In economics, supply means the amount of a good or a service a producer is willing to sell at each price. It refers to the relationship between a range of prices and the quantities supplied at those prices.
The quantity supplied refers to a specific point on the supply curve.
Price is what the producer receives for selling one unit of a good or service.
In this article, we explore the concept of supply and use a supply curve to describe the quantities a seller is willing to sell at different prices to illustrate the law of supply; by changing only the price and holding all the other factors constant.
It is a follow-up to our earlier discussions on the other economic force called market demand.
Law of Supply
A price increase almost always leads to an increase in the quantity supplied of that good or service, while a price decrease will decrease the quantity supplied.
Economists call this a positive relationship between price and quantity supplied – and it illustrates the law of supply.
Assuming that all other variables that affect supply are held constant, except the prices of goods and services, the law of supply states that a higher price leads to a higher quantity supplied and that a lower price leads to a lower quantity supplied.
Therefore, there is a direct relationship between price and quantity supplied. When the price increases, producers are willing to make and sell more quantities of the good. When the price decreases, producers tend to produce and sell fewer quantities of the good.
All supply curves slope up from left to right and illustrate the law of supply, as shown below:
Change in Supply vs. Change in Quantity Supplied
A change in the prices of goods and services produces a movement along the supply curve. This is called a change in the quantity supplied as a result of price changes.
A change in quantity supplied refers to movement along the curve due to price changes. At lower prices, suppliers will provide fewer quantities; and at higher prices, suppliers will provide more quantities of goods and services.
When the price of a product increases, the supply curve remains the same but the quantity supplied increases.
A change in supply refers to a shift in the entire supply curve, which can happen due to factors other than price changes.
A shift to the right signifies an increase in supply, while a shift to the left shows a decrease in supply. These shifts are captured in the illustration below:
Factors that Cause a Shift in the Supply Curve
A variable that can change the quantity of a good or service supplied at each price is called a supply shifter or a determinant of supply. Determinants of supply are changes in non-price factors that cause the entire supply curve to shift – increasing or decreasing market supply. These determinants of supply include the following:
- Price of inputs/economic resources – cost of production,
- Prices of related goods (substitutes/complementary goods for production) or returns from alternative economic activities,
- Number of suppliers/producers,
- Technology: technological improvements,
- Taxes and Subsidies,
- The expected future prices (Producer Expectations), and
- Natural events.
Let’s discuss each factor individually as follows:
Prices of Resources
The production of goods and services requires inputs, which are the economic resources or factors of production. The prices of these factors of production affect the overall supply of goods and services in the market.
A change in the price of labour or some other factor of production will change the cost of producing any given quantity of the good or service. If the price goes up, the cost of production increases and reduces the producers’ profit margins. Thus, they are willing to produce less and market supply decreases.
An increase in factor prices will decrease the quantity suppliers will offer at any given price, shifting the supply curve to the left.
A reduction in factor prices increases the quantity suppliers will offer at any price, shifting the supply curve to the right.
Returns from Alternative Activities
Producing one good or service means forgoing the production of another.
If the returns from an alternative economic activity increase, producers will be willing to direct their resources to produce these alternative goods and services. This will lead to a decrease in the supply of the main goods, shifting the curve to the left.
Number of Producers
The total number of producers has an impact on the total number of products (goods and services) in the market.
Therefore, if the total number of producers increases, there will be an increase in supply, shifting the supply curve to the right.
Also, a decrease in the number of producers will decrease supply, shifting the supply curve to the left.
Technology
Advanced technology helps in improving the production of goods and services.
A technology change alters the combinations of inputs required in the production process. Technological improvement usually means fewer and less costly inputs are needed. If the cost of production is lower, profits available at a given price will increase, and producers will produce more. Therefore, the supply curve will shift to the right.
Taxes and Subsidies
Increased taxes lead to an increase in the cost of running a business, which eats into the company’s profits. This discourages production, resulting in fewer quantities of goods and services produced at the same market price. The supply curve will then shift to the left, signifying a decrease in supply.
When the government increases subsidies to manufacturers, it helps reduce the cost of producing physical goods and running a business. At the same market price, companies will produce and sell more quantities of goods and services in the market. This will increase supply, resulting in the supply curve shifting to the right.
Future Expectations
This asks the question, what are the expectations of the producers about the future market prices of their goods and services? Are they optimistic or pessimistic?
If producers think they can make more profit sometime in the future, they will hold back supply now and increase supply later on.
Also, if they expect that their profit margins will decline in the future, they will be willing to produce and sell more today to maximise the present profit-making opportunities.
Natural Events
Natural events are rare and do not affect the production of all types of goods and services.
However, things such as droughts and famine may affect agricultural produce. When there is plenty of rainfall and other favourable weather conditions, the agricultural yields may go up. In the event of an extended drought, the quantities of produce from the farms decrease significantly.
Other natural events may include things like global pandemics that affect the productivity of key industries. An example is the COVID-19 effect on construction activities, and its impacts on healthcare (in terms of the production and distribution of drugs and related protective equipment for combating the same).
Supply Elasticity or Price Elasticity of Supply
The elasticity of supply (also known as the price elasticity of supply) is an economic measure of how responsive the quantity supplied of goods and services is to price changes
Simply, it refers to the degree to which rising prices translate into rising quantity supplied.
Elastic supply curves indicate that the quantity supplied responds to price changes in a greater-than-proportional manner.
An inelastic supply curve is one where a given percentage change in price will cause a smaller percentage change in quantity supplied.
Unitary elasticity means that a given percentage change in price leads to an equal percentage change in quantity supplied.
In summary; the supply curve is shallower (close to horizontal) for the products with more elastic supply and steeper (closer to vertical) for products with less elastic supply.