Determinants of Supply

IB Economics

The Law of Supply

• Supply is the quantity of a product that a producer is willing and able to supply onto the market at a given price over a given time period

• The basic law of supply is that as the market price of a commodity rises, so producers expand their supply onto the market as the higher price makes it more profitable to do so

The Supply Curve

Price

Quantity

Supply

P1

Q1

P2

Q2Q3

P3

A Shift in the Supply Curve

• A change in price level causes a movement along the supply curve but a change in any factor other than price causes the whole supply curve to shift.

An outward shift/increase in the Supply

Price

Quantity

S1

P1

Q1 Q2

S2

An inward shift/decrease in the Supply

Price

Quantity

S1

P1

Q1 Q2

S2

S3

Q3

Causes of shifts in market supply

• Changes in production costs – an increase in the costs of production lowers profitability and therefore reduces supply. Costs of Production include:

– Wage costs

– Raw materials and components

– Energy costs

• Government taxes and subsidies

– A tax increases the costs of production, lowers profitability and therefore lowers supply.

– A subsidy is a sum of money given by the government to producers and therefore lowers the costs of production and increases supply as it increases profitability.

Causes of shifts in market supply

• Changes in Technology

– New technology can speed up the production process and reduce the costs of production making it more profitable and therefore will increase the supply.

• Natural factors

– The weather and natural disasters can affect supply. Bad weather can reduce the supply of agricultural products.

Price Elasticity of Supply

Price Elasticity of Supply measures the responsiveness of quantity supplied to a change in price

PES = % Change in Qs % Change in P

Range of Values:Perfectly Inelastic 0Inelastic 0 < x < 1Unitary Elastic 1Elastic 1 < x < ∞Perfectly Elastic ∞

Elasticity of Supply

• Explain and illustrate each of the different values of PES

• Complete the questions on the determinants of PES (Small Cars and Roses)

Price Elasticity of Supply

• Availability of Stocks of Finished Products and Raw Materials - If a firm has stocks of finished products they can be released to the market quickly following an increase in demand. In addition stocks of raw materials allow a firm to produce products more quick. The availability of stocks makes the supply elastic

Price Elasticity of Supply

• Time – some products take a long time to produce and/or grow and therefore in the short-run the supply is inelastic

• Possibility of Switching Resources from one use to another – If a firm produces a number of products and the demand for one product rises then the firm is able to expand it’s output by switching resources from another use.

Price Elasticity of Supply

• Spare Capacity – a firm is said to have spare capacity when it is not using all of it’s available resources fully. So if the machines are not running for example 24 hours a day and the labour is not all working full time then spare capacity exists and it is possible to increase output quickly by using these resources fully.

Questions

• Calculate PES in each of the following cases:

– An increase in price of 30% leads to an increase in quantity supplied of 50%;

– A decrease in price leads to an equal percentage change in quantity supplied;

– An increase in price leads to no change in quantity supplied.

• Explain and illustrate the difference between price elastic and price inelastic supply.

• Explain why the supply of agricultural products is more inelastic than that of cars.

Joint Supply

• Two products are in joint supply when a rise in the output of one product leads to a rise in the supply of the other product

Diagram to show joint supply

Price Price

Quantity bought and sold Quantity bought and sold

D

S Beef

P1

Q1

D

S Beef hide

D1

P2

P3

Qa

S1

Qc

P4

QbQ2

Two products are in joint supply when a rise in the output of one product leads to a rise in the supply of the other product