Supply Analysis

Discussion on Current News

German luxury carmaker BMW aims double-digit
growth in sales in India
 Learning Outcomes

•To discuss the effects of the various determinants on

supply function.
•To discuss the causes of change in supply.
 Supply

• Indicates the quantities of a good or service that the

seller is willing and able to provide at a price, at a given
point of time, other things remaining the same.
• Supply of a product X (Sx) depends upon:
– Price of the product (Px)
– Cost of production (C)
– State of technology (T)
– Government policy regarding taxes and subsidies (G)
– Other factors like number of firms (N)
• Hence the supply function is given as:
Sx = (Px, C, T, G, N)
 Law of Supply
 Law of Supply states that other things remaining the same, the
higher the price of a commodity the greater is the quantity supplied.
 Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the
incentive to supply.
 Supply bears a positive relation to the price of the commodity.

Supply Schedule Supply Curve

Point on Price Supply (‘000 35

Price of Coffee
Supply (Rs. Per cups per e
Curve cup) month) 30
a 15 10 25 d
c
b 20 20 20
b
c 25 30 15 a
d 30 45
e 35 60 0
10 20 30 40 50 60
Quantity of Coffee
 Change in Supply

 Shift in the supply curve from

S0 to S1
Price S2  More is supplied at each
S0 price (Q1>Q0)
S1
 Increase in supply caused by:
 Improvements in the
technology
 Fall in the price of inputs
P  Shift in the supply curve from
S0 to S2
 Less is supplied at each
price (Q2<Q0)
 Decrease in supply caused by:
O  A rise in the price of inputs
Q2 Q0 Q1 Quantity
 Change in government
policy (VAT)
 Market Equilibrium
 Equilibrium occurs at the price where the quantity demanded and
the quantity supplied are equal to each other.
 At point E demand is equal to supply hence 25 is equilibrium price

Price Demand
Supply (‘000 cups/
Price (‘000 cups/ month)
S (Rs) month)

15 10 50

E 20 15 40
25
25 30 30
30 45 15

D 35 70 10
O 30 Quantity
 Let’s Analyze

Imagine that there is a drought in the nation. Discuss the

possible implications of drought on the demand and
supply of food grains in the nation.
 Let’s Analyze

Suggest the impact of a liberal monetary policy on supply

of the goods in an economy.
 Market Equilibrium
 For prices below the equilibrium, Quantity demanded exceeds
quantity supplied (D>S)
– Price pulled upward
 For prices above the equilibrium, Quantity demanded is less than
quantity supplied (D<S)
– Price pulled downward.
 At point E demand is equal to supply hence 25 is equilibrium price.

Price
S Supply Demand
Price (‘000 cups/ (‘000 cups/
30 (Rs) month) month)
E 15 10 50
25
20 15 40
20
25 30 30
30 45 15
D
35 70 10
O
30 Quantity
Changes in Market Equilibrium
(Shifts in Supply Curve)

Price
S0

D1 S1

E0 S2
P0
E
P E2
S0
P2
S1
S2 D1
O
Q0 Q Q2 Quantity
 Changes in Market Equilibrium
(Shifts in Demand Curve)

Price

D2
S1
D1
D0
E1
P1
E
P
E2
P*
D2

S1 D0 D1
O
Q* Q Q1
Quantity
 Change in Both Demand and Supply

D2
Price D2
D1
S1
S2

P2 E2
P1 E1 E0

S1 D2
S2 D2
D1
O
Q1 Q2 Quantity
 Elasticity of Demand

• Mathematically, it is the percentage change in

quantity demanded of a commodity to a percentage
change in any of the (independent) variables that
determine demand for the commodity.

• Four major types of elasticity:

– Price elasticity,
– Income elasticity,
– Cross elasticity
– Advertising (or promotional) elasticity.
 Price Elasticity of Demand

•Price elasticity of demand means the sensitivity of

quantity demanded of a commodity to a given
change in its own price.
 Degrees of Price Elasticity
Slope of demand curve is used to display Price
price elasticity of demand
Perfectly elastic demand
• ep=∞ (in absolute terms). P
D
• Horizontal demand curve
• Unlimited quantities of the commodity can
be sold at the prevailing price O
• A negligible increase in price would result Q1 Q2 Quantity
in zero quantity demanded

• Perfectly inelastic demand D

• Price
The other extreme of the elasticity range
• ep=0 (in absolute terms)
• Vertical demand curve P1

• Quantity demanded of a commodity P2

remains the same, irrespective of any
change in the price
• Such goods are termed neutral. O
Q1 Quantity
 Degrees of Price Elasticity
Contd.
Highly elastic demand
• Proportionate change in quantity Price
D
demanded is more than a given change in
price P1
• ep >1 (in absolute terms) P2 D
• Demand curve is flatter
Unitary elastic demand O
Q1 Q2 Quantity
• Proportionate change in price brings
Price D
about an equal proportionate change in
quantity demanded P1
• ep =1 (in absolute terms). P2
• Demand curves are shaped like a
rectangular hyperbola, asymptotic to the D
axes O
Q1 Q2 Quantity
Relatively inelastic demand Price
• Proportionate change in quantity D
demanded is less than a proportionate P1
change in price P2
• ep <1 (in absolute terms)
• Demand curve is steep
O D
Q 1 Q2 Quantity
Determinants of Price Elasticity of Demand

• Nature of commodity
• Availability and proximity of substitutes
• Alternative uses of the commodity
• Proportion of income spent on the commodity
• Time
• Durability of the commodity
• Items of addiction
 Income Elasticity of Demand (ey)

• ey measures the degree of responsiveness of demand for

a good to a given change in income, ceteris paribus.

Proportionate change in quantity demanded of commodity X

ey =
Proportionate change in income of consumer

• Degrees:
– Positive income elasticity
• Demand rises as income rises and vice versa
• Normal good
– Negative income elasticity
• Demand falls as income rises and vice versa
• Inferior good
 Cross Elasticity of Demand

• ec measures the responsiveness of demand of

one good to changes in the price of a related good

Proportionate change in quantity demanded of commodity X

ec =
Proportionate change in price of commodity Y

• Degrees
– Negative Cross Elasticity
• Complementary goods
– Positive Cross Elasticity
• Substitute goods
• Degrees
– Zero Cross Elasticity
 Promotional Elasticity of Demand

• Advertising (or promotional) elasticity of demand (ea) measures the

effect of incurring an “expenditure” on advertising, vis-à-vis an
increase in demand, ceteris paribus.
• Some goods (like consumer goods) are more responsive to
advertising than others (like heavy capital equipments).

Proportion ate change in quantity demanded (or sales) of commodity X

ea =
Proportion ate change in advertisin g expenditure

• Degrees
– ea>1
• Firm should go for heavy expenditure on advertisement.
– ea <1
• Firm should not spend too much on advertisement
 Importance of Elasticity

• Determination of price
• Basis of price discrimination
• Determination of rewards of factors of production
• Government policies of taxation
Thank You