The Law of Supply
Definition of supply. FActors of supply. the supply Curve.
Definition of Supply: how willing and able firms are to produce a good or service at a given price level in a given period of time.
To show the level of supply of a good, in economics we use something called the supply curve. It shows us the supply schedules of a good or service. Basically, it tells us how much of a good or service businesses supply at a given price level. The law of supply states there is a positive relationship between price and quantity sold. This is because at a higher price, firms are being rewarded more for their product. So, they have the incentive to produce more as they can make more profit. This is called the profit motive. So as the price of something goes up, firms supply more of it and vice versa. We will go through the supply curve below, but first we will look at what affects a firm's ability to supply.
The Factors of Market Supply: the factors of supply are all the things that change how willing and able the market is to supply a product. Here are some of the factors of supply. They affect how much supply the market can produce.
Price
Cost of Production
Quantity of Economic Resources (Factor inputs)
Factor Productivity (e.g. Labour, Capital)
Level of Technology
Number of firms in the market
Indirect tax on a product
Subsidies on a product
Factors 2-8 will cause a shift in supply to the right or left.
Factor 1 (price) will cause a movement along the supply curve.
All of the above have effects on a firm’s supply ability of a good or service. You can probably work these out logically but we will go through some examples below:
Price: if prices can rise, then firms are willing to produce more in general, because they are being rewarded more. This is due to the profit incentive.
Cost of Production: if the cost of production falls, this will improve the firm's ability to supply. It means that at the same price as before, they can produce more because their costs are lower.
Quantity of Resources: if there is an increase in the stock of resources e.g. land, labour, capital, then the market can supply more than before, because there are physically more units to employ.
Factor Productivity: if your factors of production can produce more per output than before, then you can supply a lot more. For example, if a worker produces 100 units a day, but then attends a training course and as a result this increases to 120 units a day, what does it mean? It means the worker produces 20% more units than before in the same time. So there is an improvement in productivity of labour.
Level of Technology: if the level of technlogy improves it can yield benefits to productivity also. For example, the launch of the Internet and email has caused huge improvements to firms and how they run. Think how many emails must be sent a day now, as opposed to letters. Now rewind back 40 years and think how different it must have been how much less communciation there was.
Number of firms in the market: if there are more firms in a market, then the market has the ability to supply more output than before.
THE SUPPLY CURVE
Definition of the Supply Curve: A curve to show the relationship between the price of a good or service and the quantity produced in a static period of time. It shows how willing and able firms are to produce a good or service.
Let’s capture all this on a diagram:
The diagram above is the market supply curve. It shows how much the market can supply at a given price. At the price of £100, the firms within the market are able to output 1000 untis of output. When the price rises, it causes a movement along the supply curve. This is shown from the movement from A to B. When the price increases from £100 to £150, the firms within the market are incentivised to produce more because they can make more profit. They are then more willing to supply and produce more than before. So they can produce 1300 units of output rather than 1000.
A Shift in the Supply Curve
The diagram above shows us a shift in supply. This is down to a factor of supply OTHER THAN PRICE. So price changes do not cause the supply curve to shift. Instead it is the other factors of supply that do it.
On the diagram you can see there are two supply curves, S and S1. S is where we start at £100 and 1000 units of output that the market produces. There is then a change in the market, an increase in supply of the good being sold. This could be due to a factor of supply (but not price). For example, the cost of production may have fallen. What happens is that at the price of £100, the market can now output 1500 units at the price of £100.
So in summary, what I want you to remember is this:
Definition of Supply
The Factors of Supply
Supply Curve Price Movements
Supply Curve Shifts (all factors except from price shift supply)
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