Supply

7.1

Factors affecting market supply

7.2

Movements along the supply curve

7.3

Shifts of the supply curve

7.4

Price elasticity of supply

7.5

Factors affecting elasticity of supply

In Chapter 6, we studied the factors influencing consumer preferences and the determination
of market demand. In this chapter, our focus shifts to the other side of the market exchange
relating to production - the supply of goods and services by business firms. In the modern
market economy, fums are the core unit of production that determine how the demands
of the household sector are met. Just as the examination of demand focused on consumer
behaviour, our examination of supply will focus on the behaviour of firms.

Supply is the quantity of a good or service that all firms in a particular industry are willing
and able to offer for sale at different price levels, at a given point in time. This essentially
represents the market supply of a particular product, which is the sum of the individual
firm supplies of individual producers at the various price levels.

7 .1 Factors affecting market supply

The main factors affecting market supply include:

The price of the good or service itself

The market price of the good or service will influence the producer's ability and willingness
to supply it. For example, if the price was too low, some producers would not be able to
cover their costs of production and would not supply the item.
The expectations of suppliers about the future price of a good or service also influences
the level of supply. If the supplier believes the price will rise in the future, perhaps due to
an increase in demand resulting from changing consumer tastes, supply of the good or
service will increase. This is due to the possibility of increased profits arising from supply
of the good. The reverse is true if future prices are expected to fall.

The Market Economy 2011

The price of other goods or services

The quantity of a good or service supplied at any time will be affected by the prices of
other goods and services. For example, if the price of good X remained the same, while
the price of good Y increased, it would become more profitable to produce good Y.
Therefore, firms may be less willing to supply good X, and more willing to start producing
and supplying good Y.
The state of technology
It took Manuel FOUR
HOURS to change the prices
on the menus. With these
rising labour costs, we have
no alternative - we'll have to
raise prices AGAIN!

Improvements in technology lower production costs and allow more firms to

supply more goods at a given price. They also allow firms to adjust production
runs to quickly accommodate changing demand patterns. For example, the use of
automated production-line techniques in the motor vehicle industry has greatly
reduced production costs, and enabled producers to increase supply.
Changes in the cost of factors of production
The costs of factors of production are among the most important influences
on the ability of firms to supply products in the market place. Any fall in the
cost of factors of production would allow firms to supply more of a particular
good, whereas any rise in factor costs would make it more difficult for firms
to maintain present supply. A rise in the price of a factor of production would
often lead to a decrease in supply of those goods and services whose production
was heavily reliant on that factor input.
For example, if the big Hollywood movie production companies that supply
cinemas with movies decided to increase their prices sharply, they might force
smaller, less profitable cinemas out of business. This would lower market supply of
movies to consumers, since there would be fewer places to go to see movies.
The quantity of the good available
The actual quantity of the good available is an overall limiting factor that affects stipply.
For example, the supply of original paintings by the late Australian artist Arthur Boyd
is limited. Similarly, the quantity of oil that can be supplied is ultimately determined by
the known reserves of oil.
In many industries, the number of suppliers also affects the quantity of the good or
service available. As more suppliers enter an industry, supply increases and vice versa. For
example, the supply of energy drinks available on the market has gradually increased as
more suppliers have entered this market.
Climatic and seasonal influence
Changes in climatic conditions and seasons will obviously affect agricultural production.
For example, an extended period of drought would cause the supply of most agricultural
products to decline.

1 Outline how an increase in the level of wages in the economy might affect
market supply.

2 Describe TWO factors that may cause an increase in market supply.

Chapter 7: Supply

7 .2 Movements along the supply curve

In the analysis that follows, we will examine the response of supply to price changes, while
assuming that all the other possible influences remain constant.

Changes in price: movements along the supply curve

Assuming that all other factors that could influence supply, apart from price, remain
constant, we can construct a supply schedule. It shows the quantity of a good that will be
supplied over a range of prices, at a given point in time.
,--Quantity supplied
Figure 7.1 shows the weekly market supply of shoes over
Price ($)
(pair of shoes)
,---a given price range. The market supply schedule would be
100
200
derived from the summation of all the supply schedules
80
160
of the individual firms that operate in the industry. The
60
120
supply schedule demonstrates the relationship between
price and quantity supplied as stated by the law of supply.
40
80
According
to the law of supply, as the price of a certain
20
40
product rises, the quantity supplied by producers will
Figure 7.1 - Market supply
rise. This occurs for two reasons:
schedule: shoes

For firms already in the industry, producing the good becomes more profitable, so
they increase their production of that good.

The higher price also makes producing this good more profitable for other
businesses, which will attract new firms to the industry. This will also cause an
increase in the quantity supplied.

The supply curve

Price $
100

I . ............................................ ':

80

60
40

20

40

80

120

160
200
Quantity supplied

Figure 7.2 - The supply curve: shoes

The supply curve is the graphical

representation of the supply schedule,
depicted in Figure 7.2, where we plot
price on the vertical axis and quantity
supplied on the horizontal axis.
The typical supply curve slopes upwards
from left to right, portraying the same
relationship between price and quantity
supplied as the law of supply (more is
supplied at a higher price and less at a
lower price). For example, at price $20
only 40 pairs of shoes are supplied, but at
price $100, suppliers are willing and able
to put 200 pairs of shoes on the market.

Assuming all other factors remain constant, any change in the price of a good will lead to
a change in the quantity supplied in the same direction as the price change.
As a result of a price change, there is movement along the supply curve, which we refer
to as expansions and contractions of supply. These are shown in Figure 7.3 overleaf

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The Market Economy 2011

From the diagram:

Contraction of supply
is when a decrease
in the price of a good
or service causes a
decrease in quantity
supplied. It is shown by
a downward movement
along the supply curve.

Expansion of supply
is when an increase
in the price of a good
or service causes an
increase in quantity
supplied. It is shown by
an upward movement
along the supply curve.

Price $

A contraction in supply occurs

when a decrease in price from OPl
to OP 2 causes the quantity supplied
to fall from OQl to OQ2'

~o(;
~'b-(j

An expansion in supply occurs

when an increase in price from OP 1
to OP 3 causes the quantity supplied
to rise from OQl to OQ3'

Only a change in the price of the good

itself will lead to movements along the
existing supply curve (i.e. expansions and
contractions in supply).

o~

P2 ...... 9 ... :

03
Quantity supplied

Figure 7.3 - Expansions and contractions in supply

1 Explain why the supply curve slopes upwards from left to right.
2 Using a diagram, identify the movement along the supply curve caused by:

a) a decrease in price
b) an increase in quantity supplied
c) an increase in price.

7.3 Shifts of the supply curve

Having looked at price, we can now turn our attention to the other factors that can influence
supply. Again, when we consider the effect of a change in one of these factors, we use the
ceteris paribus assumption. In other words, we assume that all other factors that could
influence supply, apart from the one under consideration, remain constant.
A change in anyone of the factors, other
than the price of the good itself, will lead
to a shift of the entire supply curve for
the product. These shifts are referred to as
increases and decreases in supply and are
brought about by changes in conditions for
the business firm, and not price changes.

Price $

Increases in supply
A movement in the supply curve to the
right is called an increase in supply. This
is shown in Figure 7.4.

O2 Quantity supplied

Figure 7.4 - Increase in supply

Because the change in supply is not due to

a price change, we can make the following observations:

II

First, an increase in supply means that firms are willing and able to supply more of
a product at each price level than before. At price OP l' firms originally supplied OQI
goods. However, following an increase in supply (shift in the supply curve from 5151 to
5252) firms can now supply more of the good (OQ2) at the same price.

Chapter 7: Supply

Second, an increase in supply also means that firms are willing to supply a given
quantity at a lower price than before. Originally, firms were only willing to supply
quantity OQ\ at the price OP\. However, following the increase in supply, firms are
now prepared to supply the same quantity OQ\ at the lower price OP r

Decreases in supply
Movement in the supply curve to the left
is called a decrease in supply. This is
shown in Figure 7.5.
Again, because the change in supply is not
due to a price change, we can make the
following observations:

First, a decrease in supply means

that firms are willing and able to
supply less of a good "at each price
level than before. At price OP p firms
originally supplied the quantity OQ\

Price $
S1

P1

P2

01 Quantity supplied

Figure 7.5 - Decrease in supply

of the product. However, following the decrease in supply (shift in the supply curve
from S\S\ to S2SJ, firms now supply less of the product (OQJ at the same price.

Second, a decrease in supply also means that firms are only willing and able
to supply a given quantity at a higher price than before. Originally, firms were
supplying a quantity OQ2 at the lower price OP r However, following the decrease
in supply, firms are now only prepared to supply O~ at the higher price of OP\.

Factors that cause shifts in the supply curve

Any factor other than a change in the price of the product itself, that will cause the supply
of a good to be greater or less than it was previously, will cause a shift in the supply curve.
They can be briefly summarised as follows:

FACTORS CAUSING AN INCREASE OR DECREASE IN SUPPLY

Increase

Decrease

A fall in the price of other goods,

which makes production of other
goods less profitable.

A rise in the price of other goods.

An improvement in the technology

used in the production process.

A rise in the cost of factors

of production.

A fall in the cost of factors of

production such as labour or capital.

A decrease in the quantity of

resources available.

An increase in the quantity of resources

available to be used in production.

Regulations restricting the sale of a

good because of its risks to health and
safety (e.g. fireworks).

Climatic conditions or seasonal

change that is more favourable to
the production process.

A certain technology no longer being

available (which is highly unlikely).

Climatic conditions, or a seasonal

change, that is less favourable to the
production of a particular good.

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The Market Economy 2011

1 Distinguish between an increase in supply and an expansion in supply.

2 Outline THREE factors that could cause a decrease in supply.

3 Outline the likely effect of the following on market supply:

a) an increase in the price of substitute goods
b) a rise in the productivity of labour
c) an improvement in production technology
d) tougher government regulation of the sale of a good or service.

7 .4 Price elasticity of supply

The idea of price elasticity applies to supply in a similar way that it does to demand.
Price elasticity of
supply measures the
responsiveness of quantity
supplied to a change in
price. It is calculated as
the percentage change in
quantity supplied divided
by the percentage change
in price.

The price elasticity of supply measures the responsiveness of the quantity supplied of a product
to changes in price. Specifically, the price elasticity of supply is the percentage change in the
quantity supplied caused by a 1 per cent change in price. For example, we know that for most
goods, a rise in price will cause an expansion in supply, which means that for most goods the
price elasticity of supply is positive. However, if the rise in quantity supplied is proportionately
greater than the increase in price, then we could say that supply is very responsive to a price
change, and thus relatively elastic. The opposite situation - a less-than-proportionate change
in quantity supplied - would indicate relatively inelastic supply. If quantity supplied rises by
the same proportion as the price increase, supply is unit elastic.

Price elasticity and the

slope of the supply curve
We can recognise two extremes of elasticity
of supply - perfecdy elastic supply and
perfecdy inelastic supply. Each will be
examined in turn:

Price $

P I--_ _ _ _ _ _ _ _ _s

Perfectly elastic supply

Perfect ly elastic supply
is where producers are
willing to supply an
infinite quantity of a good
or service at a particular
price but nothing at all
at a price below this.
This situation can
be represented by a
horizontal supply curve.

When supply is perfectly elastic, the supply

curve is a horiwntal straight line, as shown
in Figure 7.6.
Figure 7.6 reveals that at price Op, suppliers
would supply an infinite quantity of the
good, whereas below that price they would
not be willing to supply any. In reality, this
is a highly unlikely situation.

Quantity supplied

Figure 7.6 - Perfectly elastic supply

Price $

Perfectly inelastic supply

Perfectly inelastic supply
is where producers are
willing to supply a given
quantity of a good or
service regardless of
price. This situation can
be represented by a
vertical supply curve.

When supply is perfectly inelastic, the

supply curve is a vertical straight line, as
shown in Figure 7.7.
Figure 7.7 reveals that the quantity
supplied is fixed at OQ regardless of the
price. The supply of a unique piece of
art may be perfectly inelastic - if only
one exists, then the supply is fixed at one
regardless of the price.

Quantity supplied

Figure 7.7 - Perfectly inelastic supply

Chapter 7: Supply

Between these two theoretical extremes of perfectly elastic and inelastic supply, there are
many possible variations in the shape of the supply curve. AI; is the case with demand, the
slope of the curve will not necessarily give a true indication of elasticity of supply.

1 Distinguish between relatively elastic supply and relatively inelastic supply.

2 Identify TWO examples of goods with relatively inelastic supply, and TWO
examples of goods that might have perfectly inelastic supply.

7 .5 Factors affecting elasticity of supply

There are a number of factors that can affect the responsiveness of supply to price changes.
They can be summarised as follows:

Time lags after a price change

Generally speaking, the greater the amount of time that producers have to respond to
a price change, the more elastic the supply for the product in question. Following a
price increase, producers are restricted in their attempts to increase production in the
short run. In the time immediately after the price change, the supply of most products
would be virtually perfectly inelastic, because producers cannot increase any of their
inputs. All the producer can do is try to increase production with existing workers and
equipment by working them harder. In the short run, producers can vary some of the
inputs to the production process (such as the number of workers they employ, or the
quantity of raw materials) so they can respond to price changes more readily. Therefore,
in the short run, the price elasticity of supply increases, although it is still likely to be
relatively inelastic. In the long run, however, the producer would be able to increase any
of the inputs, including the size of the production plant or the amount of machinery,
and thus facilitate a greater increase in production in response to a price change, making
supply relatively price elastic.

The ability to hold and store stock

It is possible to store some goods and not offer them for sale when there is a downturn
in market conditions and the price falls. This stock of goods, known as inventory, can be
offered for sale when prices rise again. Obviously, the ability to hold stock will affect the
ease with which producers can respond to price changes. AI; a general rule, the easier it is
to hold stock, the more elastic the supply. To a large degree, this will depend on the nature
of the good itself For example, highly perishable items such as fresh fruit and vegetables
would be difficult to hold in stock (and therefore their supply may be relatively inelastic)
whereas holding stock of durable goods such as furniture would be easier, making supply
more elastic.

Inventory is the total

stock of goods and
services held by a firm at
a particular point in time,
which is intended for sale
to consumers.

Excess capacity
Excess capacity exists when a firm is not using its existing resources to their full capacity.
Supply will be elastic when firms have excess capacity, because they can respond quickly to
any price increase by simply using their existing resources more intensively. For example,
a firm operating its plant and machinery at only half capacity could double its output
very quickly in response to a price increase. On the other hand, supply will tend to be
inelastic when resources are already being used at full capacity.

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The Market Economy 2011

1 Explain how the elasticity of supply changes over time after a change in price.
2 Outline how an increase in the ability to store stock would affect the elasticity

of supply.

Supply is the quantity of a particular good or service that producers are willing
and able to supply at various price levels, at a given point in time.

Individual supply refers to the supplies of individual producers at various price

levels. Market supply is the supply of the entire industry at various price levels.

The law of supply states that as the price of a good increases the quantity
supplied will increase.
The supply of a good depends on a number of factors: the price of the good
itself, the price of other goods and services, the state of technology, changes in
the cost of factors of production, the quantity of the good available and climatic

and seasonal influences.

5

The higher the price of a good, the greater the willingness of producers to supply
that good, which will lead to an expansion in supply.

Movements along the supply curve are caused by changes in price and are called
expansions or contractions in supply. All other factors. cause shifts in the
supply curve. These are called an increase or decrease in supply.

The price elasticity of supply measures the responsiveness or sensitivity of

quantity supplied due to changes in price. The more elastic the supply, the greater
its response to a change in price.

Supply elasticity varies from perfectly elastic (a change in price will totally
remove supply for the good) to perfectly inelastic (a change in price has no
effect on quantity supplied).

Factors that affect the elasticity of supply include the time lags after a price
change, the ability to hold and store stock, and excess capacity.

10

Supply will be more elastic if a firm has more time to respond to a price change,
the ability to store stock, and the ability to increase production with existing
facilities (excess capacity).

Define what is meant by market supply.

Explain, using diagrams, the meaning and cause of:

a) a contraction in supply
b) an expansion in supply.

Using a diagram, demonstrate an expansion and a contraction in supply.

From the following supply schedule, plot the market supply curve for sunglasses,
and explain the relationship that exists between price and the quantity supplied.

Price ($)

10

12

Quantity ('000)

20

40

60

80

100

Explain (using diagrams) what is meant by:

a) an increase in supply
b) a decrease in supply.

Draw up a table with two columns, and summarise the factors that can cause an
increase and decrease in supply:
Factors that can cause an
increase in supply

Factors that can cause an

decrease in supply

Explain the term price elasticity of supply.

Explain what is meant by the terms perfectly elastic supply and perfectly inelastic
supply. Use diagrams to illustrate your answer.

The Market Economy 2011

chapterreVlew
9

Draw up a table with two columns, and summarise the factors affecting price
elasticity of supply.
Factors causing supply
to be elastic

10

Factors causing supply

to be inelastic

Classify the following products according to their supply elasticity:

a) fruit and vegetables that are perishable
b) furniture from a firm with excess capacity
c) bottles of 25-year-old whiskey.

Extended response
a) Explain the term market supply. Compare a movement along a supply curve to a
shift of the supply curve. Distinguish between the factors that may cause expansions
and contractions, and increases and decreases in supply. Use diagrams to illustrate
your answer.
b) Outline what is meant by price elasticity of supply. Discuss the factors affecting price
elasticity of supply for a business firm. Explain why an understanding of elasticity of
supply is important to both business firms and the government.