one of the other determinants of supply change?
The curve shifts.
For example:
If a change in cost of production, say cost of production decreases will result in shift of the supply curve to the right.
On the other hand if the cost of production rises, the supply curve will shift to the left.
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Shift in supply curve
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S0
S1
Increase
S2
Decrease
O
P
Q
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Variables that influence sellers
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Equilibrium
It is the point where quantity demanded equals quantity supplied. It is the point that lasts.
It is the intersection between the demand curve and supply curve.
It is the point where conflicting interests between the consumers and producers are balanced.
It is reached through the interaction between demand and supply forces.
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Equilibrium
Equilibrium point – the intersection of the demand and supply curves (D=S).
Equilibrium price – is the price at the equilibrium point. It is the price that clears the market : the price where D=S.
Equilibrium quantity – is the quantity at the equilibrium point.
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The determination of market equilibrium (tomatoes: monthly)
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a
b
d
e
Supply
Demand
A
B
D
E
Qe
Quantity (tonnes: 000s)
Price (SR per kg)
Prepared by: Ms.Farha Zeba Ibrahim
The Determination of Price
Equilibrium price and output
response to shortages and surpluses
significance of “equilibrium”
Demand and supply curves
effect of price being above equilibrium (S>D)
surplus price falls
effect of price being below equilibrium (D>S)
shortage price rises
equilibrium: where D = S
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The determination of market equilibrium (tomatoes: monthly)
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a
b
d
e
Supply
Demand
A
B
D
E
Quantity (tonnes: 000s)
Price (SR per kg)
SURPLUS
(360 000)
C
c
Prepared by: Ms.Farha Zeba Ibrahim
The determination of market equilibrium (tomatoes: monthly)
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a
b
d
e
Supply
Demand
A
B
D
E
Quantity (tonnes: 000s)
Price (SR per kg)
C
c
SHORTAGE
(300 000)
Prepared by: Ms.Farha Zeba Ibrahim
Price elasticity of supply ( PeS )
It is the degree of responsiveness of quantity supplied to changes in price.
For Example:
Curve S2 is more elastic between any two prices than curve S1.
Thus, when prices rises from P1 to P2 there is a larger increase in quantity supplied with S2 ( Q1 to Q3) than there is with S1 ( Q1 to Q2 ).
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Price elasticity of supply ( PeS )
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0
Q
P
P1
P2
Q1
Q2
Q3
S1
S2
Prepared by: Ms.Farha Zeba Ibrahim
Measuring the price elasticity of supply
To compare the size of the change quantity supplied with the size change in price.
But price and quantity are measured in different units, therefore we use percentage or proportionate changes. That can be given by,
Where ‘ε’ = Elasticity, ‘’ = change in, ‘Qs = qantity supplied ,
‘P = change in price.
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Price elasticity of supply (PεS)
=
Percentage (proportionate)Change in quantity supplied
Percentage (proportionate)Change in price
% Qs
% P
PεD
=
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Measuring the price elasticity of Supply
Example : If a 10% rise in price caused a 25% rise in quantity supplied, the price elasticity of supply would be 25/10 = 2.5 (Supply in ELASTIC)
Example : If a 10% rise in price caused ONLY a 5% rise in quantity supplied, the price elasticity of supply would be 5/10 = 0.5 (Supply in INELASTIC)
Note: Unlike the price elasticity of demand, the figure is positive. This is because price and quantity supplied change in the same direction.
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Measuring the price elasticity of supply
Example:
If the price of Potatoes increases from $4.00 to $5.20 and the amount of quantity supplied will rise from 100 to 300 kilograms, then elasticity of supply would be calculated as:
using the formula,
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Pεs
=
% Qs
% P
Pεs
=
{[QSupplied(NEW) - QSupplied(OLD)] / QSupplied(OLD)} X 100
{[Price(NEW) - Price(OLD)] / Price(OLD)} X 100
Prepared by: Ms.Farha Zeba Ibrahim
Measuring the price elasticity of supply
Therefore,
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PεS
=
{[ 300 – 100 ] / 100} x 100
{[ 5.20 -4.00] / 4.00 } x 100
PεS
=
200%
30%
PεS
=
6.6
Prepared by: Ms.Farha Zeba Ibrahim
Measuring the price elasticity of supply
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| Price elasticity of supply | Elasticity value |
| Vertical supply | Zero (0) : Totally unresponsive to a change in price |
| Horizontal supply | Infinite (∞) : There is no limit to the amount supplied at the price where the curve crosses the vertical axis |
| When two supply curves cross, the steeper one will have the lower price elasticity of supply (e.g. curve S1 in Figure on slide number- 21) | |
| Any straight line supply curve starting at the origin, however will have an elasticity equal to 1 throughout its length, irrespective of its slope. (e.g. Figure next slid) |
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Unit elastic supply curves
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P (£)
Q
a
b
S1
c
d
S2
e
f
S3
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Determinants of supply elasticity
Amount that costs rise as output rises - the less the additional costs of producing additional output, the more firms will be encouraged to produce for a given price rise : the more elastic will supply be
Time period
- Supply is inelastic in the immediate time. Firms are unlikely to be able to increase supply by much immediately. Supply is virtually fixed or can only vary according to available stocks.
- Supply elasticity improves in short run. If a slightly longer period of time is allowed to elapse, some inputs can be increased (e.g. raw materials) while others will remain fixed (e.g. heavy machinery). Supply can increase somewhat.
- Supply is elastic in the long run. In the long run, there will be sufficient time for all inputs to be increased and for new firms to enter the industry. Supply therefore, is likely to be highly elastic. In some circumstances, the long run supply surve may even slope downwards.
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Reference : Basic Text : John Sloman; Economics; 2009; 7th Edition; Pearson Prentice Hall
End of Module 3
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