Market Supply Theory

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 law of supply states that producers are able and willing to sell more as the price increases. This means that the higher the price, the higher the quantity supplied.

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.

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Law of Supply Explained

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.

What is a Supply Curve?

Economists graphically represent the relationship between price and quantity supplied with a supply curve.

Typically, supply curves are upward-sloping, because as price increases, sellers are more likely to be willing to sell something.

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Expansion of Supply
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Contraction of Supply
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Supply Schedule
A supply schedule is a table that shows the relationship between the price of a good and the quantity supplied. Notice that the supply schedule obeys the Law of Supply.

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Supply Curve
Based on the supply schedule above, the supply curve can be drawn as such.

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Market Supply vs. Individual Supply

The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.

For example, suppose that Starbucks and Dunkin’ Donuts are the only two sellers of coffee in the market.

Qs = Quantity Supplied

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[Optional] Difference between Individual and Market Supply
Watch this 6-minute video to learn more.
Link to the video:
Price Elasticity of Supply

The elasticity of supply measures how responsive the quantity supplied is to a change in price.
To determine the elasticity of supply, we can use the same equation that we use for demand:
Elasticity = (% change in quantity / % change in price)
Elastic vs. Inelastic Supply

Elasticity of supply is a producer’s sensitivity to changes in price on the quantity they are willing to produce. The key factor in supply elasticity is the amount of time it takes to produce the good or service.

• 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.

[Optional] Explaining Price Elasticity of Supply
What Causes Supply to Change?

Supply is influenced by nature, the price of inputs, competition, expected prices, related profits, and the government.

Factors Affecting Supply

Changes in the following factors lead to a shift of the supply curve (while price remains the same):*

• Number of Sellers
• Input Prices
• Technology
• Expectations

An increase in supply leads to a rightward shift while a decrease in supply leads to a leftward shift of the supply curve.

Jim Rohn Sứ mệnh khởi nghiệp