Market supply


Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period.
Normally as the market price of a commodity rises, producers will expand their supply onto the market.

There are three main reasons why supply curves for most products slope upwards from left to right giving a positive relationship between the market price and quantity supplied

When the market price rises (for example following an increase in consumer demand), it becomes more profitable for businesses to increase their output.
Higher prices send signals to firms that they can increase their profits by satisfying demand in the market. When output rises, a firm's costs may rise, therefore a higher price is needed to justify the extra output and cover these extra costs of production

Higher prices makes it more profitable for other firms to start producing that product so we may see new firms entering the market leading to an increase in supply available for consumers to buy For these reasons we find that more is supplied at a higher price than at a lower price.

The supply curve shows a relationship between the price of a good or service and the quantity a producer is willing and able to sell in the market.
What causes a shift in the supply curve?


i) Costs of production

A fall in the costs of production leads to an increase in the supply of a good because the supply curve shifts downwards and to the right. Lower costs mean that a business can supply more at each price. For example a firm might benefit from a reduction in the cost of imported raw materials.
If production costs increase, a business will not be able to supply as much at the same price - this will cause an inward shift of the supply curve. An example of this would be an inward shift of supply due to an increase in wage costs.

ii) Changes in production technology

Technology can change very quickly and in industries where the pace of technological change is rapid we expect to see increases in supply (and therefore lower prices for the consumer)

iii) Government taxes and subsidies

Government intervention in a market can have a major effect on supply. A tax on producers causes an increase in costs and will cause the supply curve to shift upwards. Less will be supplied after the tax is introduced.
A subsidy has the opposite effect as a tax cut. A subsidy will increase supply because a guaranteed payment from the Government reduces a firm's costs allowing them to produce more output at a given price. The supply curve shifts downwards and to the right depending on the size of the subsidy.

iv) Climatic conditions

For agricultural commodities such as coffee, fruit and wheat the climate can exert a great influence on supply. Favourable weather will produce a bumper harvest and will increase supply. Unfavourable weather conditions such as a drought will lead to a poor harvest and decrease supply. These unpredictable changes in climate can have a dramatic effect on market prices for many agricultural goods.

v) Change in the price of a substitute

A substitute in production is a product that could have been produced using the same resources. Take the example of barley. An increase in the price of wheat makes wheat growing more attractive. This may cause farmers to use land to grow wheat and less to grow barley. The supply of barley will shift to the left.

vi) The number of producers in the market

The number of sellers in a market will affect total market supply. When new firms enter a market, supply increases and causes downward pressure on the market price. Sometimes producers may decide to deliberately limit supply by controlling production through the use of quotas. This is designed to reduce market supply and force the price upwards.

The entry of new firms into a market causes an increase in market supply and normally leads to a fall in the market price paid by consumers. More firms increases market supply and expands the range of choice available.

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Price elasticity of supply

Price elasticity of supply measures the relationship between change in quantity supplied and a change in price. The formula for price elasticity of supply is:

Percentage change in quantity supplied / Percentage change in price

The value of elasticity of supply is positive, because an increase in price is likely to increase the quantity supplied to the market and vice versa.

FACTORS THAT DETERMINE ELASTICITY OF SUPPLY

The elasticity of supply depends on the following factors

The value of price elasticity of supply is positive, because an increase in price is likely to increase the quantity supplied to the market and vice versa. The elasticity of supply depends on the following factors:

SPARE CAPACITY

How much spare capacity a firm has - if there is plenty of spare capacity, the firm should be able to increase output quite quickly without a rise in costs and therefore supply will be elastic

STOCKS

The level of stocks or inventories - if stocks of raw materials, components and finished products are high then the firm is able to respond to a change in demand quickly by supplying these stocks onto the market - supply will be elastic

EASE OF FACTOR SUBSTITUTION

Consider the sudden and dramatic increase in demand for petrol canisters during the recent fuel shortage. Could manufacturers of cool-boxes or producers of other types of canister have switched their production processes quickly and easily to meet the high demand for fuel containers?
If capital and labour resources are occupationally mobile then the elasticity of supply for a product is likely to be higher than if capital equipment and labour cannot easily be switched and the production process is fairly inflexible in response to changes in the pattern of demand for goods and services.

TIME PERIOD

Supply is likely to be more elastic, the longer the time period a firm has to adjust its production. In the short run, the firm may not be able to change its factor inputs. In some agricultural industries the supply is fixed and determined by planting decisions made months before, and climatic conditions, which affect the production, yield.

Economists sometimes refer to the momentary time period - a time period that is short enough for supply to be fixed i.e. supply cannot respond at all to a change in demand.

ILLUSTRATING PRICE ELASTICITY OF SUPPLY

When supply is perfectly inelastic, a shift in the demand curve has no effect on the equilibrium quantity supplied onto the market. Examples include the supply of tickets for sports or musical venues, and the short run supply of agricultural products (where the yield is fixed at harvest time) the elasticity of supply = zero when the supply curve is vertical.

When supply is perfectly elastic a firm can supply any amount at the same price. This occurs when the firm can supply at a constant cost per unit and has no capacity limits to its production. A change in demand alters the equilibrium quantity but not the market clearing price.

When supply is relatively inelastic a change in demand affects the price more than the quantity supplied. The reverse is the case when supply is relatively elastic. A change in demand can be met without a change in market price.

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