Subject Name – Economic Analysis for Business Decisions

Topic Name – Supply Market Equilibrium & Cost Analysis

Student Name – Kashish Shaikh

Class – First Year MBA

Division – C
Academic Year – 2022-23
Roll No - 13
Supply Analysis
• Supply Analysis is a research and analysis done to understand the supply trends
and responses to changing market and production variables. Supply Analysis
takes into account the production costs, raw material costs, technology, labour
wages etc. The analysis helps the manufacturers and companies to understand the
impact of these variables on supply and eventually demand.
• The goal of demand-supply chain is to make sure that the supply and demand
work properly. The demand should be met and supply should not be more than
what expected. There are lot of variables which are considered in demand analysis
and supply analysis.
 • The supply function in economics is a mathematical formula that depicts the
relationship between quantity supplied, price of the commodity, and other related
variables. Here, the quantity supplied is expressed as a function of the price. It helps
Supply businesses and governments to study and monitor an economy’s demand-supply
situation.

Function • The supply function in economics is of utmost importance to businesses. They can
establish the optimum quantity-price relationship to control costs and make high
profits. Firms can study the variations in quantity supplied with price changes.
However, it depends on many factors, such as market conditions and government
policies.
The supply function formula is as follows:
Qa = f (Pa, Pb , x , y , z)
Here, Qa is the quantity of commodity A supplied
Pa is the price of commodity A
Pb is the price of related commodity B
x, y, and z are other variables affecting the product’s supply, like the cost of production,
government intervention, level of technology, etc.
Let us look at the various factors affecting supply function in detail.
• Firstly, the price of related goods like complementary items and substitutes affects the price of a particular
commodity. Consider, for example, a printer that costs $200; if an ink cartridge costs $150, people will not buy
the cartridge. Similarly, it is important to take into consideration the competitors’ prices. Therefore, a too high
or too low price can be both dangerous for a business.
• Secondly, the cost of production affects the selling price. This is because the final price is nothing
but profit added to the production cost. Therefore, a higher cost will correspond to a higher price. A high cost
can directly affect the capacity of a firm to supply. Production cost includes raw materials, wages, and other
direct and indirect expenses.
• Thirdly, government interventions and policies control the supply level. For example, the government can
restrict the amount of a certain commodity that one can supply every month. Lastly, the level of technology
affects the speed of supply. Like, advanced production techniques and technology can enable sellers to supply
more.
• An ideal aggregate supply function can be plotted as a slightly convex line, passing through the origin. This
shows that as price increases, supply also increases and vice-versa. That is, if the price of a commodity is high,
the seller will be motivated to supply more, as they can earn more from selling high.
Determinants of Supply
• Supply does not remain constant all the time in the market. There are many factors that influence
the supply of a product. Generally, the supply of a product depends on its price and cost of
production.
• Thus, it can be said that supply is the function of price and cost of production. These factors that
influence the supply are called the determinants of supply.

9 Determinants of supply are:

1. Price of a product
2. Cost of production
3. Natural conditions
4. Transportation conditions
5. Taxation policies
6. Production techniques
7. Factor prices and their availability
8. Price of related goods
9. Industry structure
Price of a Product
• The major determinants of the supply of a product is its price. An increase
in the price of a product increases its supply and vice versa while other
factors remain the same.
• Producers increase the supply of the product at higher prices due to the
expectation of receiving increased profits. Thus, price and supply have a
direct relationship.
Cost of Production
• It is the cost incurred on the manufacturing of goods that are to be offered
to consumers. Cost of production and supply are inversely proportional to
each other.
• This implies that suppliers do not supply products in the market when the
cost of manufacturing is more than their market price. In this case, sellers
would wait for a rise in price in the future.
• The cost of production increases due to several factors, such as loss of
fertility of land; high wage rates of labour; and increase in the prices of raw
material, transportation cost, and tax rate.
Natural conditions
• The supply of certain products is directly influenced by climatic conditions. For
instance, the supply of agricultural products increases when the monsoon comes
well on time.
• On the contrary, the supply of these products decreases at the time of drought.
Some of the crops are climate specific and their growth purely depends on climatic
conditions.
• For example, Kharif crops are well grown at the time of summer, while Rabi
crops are produced well in the winter season.

Transportation Conditions
• Better transport facilities result in an increase in the supply of goods. Transport is
always a constraint to the supply of goods. This is because goods are not available
on time due to poor transport facilities.
• Therefore, even if the price of a product increases, the supply would not increase.
Taxation Policies
• Government’s tax policies also act as a regulating force in supply. If the rates of
taxes levied on goods are high, the supply will decrease. This is because high tax
rates increase overall productions costs, which will make it difficult for suppliers
to offer products in the market.
• Similarly, reduction in taxes on goods will lead to an increase in their supply in
the market.

Production techniques
• The supply of goods also depends on the type of techniques used for production.
Obsolete techniques result in low production, which further decreases the supply
of goods.
• Over the years, there has been tremendous improvement in production
techniques, which has led to increase in the supply of goods.
 Factor Prices and their availability
• The production of goods is dependent on the factors of production, such as raw material,
machines and equipment, and labour.
• An increase in the prices of the factors of production increases the cost of production. This
will make difficult for firms to supply large quantities in the market

Price of related goods

• The prices of substitutes and complementary goods also influence the supply of a product
to a large extent.
• For example, if the price of tea increases, farmers would tend to grow more tea than
coffee. This would decrease the supply of tea in the market.

Industry structure
• The supply of goods is also dependent on the structure of the industry in which a firm is
operating. If there is monopoly in the industry, the manufacturer may restrict the supply
of his/her goods with an aim to raise the prices of goods and increase profits.
• On the other hand, in case of a perfectly competitive market structure, there would be a
large of number of sellers in the market. Consequently, the supply of a product would
increase.
 Law of supply
• The law of supply in economics suggests that with other factors remaining constant, if the
price of a commodity increases, its market supply also goes up and vice-versa. It is one of
the fundamental laws in economics. It establishes a direct relationship between the price
and supply of a commodity.
• Therefore, if there is a rise in the price, the supply also increases, giving sellers a chance
to make more money.
• The law of supply is a theory in economics that indicates a direct relationship between
price and supply. It suggests that all factors remaining constant, if the price of a
commodity increases, it leads to an increase in its market supply and vice-versa. This is
because sellers will try to gain maximum profit by increasing sales.
• As opposed to this, the law of demand suggests that the with all things remaining
constant, when the price of a commodity increases, it leads to a fall in demand and vice-
versa. The reason behind being consumers tend to spend more on normal goods if their
price falls down due to greater affordability.
• Supply and demand determine the prices of various goods. The supply law also has an
important significance in determining the number of firms operating in a domain. If the
price falls too low, many companies stop production.
 The law of supply graph is upward sloping,
reflecting the direct relationship between
Law of supply GRAPH price and supply. Let us look at the example
below to gain more clarity on this.

Price Quantity Supplied

$4 3

$6 6

$8 9
elasticity of supply
• The elasticity of supply establishes a quantitative relationship between the supply of a
commodity and it’s price. Hence, we can express the numeral change in supply with the
change in the price of a commodity using the concept of elasticity. Note that elasticity can
also be calculated with respect to the other determinants of supply.
• However, the major factor controlling the supply of a commodity is its price. Therefore,
we generally talk about the price elasticity of supply. The price elasticity of supply is the
ratio of the percentage change in the price to the percentage change in quantity supplied
of a commodity.

Es= [(Δq/q)×100] ÷ [(Δp/p)×100] = (Δq/q) ÷

(Δp/p)
Δq= The change in quantity supplied
q= The quantity supplied
Δp= The change in price
p= The price
elasticity from a supply curve
• Along with the method mentioned above, there are two more ways to
calculate the price elasticity of supply, both of which make use of the
supply curve. We can either calculate the elasticity at a specific point on the
supply curve, known as point elasticity or between two prices, known as
arc-elasticity.

The formula for calculating the point elasticity of supply is:

Es= (dq/dp)×(p/q)
Here dq/dp is the slope of the supply curve.
The formula for calculating the arc-elasticity of supply is:
• Es= [(q1 – q2)/( q1 + q2)] × [( p1 + p2)/(p1 – p2)]
Types of
elasticity
of supply
Perfectly inelastic supply
• A service or commodity has a perfectly inelastic supply if a given quantity of it can
be supplied whatever might be the price. The elasticity of supply for such a service
or commodity is zero. A perfectly inelastic supply curve is a straight line parallel to
the Y-axis. This is representative of the fact that the supply remains the same
irrespective of the price.

Relatively less elastic supply

• When the change in supply is relatively less when compared to the change in
price, we say that the commodity has a relatively-less elastic supply. In such a
case, the price elasticity of supply assumes a value less than 1.

Relatively greater elastic supply

• When the change in supply is relatively more when compared to the change in
price, we say that the commodity has a relatively greater-elastic supply. In such a
case, the price elasticity of supply assumes a value greater than 1.
Unitary elastic
• For a commodity with a unit elasticity of supply, the change in quantity supplied
of a commodity is exactly equal to the change in its price. In other words, the
change in both price and supply of the commodity are proportionately equal to
each other. To point out, the elasticity of supply in such a case is equal to one.
Further, a unitary elastic supply curve passes through the origin.

Perfectly elastic supply

• A commodity with a perfectly elastic supply has an infinite elasticity. In such a
case the supply becomes zero with even a slight fall in the price and becomes
infinite with a slight rise in price. This is indicative of the fact that the suppliers of
such a commodity are willing to supply any quantity of the commodity at a higher
price. A perfectly elastic supply curve is a straight line parallel to the X-axis.
Thank You