Supply and Market Equilibrium

Introduction
 In economics supply and demand are two
basic concepts and backbone of market
economy.
 Supply means “an amount of a
commodity or service which sellers are
willing and able to sell at a given price
during a given period of time”.
 Determinants of Supply
 Price of the commodity
 Input prices
 Price of related goods
 Techniques of Production
 Nature of the commodity
 The policy of Taxation and Subsidies
 Expectations of Future Prices
 Government policies
 Natural Factors
Individual Supply Vs Market Supply
 Individual Supply: It refers to the quantity of
a commodity which a firm or producer is
willing to produce and offer for sale at a
particular price during a particular period of
time.
 Market supply: It refers to the quantity of a
commodity which all firms or producers are
willing to produce and offer for sale at a
particular price during a particular period of
time.
Difference between Stock and Supply

 Supply means the quantity of goods which

sellers are willing to sell in market at a
given price.
 Stock means quantity of a commodity
which exists in the market but not
offered for sale at a given price.
 Supply can be equal to or less than stock
but it cannot be greater than stock
 Law of Supply

 The law of supply states that price and quantity

supplied are inversely related. It states that
“other things remaining the same the quantity
supplied of a commodity extends with a rise in
its price and contracts with a fall in its price”.
 In other words the quantity supplied changes
directly with price. The law explains a definite
relationship between the prices of a commodity
and its quantity supplied.
Supply Schedule
 Assumptions
1. No change in the income
2. No change in technique of production
3. There should be no change in transport cost
4. Cost of production be unchanged
5. There should be fixed scale of production
6. There should not be any speculation
7. The prices of other goods should remain
constant
8. There should not be any change in the
government policies
 Exceptions
 Speculation
 Agricultural Products
 Monopoly
 Competition
 Out of fashion goods
 Rate of Interest and Savings Position
 Changes in Supply
 Change in supply means when the quantity supplied of a
commodity changes(rises or falls) as a result of changes in its own
price, while other determinants of supply remain constant, it is
known as change in quantity supplied/ Supply.

 Extension in supply - When the quantity supplied of a commodity

rises due to rise in its price, other things remaining the same. It is
called rise in quantity supplied or extension of supply.

 Contraction in supply -When the quantity supplied of a

commodity decreases due to fall in its price, other things
remaining the same. It is called fall in quantity supplied or
contraction of demand.
 Shift in Supply
 When the amount supplied of the commodity rises or falls because of

change in factors other than the own price of the commodity, it is called

change in Supply.

 Increase in supply- It refers to a situation when the producers are willing

to supply a larger amount of a commodity at the same price or same

quantity at a lower price.

 Decrease in supply. - It refers to a situation when the producers are

willing to supply a smaller amount of a commodity at the same price or

same quantity at a higher price.

 Elasticity of Supply
 Price elasticity of supply measures the
degree of responsiveness of the quantity
supplied of a commodity to a change in its
price.
 Es= Proportionate change in quantity supplied/
Proportionate change in Price
Degrees of Elasticity of Supply
 Perfectly Elastic supply
 Perfectly Inelastic Supply
 Relatively Elastic Supply
 Unit elastic supply
 Relatively inelastic supply
Factors Determining Elasticity of supply

1. Price of the goods

2. Probability that the Price would Change in Future

3. Conditions Regarding Cost of Production

4. Nature of the Good

5. Length of Time
Practical Importance of Elasticity of
Supply
 Helpful in taking business decisions.
 Formation of Tax policy of the
government.
 For determining the rewards of factors of
production
 To determine the terms of trade between
two countries
MARKET EQUILIBRIUM
 Introduction
• A production function is a descriptive relation that links inputs
with output.
• It specifies the maximum feasible output that can be produced for
given amounts of inputs.

• A production function specifies maximum output from given

inputs
Q  f ( x1 , x2 ,...xn )
 In this Section look for the answers to
these questions:
 What is a production function? What is marginal
product? How are they related?
 What are the various costs, and how are they
related to each other and to output?
 How are costs different in the short run vs.
the long run?
 What are “economies of scale”?

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 Meaning of Production
 Production refers to the
transformation of inputs or resources
into outputs or goods and services.
 Production is a process in which
economic resources or inputs are
combined by entrepreneurs to create
economic goods and services.
 The aim of the producer is to
maximize his profit. For this sake, he
decides to maximize the production
at minimum cost by means of the best
combination of factors of production.
Production Function
 The term production function refers to
the relationship between the inputs and
the outputs produced by them.
 Production function defined as “the
relation between a firm’s physical
production (output) and the material
factors of production (inputs).”
---Prof. Watson
 The production function could be written as
Q = f (Ld, L, K, R)
Where,
Q = output in physical units of good X
 Ld = land units employed in the production
 L = Labour units employed in the production
 K = capital units employed in the production
 R = Raw Material employed in the
production
 Explanation
 This function gives the maximum possible
output that can be produced from a given
amount of various inputs, or, alternatively,
the minimum quantity of inputs necessary
to produce a given level of output.
 The relative importance of various inputs
in production varies from product to
product.
 Example
 Production functions for agricultural products generally
have inputs as land, fertilizer, rainfall, seeds, etc.
 In contrast, the production function for industrial
products have inputs as labour, capital, management and
technology. •
 Land is an important factor of production in agriculture,
while labour is an important factor of production for
industry.
 Features of Production Function
 Substitutability:
The factors of production or inputs are substitutes of one another which make it
possible to vary the total output by changing the quantity of one or a few inputs, while
the quantities of all other inputs are held constant. It is the substitutability of the
factors of production that gives rise to the laws of variable proportions.
 Complementarily:
The factors of production are also complementary to one another, that is, the two or
more inputs are to be used together as nothing will be produced if the quantity of
either of the inputs used in the production process is zero.
 Specificity:
It reveals that the inputs are specific to the production of a particular product.
Machines and equipment’s, specialized workers and raw materials are a few examples
of the specificity of factors of production. The specificity may not be complete as
factors may be used for production of other commodities too. This reveals that in the
production process none of the factors can be ignored and in some cases ignorance
to even slightest extent is not possible if the factors are perfectly specific.
ECONOMIES AND DISECONOMIES OF
SCALE
ECONOMIES OF SCALE –
 The advantages that a firm accurse as a result of increase in
its
scale of production is called economies of scale
 When more goods or services can be produced on a large
scale, yet with less input
ECONOMIES AND DISECONOMIES OF
SCALE
Diseconomies of scale
• “When the firm expands and becomes difficult to manage than
diseconomies of scale arises.”
• In large scale organizations increased production may cause
certain diseconomies and disadvantages.
• In the firm’s course of expansion, a stage may reach when the
firm becomes too large to manage.
• It may face several problems just because its size has become
very large.
COST CONCEPTS (MEANING AND
IMPORTANCE)
 The cost of production of an individual firm has an important
influence on the market supply of a commodity.

 The product prices are determined by the interaction of the

forces of demand and supply.

 A firm aims at maximizing its profits; profits depend on the

costs of production and the prices of products.

 Costs may be nominal costs or real costs. Nominal cost is the

money cost of production. It is also called expenses of
production. The real cost is the opportunity cost of
production (see below). Money costs and real costs do not
coincide with each other.

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Opportunity Cost
 It is the forgone cost of taking next best
alternative. In simple words we can say
that when we sacrifice something to get
another thing in that condition the cost of
the thing which we sacrificed is known as
opportunity cost.
 Example if person uses his own land in his
business in that case the rent he could get
from that land will be his opportunity
cost.
 Let’s say that a farmer has a piece of land on which he
can grow wheat or rice. Therefore, if he chooses to
grow wheat, then he cannot grow rice and vice-versa.
Hence, the opportunity cost for rice is the wheat crop
that he forgoes.The following diagram explains this:
Explanation
 Let’s assume that the farmer can produce either 50 quintals of rice (ON) or 40 quintals of
wheat (OM) using this land. Now, if he produces rice, then he cannot produce wheat.

 Further, the farmer can choose to produce any combination of the two crops along the
curve MN (production possibility curve). Let’s say that he chooses the point A as shown
above.

 Therefore, he produces OD amount of rice and OC amount of wheat. Subsequently, he

decides to shift to point B. Now, he has to reduce the production of wheat from OC to
OE in order to increase the production of rice from OD to OF.

 Therefore, the OC of DF amount of rice is CE amount of wheat.

Accounting Costs & Economic Costs
 Accounting costs are actual costs, also
known as explicit costs, are costs that
involve money being spent such as rent,
utility bills, interest payments.
 The economic cost of a decision depends
on both the cost of the alternative chosen
and the benefit that the best alternative
would have provided if chosen. Economic
cost differs from accounting cost because
it includes opportunity cost.
Explicit cost & Implicit Cost
 Explicit cost :-Explicit cost is the monetary
payment made by the entrepreneur for
purchasing or hiring the services of various
productive factors, which do not belong to him.
This cost is in the nature of contractual payment.
 Implicit cost :-Implicit cost arises in the case of
those factors, which are possessed by the
entrepreneur himself. It is cost of self owned, self
employment resources that are frequently
overlooked in computing the expenses of a firm.
 Private Cost & Social Cost
 Private costs are the costs which are incurred
by business or person who are directly involved
in economic activity. For a producer of a good,
service, or activity include the costs the firm
pays to purchase capital equipment, hire labor,
and buy materials or other inputs.
 Example If a person driving a car he will pay the
cost of the fuel and oil, maintenance, depreciation
etc.
 Social Costs
 Social costs refer to the total costs to society on account of a production or
consumption activity. Whatever the things while producing (in business) or
while consuming (by person) affect the society are considered as social cost.
Example of social cost of building airport

 Private costs of airport

 Cost of constructing an airport.

 Cost of paying workers to run airport

 External costs of airport

 Noise and air pollution to those living nearby.

 Risk of an accident to those living nearby.

 Loss of landscape.
 cost-output relationship
 The cost-output relationship plays an important role in
determining the optimum level of production.
Knowledge of the cost-output relation helps the
manager in cost control, profit prediction, pricing,
promotion etc. The relation between cost and its
determinants is technically described as the cost
function.
C= f (S, O, P,T ….)
 Where;
 C= Cost (Unit or total cost)
 S= Size of plant/scale of production
 O= Output level
 P= Prices of inputs
 T= Technology
 Considering the period the cost function
can be classified as
(1) short-run cost function
(2) long-run cost function.
Cost-Output Relationship in the
Short-Run
 The short-run is defined as that period during
which the physical capacity of the firm is fixed and
the output can be increased only by using the
existing capacity allows to bring changes in output
by physical capacity of the firm.
 Short Run may be studied in terms of
◦ Average Fixed Cost
◦ Average Variable Cost
◦ Average Total cost
 Total, average &  Fixed cost &
marginal cost variable cost
1.Total cost (TC) = TFC 1.Total fixed cost (TFC)
+ TVC, rise as output = cost of using fixed
rises factors = cost that
does not change
2. Average cost (AC) = when output is
TC/output changed, e.g.

3. Marginal cost (MC) = 2.Total variable cost

change in TC as a (TVC) = cost of using
result variable factors =
of changing output by cost that changes
one unit when output is
changed,
Average Fixed Cost and Output

 The greater the output, the lower

the fixed cost per unit, i.e. the
average fixed cost.

 Total fixed costs remain the same &

do not change with a change in
output.
Average Variable Cost and output

 The avg. variable costs will first fall & then rise as more &
more units are produced in a given plant.

 Variable factors tend to produce somewhat more efficiently

near a firm’s optimum output than at very low levels of
output.

 Greater output can be obtained but at much greater avg

variable cost.

 E.g. if more & more workers are appointed, it may ultimately

lead to overcrowding & bad org. moreover, workers may have
to be paid higher wages for overtime work.
Average Total cost and output
 Average total cost, also known as average costs, would decline
first & then rise upwards.

 Average cost consists of average fixed cost plus average variable

cost.

 Average fixed cost continues to fall with an increase in output

while avg. variable cost first declines & then rises.

 So , as Avg. variable cost declines the Avg. total cost will also
decline. But after a point the Avg. variable cost will rise.

 When the rise in AVC is more than the drop in Avg. fixed cost
that the Avg. total cost will show a rise.
Short Run Cost Function
 Cost and Out Put Relationship Long
Run
 long run period enables the producers to
change all the factor & he will be able to
meet the demand by adjusting supply. Change
in Fixed factors like building, machinery,
managerial staff etc..

 All factors become variable in the long run.

 In the long run we have only 3 costs i.e. total

cost,Average cost & Marginal Cost
1.Total cost (TC) = TFC + TVC, rise as
output rises

2. Average cost (AC) = TC/output

3. Marginal cost (MC) = change in TC as a

result of changing output by one unit
 When all the short run situations are combined, it
forms the long run industry.

 During the SR, Demand is less & the plant’s capacity

is limited. When demand rises, the capacity of the
plant is expanded.

 When SR avg. cost curves of all such situations are

depicted, we can derive a long run cost curve
out of that.

 We can make a LR cost curve by joining the

tangency points of all SR curves
 We use long run costs to decide scale issues, for example
mergers.

 In the long run, we can build any size factory we wish,

based on anticipated demand, profits, and other
considerations.

 Once the plant is built, we move to the short run.

Therefore, it is important to forecast the anticipated
demand. Too small a factory and marginal costs will be high
as the factory is stretched to over produce.

 Conversely too large a factory results in large fixed costs

(e.g.. air conditioning, or taxes) and low profitability.
Thank You