FINA 1126: Introduction to Finance and

Economics
LECTURE TWO
SUPPLY AND MARKET EQUILIBRIUM

Padlet : https://padlet.com/sarwar/fina1126
Learning Outcomes

o Define ‘supply’ and identify the factors that affect the

available supply of a product or service.
o Explain when supply curves shift.
o Identify conditions for ‘stable equilibrium’ within a market
for a product or service.
o Investigate factors that cause ‘equilibrium’ position to
change or to become unstable.
o Understand the theory of production (supply)
Supply

o Amount of goods sellers are willing to make available

for sale at different price levels.
o Higher the unit price (changes in price) – more the
available supply
o The supply curve usually slopes upwards from left to
right
The supply curve:
The supply of strawberries (monthly)

Price of Farmer X's Total Market

Strawberries supply supply (tonnes:
(pence per kg) (tonnes) 000s)
a 20 50 100
b 40 70 200
c 60 100 350
d 80 120 530
e 100 130 700
 Market supply of Strawberries (monthly)
100 e
Supply
d P Q
80
Price (pence per kg) a 20 100
b 40 200
c
60 c 60 350
d 80 530
e 100 700
40
b

20
a

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
Factors that affect market supply

o Technology and new product development

o The cost of factor resources used in production
• Wage costs
• Raw material prices
o The prices of “related goods”
o The number of producers / suppliers in the market
o Government legislation and regulation (taxes and
subsidies)
 P
Shifts in the supply S2 S0 S1
curve

 Possible causes of a rise

in supply
 Fall in costs of
production Decrease Increase
 Reduced profitability of
alternative products that
could be supplied
 Increased profitability of
goods in joint supply
 Benign shocks
 Expectations of a fall in
price
O Q
THE PRICE MECHANISM

The one common factor in both demand and supply is

price.
Price plays a fundamental role in the process of allocating
resources within the economy – the price of any particular
good is determined through the interaction of supply and
demand (Price equilibrium).
Therefore, the “how” of economics.
Equilibrium price and output
The market demand and supply of Strawberries (monthly)

Price of Strawberries Total market demand Total market supply

(pence per kilo) (tonnes: 000s) (tonnes: 000s)

20 700 (A) 100 (a)

40 500 (B) 200 (b)

60 350 (C) 350 (c)

80 200 (D) 530 (d)

100 100 (E) 700 (e)

 The determination of market equilibrium
(Strawberries: monthly)
E e
100
Supply
D d
80
Price (pence per kg)

Cc
60

40 b B

a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(Strawberries : monthly)
E e
100
Supply
D d
80
Price (pence per kg)

Cc
60

40 b SHORTAGE B
(300 000)
a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(Strawberries : monthly)
E e
100
Supply

80
D SURPLUS d
Price (pence per kg)

(330 000)
Cc
60

b B
40

a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(Strawberries : monthly)
E e
100
Supply
D d
80
Price (pence per kg)

Equilibrium established when

60
market demand = market
supply
b B
40

a A
20

Demand
0
0 100 200 300 Qe 400 500 600 700 800
Quantity (tonnes: 000s)
 Effect of a shift in the supply curve
P
S2
Freeze causes a S1
fall in market
supply at each
price level k
Result is an Pe3
increase in
equilibrium price j g New equilibrium at
and a fall in point k
Pe1
quantity traded
Consumers get
squeezed?
What happens to
the total revenue
for producers?
D
O Qe 3 Qe 1 Q
THE THEORY OF PRODUCTION (Supply)

For each possible output level, a firm compares what this

output costs to make and the revenue to be earned from
sales.
The theory of supply assumes each firm chooses the level
of output that maximizes it profit.
Economist assumes that a firm profit is maximised where
Marginal cost equals Marginal revenue.
THE THEORY OF PRODUCTION (Supply)

Why will equating MR with MC result in best possible output and

sales level for the firm in terms of highest possible profit level in all
market conditions ?

If MC < MR then produce more as sale add more to TR than to TC

and profit will rise.

If MC > MR then reduce production as currently sale will be adding

more to TC than to TR and so reducing profit.
PROFIT MAXIMISATION

Economists have a slightly different view of profit.

What is level of profit that a firm will be willing to supply

to the market?

What level of output / supply will achieve the required level

of profit?
PROFIT MAXIMISATION

Two types of profit

• Normal Profit – which is the amount of profit needed to
keep a firm in its present activity supplying to the
market. Normal profit is treated as part of the total cost.
• Abnormal Profit – profits earned by the supplier above
the normal profit. (Total revenue > Total cost).
PROFIT MAXIMISATION

Some terminology
• Total Revenue = unit selling price multiply by volume of
units sold.

• Average Revenue per unit sold = Total revenue divided

by the total number of units sold.
PROFIT MAXIMISATION

Some terminology
Marginal Revenue = the change in the Total revenue
resulting from the sale of one further unit of a product.
Total Cost = Fixed costs which are independent of the level
of output + variable costs.
Marginal Cost = is the change in the total as a result of
producing the last unit.
SUPPLY DECISION (illustration)

Total Marginal
Output Total cost Marginal revenue revenue
(Q) (TC) cost (MC) (TR) (MR) Profit (MR-MC)
0 10 0 0 0 -10 0
1 18 8 20 20 2 12
2 28 10 31 11 3 1
3 40 12 36 5 -4 -7
4 54 14 35 -1 -19 -15
STUDENTS LECTURE
ACTIVITY
Using the data from table A, calculate TR, TC and Total
profit at each level of output in table B.
Table A
Output (units) 1 2 3 4 5 6
MR (£) 8 7 6 5 4 3
MC (£) 4 5 6 7 8 9

Table B
Output (units) 1 2 3 4 5 6
Total revenue (TR)
Total cost (TC)
Total profits