Economics: Supply

Module 4: Supply & Market Equilibrium

The Law of Supply

The law of supply states that there is a positive relationship between the quantity that suppliers are
willing to sell and the price level.
The law of supply is a fundamental principle of economic theory. It states that an increase in price
will result in an increase in the quantity supplied, all else held constant.
An upward sloping supply curve, which is also the standard depiction of the supply curve, is the
graphical representation of the law of supply. As the price of a good or service increases, the
quantity that suppliers are willing to produce increases and this relationship is captured as a
movement along the supply curve to a higher price and quantity combination.

The Law of Supply: Supply has a positive correlation with price. As the market price of a good increases, suppliers
of the good will typically seek to increase the quantity supplied to the market.

The rationale for the positive correlation between price and quantity supplied is based on the
potential increase in profitability that occurs with an increase in price.
All else held constant, including the costs of production inputs, the supplier will be able to increase
his return per unit of a good or service as the price for the item increases. Therefore, the net return
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to the supplier increases as the spread or difference between the price and the cost of the good or
service being sold increases.
The law of supply in conjunction with the law of demand forms the basis for market conditions
resulting in a price and quantity relationship at which both the price to quantity relationship of
suppliers and demanders (consumers) are equal. This is also referred to as the equilibrium price
and quantity and is depicted graphically at the point at which the demand and supply curve intersect
or cross one another. It is the point where there is no surplus or shortage in the market.

Law of Supply and Law of Demand: Equilibrium: The law of supply and the law of demand form the
foundation for the establishment of an equilibrium–where the price to quantity combination for both
suppliers and demanders are the same.

Supply Schedules and Supply Curves

A supply schedule is a tabular depiction of the relationship between price and quantity supplied,
represented graphically as a supply curve.
Supply is the amount of some product that producers are willing and able to sell at a given price,
all other factors being held constant. In general, supply depicts a positive relationship between the
price of a good or service and the quantity that the producer is willing to supply: if a supplier
believes it can sell the product for more, it will want to make more of the product. As a result, as
the price of a good or service increases, suppliers increase the quantity available for purchase.
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A supply schedule is a table that shows the relationship between the price of a good and the
quantity supplied. The supply curve is a graphical depiction of the supply schedule that illustrates
that relationship between the price of a good and the quantity supplied.

The Supply Schedule and Supply Curve: The supply curve is a graphical depiction of the price to
quantity pairings presented in a supply schedule. The supply schedule is a table view of the relationship
between the price suppliers are willing to sell a specific quantity of a good or service.

The supply curves of individual suppliers can be summed to determine aggregate supply. One can
use the supply schedule to do this: for a given price, find the corresponding quantity supplied for
each individual supply schedule and then sum these quantities to provide a group or aggregate
supply. Plotting the summation of individual quantities per each price will produce an aggregate
supply curve.
In theory, in the long run the aggregate supply curve will not be upward sloping but will instead
be vertical, consistent with a fixed supply level. This is due to the underlying assumption that in
the long run, supply of a good only depends on the fixed level of capital, technology, and natural
resources available.
The supply curve provides one side of the price-to-quantity relationship that ensures a functional
market. The other component is demand. When the supply and demand curves are graphed together
they will intersect at a point that represents the market equilibrium – the point where supply equals
demand and the market clears.
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Market Supply
Market supply is the summation of the individual supply curves within a specific market where
the market is characterized as being perfectly competitive.
A supply curve is the graphical representation of the supplier’s positive correlation between the
price and quantity of a good or service. As a result, the supply curve is upward sloping. Market
supply is the summation of the individual supply curves within a specific market.

Market Supply: The market supply curve is an upward sloping curve depicting the positive relationship
between price and quantity supplied.

The market supply curve is derived by summing the quantity suppliers are willing to produce when
the product can be sold for a given price. As a result, it depicts the price to quantity combinations
available to consumers of the good or service. In combination with market demand, the market
supply curve is requisite for determining the market equilibrium price and quantity.
By its very nature, conceptualizing a supply curve requires the firm to be a perfect competitor,
namely requires the firm to have no influence over the market price. This is true because each
point on the supply curve is the answer to the question “If this firm is faced with this potential
price, how much output will it be able to and willing to sell? ” If a firm has market power, its
decision of how much output to provide to the market influences the market price, then the firm is
not “faced with” any price, and the question is meaningless.
The attributes of a competitive market signal that the price is set external to any firm. Therefore,
production in the market is a sliding scale dependent on price. As price increases, quantity
Economics: Supply

increases due to low barriers to entry, and as the price falls, quantity decreases as some firms may
even opt out of the market.
The supply curve can be derived by compiling the price-to-quantity relationship of a seller. A seller
could set the price of a good or service equal to zero and then incrementally increase the price; at
each price he could calculate the hypothetical quantity he would be willing to supply. Following
this process the seller would be able to trace out its complete individual supply function. The
market supply curve is simply the sum of every seller’s individual supply curve.

Determinants of Supply
Supply levels are determined by price, which increases or decreases supply along the price curve,
and non-price factors, which shifts the entire curve.

Supply is the quantity of a good or service that a supplier provides to the market. Innumerable
factors and circumstances could affect a seller’s willingness or ability to produce and sell a good.
Some of the more common factors are:

Good’s own price: An increase in price will induce an increase in the quantity supplied.
 Prices of related goods: For purposes of supply analysis, related goods refer to goods from
which inputs are derived to be used in the production of the primary good.
 Conditions of production: The most significant factor here is the state of technology. If
there is a technological advancement related to the production of the good, the supply
increases.
 Expectations: Sellers’ expectations concerning future market conditions can directly
affect supply.
 Price of inputs: If the price of inputs increases the supply curve will shift left as sellers
are less willing or able to sell goods at any given price. Inputs include land, labor, energy
and raw materials.
 Number of suppliers: As more firms enter the industry the market supply curve will shift
out driving down prices. The market supply curve is the horizontal summation of the
individual supply curves.
 Government policies and regulations: Government intervention can take many forms
including environmental and health regulations, hour and wage laws, taxes, electrical and
natural gas rates and zoning and land use regulations. These regulations can affect a good’s
supply.
Suppliers will change their production levels along the supply curve in response to a price change,
so that their production level is equal to demand. However, some factors unrelated to price can
Economics: Supply

shift the production level. For example, a technological improvement that reduces the input cost
of a product will shift the supply curve outward, allowing suppliers to provide a greater supply at
the same price level.

Determinants of Supply: If the price of a good changes, there will be movement along the
supply curve. However, the supply curve itself may shift outward or inward in response to non-
price related factors that affect the supply of a good, such as technological advances or increased
cost of materials.

Changes in Supply and Shifts in the Supply Curve

The supply curve depicts the supplier’s positive relationship between price and quantity.

Price changes and movement along supply curve

If the price of the good or service changes, all else held constant such as price of substitutes, the
supplier will adjust the quantity supplied to the level that is consistent with its willingness to accept
the prevailing price. The change in price will result in a movement along the supply curve, called
a change in quantity supplied, but not a shift in the supply curve. Changes in supply are due to
non-price changes.
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Non-price changes and shifts of the supply curve

If production costs increase, the supplier will face increasing costs for each quantity level. Holding
all else the same, the supply curve would shift inward (to the left), reflecting the increased cost of
production. The supplier will supply less at each quantity level.
If production costs declined, the opposite would be true. Lower costs would result in an increase
in output, shifting the supply curve outward (to the right) and the supplier will be willing sell a
larger quantity at each price level. The supply curve will shift in relation to technological
improvements and expectations of market behavior in very much the same way described for
production costs.
Technological improvements that result in an increase in production for a set amount of inputs
would result in an outward shift in supply.
Supply will shift outward in response to indications of heightened consumer enthusiasm or
preference and will respond by shifting inward if there is an assessment of a negative impact to
production costs or demand.

Supply Shifts: A shift in supply from S1 to S2 affects the equilibrium point, and could be caused by
shocks such as changes in consumer preferences or technological improvements.
Economics: Supply

MARKET EQUILIBRIUM

Clearing the Market at Equilibrium Price and Quantity

When a market achieves perfect equilibrium there is no excess supply or demand, which
theoretically results in a market clearing.
The interdependent relationship between supply and demand in the field of economics is inherently
designed to identify the ideal price and quantity of a given product or service in a marketplace.
This equilibrium point is represented by the intersection of a downward sloping demand line and
an upward sloping supply line, with price as the y-axis and quantity as the x-axis. At perfect
equilibrium there is no excess demand (represented by ‘A’ in the figure) or excess supply
(represented by ‘B’ in the figure), which theoretically results in a market clearing.

Equilibrium Pricing: This chart effectively highlights the various basic implications of a simple supply
and demand chart. The equilibrium point is where market clearing will theoretically occur.
Economics: Supply

Market Clearing Assumptions

A market clearing, by definition, is the economic assumption that the quantity supplied will
consistently align with the quantity demanded. This definition requires a variety of assumptions
which simplify the complexities of real markets to coincide with a more theoretical framework,
most centrally the assumptions of perfect competition and Say’s Law:
 Perfect competition is a market where the price determined for a given good or service is
not affected by external forces or competition in a way that allows incumbents (companies)
to attain market influence.
 Say’s Law hinges on the concept that capital loses value over time, or that money is
essentially perishable. The simplest way to view this law is interest rates. When you invest
or owe money, that capital accrues interest due to the fact that there is an opportunity cost
in not investing that money elsewhere. This opportunity cost creates the assumption that
money will not go unused.
Combining these two assumptions, in a perfectly competitive market the amount of a product or
service that is supplied at a given price will equate to the amount demanded, clearing the market
of all goods/services at a given equilibrium point.

Theory and Practice

While this concept of market clearing resonates well in theory, the actual execution of markets is
very rarely perfect. Markets demonstrate consistent shifts of supply and shifts of demand based on
a wide spectrum of externalities. Even in static markets there is competitive consolidation that
allows companies to charge differing price points than that of the equilibrium. The concept of
monopolies provides a good example for this experience, as monopolies (see example) can control
price and quantity simultaneously.
Another classic criticism of market clearing is the way in which the labor market functions. In the
1930’s, during the worst depression recorded in the United States, the labor market did not clear
the way economic theories of market clearing would assume it would. Instead, there seemed to be
what John Maynard-Keynes (father of Keynesian Economics) called ‘stickiness,’ which
preventing the market from normalizing. The importance of raising these concerns is the
understanding that while the concept of market clearing, equilibrium and supply/demand charts
are highly useful in understanding the basic functioning of markets, reality does not always
conform with these models.

Impacts of Surpluses and Shortages on Market Equilibrium

The existence of surpluses or shortages in supply will result in disequilibrium, or a lack of balance
between supply and demand levels.
Economics: Supply

In the analysis of market equilibrium, specifically for pricing and volume determinations, a
thorough understanding of the supply and demand inputs is critical to economics. Surpluses and
shortages on the supply end can have substantial impacts on both the pricing of a specific product
or service, alongside the overall quantity sold over time. Shifts such as these in the supply
availability results in disequilibrium, or essentially a lack of balance between current supply and
demand levels. Surpluses and shortages often result in market inefficiencies due to a shifting
market equilibrium.

Surpluses
Surpluses, or excess supply, indicate that the quantity of a good or service exceeds the demand for
that particular good at the price in which the producers would wish to sell (equilibrium level). This
inefficiency is heavily correlated in circumstances where the price of a good is set too high,
resulting in a diminished demand while the quantity available gains excess. There are substantial
business risks inherently built into the concept of surpluses, as the general outcome will be either
selling off inventory at sub-par prices or leftover unsold inventory. In both scenarios businesses
will be forced to minimize margins or incorporate losses on that particular good. Governmental
intervention can often create surplus as well, particularly through the utilization of a price floor if
it is set at a price above the market equilibrium.

Price Floor: A price floor ensures a minimum price is charged for a specific good, often higher than that
what the previous market equilibrium determined. This can result in a surplus.
Economics: Supply

In a perfectly competitive market, particularly pertaining to goods that are not perishable, excess
supply is equivalent to the quantity available in the market beyond the equilibrium point of
intersection between supply and demand. In this theoretical scenario the equilibrium point will
transition towards a lower price point due to the increased supply, which will in turn motivate
consumers to purchase a higher quantity as a result. This allows the economic model of the market
to correct itself.

Shortages
Inversely, shortage is a term used to indicate that the supply produced is below that of the quantity
being demanded by the consumers. This disparity implies that the current market equilibrium at a
given price is unfit for the current supply and demand relationship, noting that the price is set too
low. It could also indicate that the desired good has a low level of affordability by the general
public, and can be a dangerous societal risk for necessary commodities. Indeed, Garrett Hardin
emphasized that a shortage of supply could also be perceived as a ‘longage’ of demand, as the two
are inversely related. From this vantage point shortages can be attributed to population growth as
much as resource scarcity.
In a perfectly competitive market, a shortage in supply will ultimately result in a shift in the
equilibrium point, transitioning towards a higher price point due to the limited supply availability.
This will prioritize who receives the good or service based upon their willingness and ability to
pay a premium for the specific item in demand, leveraging those along the demand curve who are
at higher levels with higher ability and willingness to pay.

Changes in Demand and Supply and Impacts on Equilibrium

Alterations to overall supply or demand dictate the cross-section or equilibrium, ascertaining price
and volume for a product or service.

The interdependent relationship between the supply of a given product or service and the overall
demand exercised by interested parties generates a theoretical equilibrium point, dictating the
average market price and purchased volume relative to that price. In a static market it would be
reasonable to assume that prices and volumes would remain fairly predictable and consistent
relative to the population, but realistic markets are not static. Instead, markets are in constant flux
as demands and supplies are subjected to varying driving forces and influences. These shifts play
a critical role in altering market equilibrium price points and volumes for products and services,
requiring constant vigilance and adaptation by providers and consumers. To better understand
market variations, it is useful to examine how changes in supply and demand may occur, as well
as the impacts and implications of these changes.
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Demand Shifts
Demand shifts are defined by more or less of a given product or service being required at a fixed
price, resulting in a shift of both price and quantity. As would be assumed, an increase in demand
will shift price upwards and volume to the right, increasing the overall value of both metrics
relative to the prior equilibrium point. Alternately, a decrease in demand will shift price
downwards and volume to the left, decreasing both measurements to realign equilibrium with a
reduced demand.

Demand Shifts: In this graph, the demand curve (red) has been affected by an increase in demand. This
consequently increases price at a given volume.

Demand shifts can be caused by a wide variety of factors, but largely revolve around drivers of
consumer behavior and circumstances. Demand shifts can therefore often be affected by economic
factors such as average spending power per person in a given economy or overall average income.
Demand can also be affected by cultural changes, demographic shifts, availability of substitutes,
environmental factors and concerns (e.g. climate change), politics, and advances in science (e.g.
declining demand for unhealthy foods). Demand is particularly malleable in respect to goods that
are not necessities, thus are desired or not based upon sociological norms.
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Supply Shifts
Supply shifts are defined by more or less of a particular product/service being available to fulfill a
given demand, affecting the equilibrium point by shifting the supply curve upwards or downwards.
A supply shift to the right, indicating more availability of the specified product or service, will
create a lower price point and a higher volume assuming a fixed demand. Alternately, a decrease
in supply with a consistent given demand will see an increase in price and a decrease in quantity.
This is an intuitive theory underlining the fact that scarcity is relevant to the willingness to pay.

Supply Shifts: In this supply and demand chart we see an increase in the supply provided, shifting
quantity to the right and price down. More of a given product, assuming the same demand, will result in
lower price points at the equilibrium.

Supply shifts, similar to demand shifts, can ultimately be a result of a wide variety of external
factors. As discussed above, scarcity plays a critical role in pricing and thus controlling supply is
often even considered a strategic play by companies in specific industries (most notably industries
like precious stones, rare earth metals, etc.). Supply shifts can also be a result of technological
advances, over-utilization or consumption, globalization, supply-chain efficiency, and economics.
For example, the discovery of a new gold deposit, acts as a shock to the supply of gold, shifting
the curve right.
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Equilibrium
In combining these two potential shifts, equilibrium is constantly subjected to both factors
resulting in supply shifts and factors resulting in demand shifts. Due to the demand curve sloping
downward and the supply curve sloping upwards, they inadvertently will cross at some given point
on any supply/demand chart. This cross-section, or equilibrium, serves as a price and quantity
tracking point based upon the consistent inputs of overall demand and supply availability. Any
change in either factor will result in immediate impact on equilibrium, balancing the new demand
or supply with a corresponding volume and appropriate average price point.

References:
Tucker, I. B. (2019). Microeconomics for Today
Banes, L.P. (2016). Principles of Economics with Taxation, Agrarian Reform and
cooperatives
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