Market Supply Theory
In this lesson, you’re expected to learn:
– what factors affect producers’ supply of goods
– how the Law of Supply and price elasticity determine market supply
– how changes in the factors that affect supply influence the market price and quantity
Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price.
The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship.
Supply reflects producers’ changing willingness and ability to make or sell at the various prices that occur in the market.
Time & Supply
Unlike the demand relationship, however, the supply relationship is a factor of time. Time is important to supply because suppliers must, but cannot always, react quickly to a change in demand or price.
So it is important to try and determine whether a price change that is caused by demand will be temporary or permanent.
Law of supply
The reason for the law of supply is the simple fact that as production increases, so do the marginal costs. As rational, self-interested individuals, suppliers are only willing to produce if they are able to cover their costs.
Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue.
There are three main reasons why supply curves are drawn as sloping upwards from left to right, giving a positive relationship between the market price and quantity supplied:
1) The profit motive: When the market price rises following an increase in demand, it becomes more profitable for businesses to increase their output.
2) Production and costs: When output expands, a firm’s production costs tend to rise, therefore a higher price is needed to cover these extra costs of production. This may be due to the effects of diminishing returns as more factor inputs are added to production.
3) New entrants coming into the market: Higher prices may create an incentive for other businesses to enter the market leading to an increase in total supply.
Typically, supply curves are upward-sloping, because as price increases, sellers are more likely to be willing to sell something.
Enlarged version: http://bit.ly/2lc65ZL
Enlarged version: http://bit.ly/2lOnviJ
For example, suppose that Starbucks and Dunkin’ Donuts are the only two sellers of coffee in the market.
Link to the video: https://www.youtube.com/watch?v=kEBkTwjh-Nc
The elasticity of supply measures how responsive the quantity supplied is to a change in price.
Elasticity = (% change in quantity / % change in price)
• If producers can respond to price changes rapidly, supply is relatively elastic.
• However, if producers need considerable time to respond to changes in the market price of their product, supply is relatively inelastic.
• Number of Sellers
• Input Prices
An increase in supply leads to a rightward shift while a decrease in supply leads to a leftward shift of the supply curve.