Theory of Supply

1Why this matters

On the hills above Lake Kivu, farmers grow coffee for export. In a year when the world price of coffee is high, something visible happens: households prune and feed bushes they had half-abandoned, pick the cherries more carefully so fewer are wasted, and some plant coffee on plots that last year grew something else. More coffee reaches the washing stations. When the price is low, the opposite happens and bushes are neglected.

Supply is the sellers' side of the market, and it answers the mirror-image question to demand: how does the quantity producers offer respond to price and to the conditions of production? You need it as precisely as you needed demand, because a market price is settled by the two sides together, and you cannot find where they meet until you can draw both.

2What "supply" means

Supply is the quantity of a good that producers are willing and able to sell at a given price, over a given period, ceteris paribus. As with demand, the words are exact: it is a planned quantity at each price, measured per period, with everything except that price held constant.

3A supply schedule, from real numbers

Return to the egg market of the previous lesson, now from the sellers' side. A survey of producers gives this supply schedule:

Read down the table: each 50 Frw rise in price brings 100 more eggs onto the market. The rule that fits every row is

Qs = 2P

Check: at P = 150, Qs = 2(150) = 300 eggs, matching the table. Keep this equation; the equilibrium lesson pairs it with Qd = 600 − 2P.

4The law of supply and the supply curve

The schedule shows the law of supply: other things being equal, a higher price brings a larger quantity supplied, and a lower price a smaller quantity. Price and quantity move in the same direction — a direct (positive) relationship, the opposite of demand.

Plotted with price on the vertical axis and quantity on the horizontal axis, the points give the supply curve, which slopes upward from left to right. That upward slope is the law of supply drawn as a picture.

5Why the curve slopes up — the reasons

Profit incentive. A higher selling price, with costs unchanged, widens the profit on each unit, so existing producers are willing to offer more.

Rising marginal cost. Producing extra units usually costs more per unit (a farm works poorer land, or pays overtime). Producers will only take on those dearer extra units if the price they receive is high enough to cover them, so more is supplied only at higher prices.

New entrants. A sustained higher price makes the good attractive to produce, so new sellers join the market, adding to the quantity supplied.

6Movement along the curve versus a shift of the curve

The rule is exactly the one you learned for demand, applied to sellers. A change in the good's own price is a movement along the supply curve: a rise in price gives an upward movement to a larger quantity, called an extension of supply; a fall gives a contraction. A change in any other condition of production shifts the whole curve: to the right if more is supplied at every price (an increase in supply), to the left if less is (a decrease).

Worked example — movement or shift?

Take a bakery selling bread.

(a) The market price of bread rises; nothing else changes. The good's own price moved, so this is a movement up the supply curve — an extension, to a larger quantity.

(b) The price of the flour and fuel the bakery buys rises sharply; the price of bread is unchanged. A production cost changed, not the price of bread, so the whole supply curve shifts left: at every price of bread, higher costs mean the bakery is willing to supply less. Same reliable test as before — own price is a movement, anything else is a shift.

7The determinants of supply — what shifts the curve

• Costs of production. Higher input prices — wages, fuel, raw materials, rent — shift supply left; lower input prices shift it right.
• Technology. Better technology or techniques lower the cost of producing each unit, so supply shifts right. (Note the direction carefully: an improvement shifts supply right, not left.)
• Taxes and subsidies. A tax on producers acts like an extra cost and shifts supply left. A subsidy lowers cost and shifts supply right.
• Number of producers. More sellers in the market shift supply right.
• Natural conditions. For farmed goods, good weather and healthy crops shift supply right; drought, pests or floods shift it left.

8Joint supply and competitive supply

Two goods can be linked on the production side, and A-Level questions exploit this.

Joint supply means two goods are produced together, so that making more of one automatically yields more of the other. Slaughtering cattle for beef also produces cowhide; refining crude oil yields petrol, diesel and kerosene together. If a rise in the demand for beef leads to more cattle being slaughtered, the supply of cowhide rises as a by-product — its supply curve shifts right — even though nothing happened in the hide market itself.

Competitive supply means two goods compete for the same resources, so producing more of one means producing less of the other. A farmer's single plot can grow maize or beans, not both at once. If the price of beans doubles and the farmer switches land to beans, the supply of maize falls — its curve shifts left. The resource (land) is fixed, so the two goods are rivals in production.

Practice

Solutions