CHAPTER THREE
3. SUPPLY
3.0. Introduction
Supply is one of the fundamental concepts of microeconomics. While demand explains
consumer behavior, supply explains producer behavior. Producers aim to maximize profit,
and their willingness to offer goods and services in the market depends largely on price and
production conditions. The interaction between supply and demand determines the price and
quantity exchanged in a market. Understanding supply helps businesses make production
decisions, governments design economic policies, and economists analyze market outcomes.
3.1. Meaning of Supply
Supply refers to the quantity of a good or service that producers are willing and able to offer
for sale at different price levels during a given period of time. Supply is not just the ability to
produce it must also include the willingness to sell at a particular price. There is generally a
direct (positive) relationship between price and quantity supplied:
When price increases → quantity supplied increases
When price decreases → quantity supplied decreases
Other factors remain constant (ceteris paribus)
3.2. Types of Supply
Individual Supply: Individual supply refers to the quantity of a good that a single
producer is willing and able to sell at different prices during a specific period of time. It
shows the direct relationship between price and quantity supplied, assuming other factors
remain constant. Generally, as the price increases, the producer is motivated to supply
more due to higher potential profit. For example, a farmer may supply 50 bags of maize
at $10 per bag but increase supply to 80 bags when the price rises to $15 per bag.
Market Supply: Market supply is the total quantity of a good that all producers in the
market are willing and able to sell at various price levels during a given period. It is
calculated by horizontally summing the individual supply curves of all producers. This
means adding together the quantities supplied by each producer at the same price. For
example, if Producer A supplies 100 units at $5 and Producer B supplies 200 units at $5,
the total market supply at that price is 300 units.
Short-Run Supply: Short-run supply refers to the quantity of goods that firms can
supply during a period in which at least one factor of production is fixed, such as
machinery, factory size, or land. In the short run, firms cannot change their production
capacity significantly, so they increase output mainly by intensifying the use of variable
factors like labor and raw materials. As a result, supply adjustments in the short run are
limited compared to the long run.
Long-Run Supply: Long-run supply refers to the quantity of goods that firms can
supply when all factors of production are variable. In the long run, firms can expand or
reduce their production capacity, adopt new technology, hire more workers, build new
factories, or even enter and exit the industry. Because there are no fixed factors in the
long run, firms have greater flexibility to adjust their output in response to changes in
price and market conditions.
Joint Supply: Joint supply occurs when the production of one good automatically results
in the production of another good at the same time. These goods are produced together
from a single production process, and it is difficult to produce one without the other. For
example, beef and leather are jointly supplied from cattle; when cattle are slaughtered for
beef, leather is also produced as a by-product.
Composite Supply: Composite supply occurs when a single good can be supplied for
multiple different uses. In this case, the total supply of the good must be allocated among
its various uses, depending on demand and profitability. For example, electricity can be
used for lighting, heating, and industrial production. The allocation of electricity among
these uses depends on market demand and pricing conditions.
3.3. Law of Supply
The law of supply states that, ceteris paribus (all other factors remaining constant), the quantity
of a good supplied increases when its price increases and decreases when its price decreases. In
other words, there is a direct or positive relationship between price and quantity supplied. This
happens because higher prices provide greater profit incentives to producers, encouraging them
to increase production and offer more goods for sale. Conversely, when prices fall, profit
margins decline, and producers may reduce the quantity supplied. Therefore, the supply curve
generally slopes upward from left to right, reflecting this positive relationship between price and
quantity supplied. Mathematical Expression
Qs=f ( P)
ΔQs
>0
ΔP
Where :Qs=Quantity supplied P=Price
3.4. Reasons for the Law of Supply
Profit Motive: One of the main reasons for the law of supply is the profit motive.
Producers aim to maximize profits, and when prices increase, the potential revenue and
profit also increase. This encourages firms to supply more goods to the market. Higher
prices make production more attractive, while lower prices reduce profitability and
discourage supply.
Entry of Firms: When market prices rise significantly, the industry becomes more
profitable. This attracts new firms to enter the market, increasing the overall supply of the
good. Conversely, if prices fall and profits decline, some firms may exit the market,
reducing supply.
Increased Production: Higher prices motivate existing firms to expand their output.
They may increase working hours, hire additional labor, or use more raw materials to
produce more goods. In the short run, firms intensify the use of available resources, and
in the long run, they may expand capacity to take advantage of higher prices.
3.5. Supply curve
A supply curve is a graphical representation of the relationship between the price of a good and
the quantity supplied by producers. It shows how the quantity supplied changes as the price
changes, assuming other factors remain constant. The supply curve generally slopes upward from
left to right, indicating a positive relationship between price and quantity supplied. This upward
slope reflects the law of supply, which states that higher prices motivate producers to supply
more, while lower prices lead them to supply less. An individual firm’s supply curve shows the
quantity of a good that a single producer is willing and able to sell at different prices. For
example, consider a hypothetical gasoline supplier with the following supply schedule Supply
Schedule for Gasoline:
Price per Gallon ($) Quantity Supplied (Gallons per Month)
5.00 3,500
4.50 3,000
4.00 2,500
3.50 2,000
3.00 1,500
2.50 1,000
3.5.1. Movement along the Supply Curve
Movement along the supply curve occurs when the quantity supplied changes as a result of a
change in the good’s own price, while other factors affecting supply remain constant. This is
different from a shift of the supply curve, which happens due to changes in non-price factors.
Extension of Supply An extension of supply happens when the price of a good rises,
causing producers to supply a larger quantity. Example if the price increases from $5 to
$7, the quantity supplied rises from 50 to 70 units. This movement upward along the
supply curve demonstrates that higher prices incentivize producers to supply more.
Contraction of Supply: A contraction of supply occurs when the price of a good falls,
leading producers to supply a smaller quantity. Example if the price decreases from $7 to
$5, the quantity supplied falls from 70 to 50 units. This movement downward along the
supply curve reflects that lower prices discourage production. The upward-sloping supply
curve visually captures these extensions and contractions as movements along the curve.
3.5.2. Shifts in the Supply Curve (Upward and Downward Shifts)
A shift in the supply curve occurs when factors other than the price of the good or service
change. These changes cause the entire supply curve to move either to the right or to the left.
Rightward Shift (Upward/Increase in Supply): This means producers are willing and
able to supply more goods at every price level.
Leftward Shift (Downward/Decrease in Supply): This means producers are willing and
able to supply less goods at every price level. The direction of the shift depends on the
following determinants:
Cost of Production: The cost of production directly affects supply. If production costs
increase, the overall supply decreases because it becomes more expensive for producers
to produce the good. Conversely, if production costs decrease, supply increases. Factors
that influence production costs include wages paid to workers, the cost of raw materials,
and transportation expenses.
Technology: Advances in technology can reduce production costs and increase
productivity. Improved technology allows producers to make goods more efficiently,
which leads to an increase in supply.
Government Policy: Government interventions such as taxes and subsidies can affect
supply. Taxes increase production costs, causing the supply curve to shift left. On the
other hand, subsidies lower production costs, encouraging producers to supply more,
which shifts the supply curve to the right.
Prices of Related Goods in Production: The supply of a good can be influenced by the
prices of other goods that can be produced using the same resources. For example, if the
price of wheat rises, farmers may allocate more resources to grow wheat instead of corn.
This reduces the supply of corn while increasing the supply of wheat.
Expectations: Producers’ expectations about future prices can influence current supply.
If producers anticipate that prices will rise in the future, they may hold back some of their
current production to sell later at higher prices. This reduces current supply in the market.
Number of Sellers: The total number of sellers in a market affects overall supply. When
more firms enter the market, supply increases. Conversely, if firms exit the market, the
supply of the good decreases.
Natural Factors: Natural conditions, particularly in agriculture, have a strong impact on
supply. Favorable weather, such as adequate rainfall, can increase supply, while adverse
conditions, like droughts or floods, can significantly reduce supply.
3.6. Exceptions to the Law of Supply
although the law of supply states that quantity supplied increases when price increases,
there are certain situations where this relationship does not hold true. These situations are
known as exceptions to the law of supply.
Backward-Bending Labour Supply: In the labor market, at very high wage rates,
workers may choose to work fewer hours instead of more. As wages rise significantly,
workers may prefer to enjoy more leisure time rather than increase their working hours.
This creates a backward-bending labor supply curve, where higher wages lead to a
reduction in the quantity of labor supplied.
Agricultural Products (Short Run): In the short run, agricultural producers cannot
easily increase output in response to a price increase. Once crops are planted, farmers
must wait until harvest time. Therefore, even if prices rise, the supply cannot immediately
increase, making supply relatively inelastic in the short run.
Perishable Goods: For perishable goods such as fruits, vegetables, or milk, producers
may sell more even when prices fall. Since these goods cannot be stored for long periods,
sellers prefer to dispose of them quickly to avoid spoilage. In such cases, supply may
increase even at lower prices.
3.7. Elasticity of Supply (Es)
3.7.1. Meaning
Elasticity of supply measures the responsiveness of quantity supplied to changes in price.
3.7.2. Formula
%Change ∈Quantity Supplied
Simple method Es=
% Change ∈Price
Q 2−Q 1
Q 1+Q 2
( )
2
(Midpoint Method) Es=
P 2−P 1
P 1+ P 2
( )
2
1) Perfectly Inelastic Supply (Es = 0)
Perfectly inelastic supply occurs when the quantity supplied of a good remains completely
unchanged, regardless of changes in its price. In this extreme case, the numerical value of
elasticity of supply (Es) is exactly zero. Graphically, this relationship is represented by
a vertical supply curve, indicating that the same quantity is supplied at every price level.
Example:
To illustrate this concept, consider the market for seats in a stadium on the night of a
championship final. Initially, the average ticket price is $10, and the stadium supplies 100 seats.
Due to high demand, the price doubles to $20.
Solution
According to the example
Original Price (P1): $10
New Price (P2): $20
Original Quantity (Q1): 100 units
New Quantity (Q2): 100 units
Q2−Q1
Q1+Q 2
2
Midpoint Method Es=
P 2−P1
P1+ P 2
2
100−100 0
= =0
100+100 100
( )
2
20−10 10
=
20+10 15 = 0.66667
( )
2
0
=0
0.6667
2) Relatively Inelastic Supply (Es < 1)
Relatively inelastic supply occurs when the percentage change in quantity supplied is less
than the percentage change in price. This indicates that producers are unable or unwilling to
significantly increase or decrease production in response to price fluctuations, often due to
capacity constraints, high fixed costs, or time limitations. In this case, the numerical value of
elasticity of supply (Es) is greater than zero but less than one ($0 < Es < 1$). Graphically, this is
represented by a steep upward-sloping supply curve, showing that changes in price result in
relatively smaller changes in quantity supplied.
Example (Using the Midpoint Method):
To illustrate this concept, consider the market for luxury waterfront apartments in a busy city. In
the short run, builders cannot construct new high-rise buildings instantly due to permitting,
construction time, and limited waterfront land.
Suppose the average rent (price) for these apartments’ increases from $2,000 to $2,500 per
month. In response, developers manage to convert a few existing buildings and increase the
available units slightly from 1,000 to 1,100 apartments.
Solution
Original Price (P1): $2,000
New Price (P2): $2,500
Original Quantity (Q1): 1,000 units
New Quantity (Q2): 1,100 units
We apply the Midpoint Method (Arc Elasticity) to ensure accuracy regardless
of direction:
The Percentage Change in Quantity (using Midpoint)
1,100−1,000 100
= =0.952
1,000+1,1000 1,050
( )
2
The Percentage Change in Price (using Midpoint)
2 ,50 0−2,000 500
= =22.22
2,000+2,500 2,250
( )
2
0.0 952
=0.43
0.2222
3) Unit Elastic Supply (Es = 1)
Unit elastic supply occurs when the percentage change in quantity supplied is exactly equal
to the percentage change in price. This means that suppliers are adjusting their output in
direct proportion to the price movement. In this case, the numerical value of elasticity of
supply (Es) is precisely one (1). Graphically, this relationship is represented by any straight-
line supply curve that passes through the origin (0, 0 point). Whether the curve is steep or
flat, as long as it starts from the origin, the ratio of percentage change in quantity to
percentage change in price will remain constant at 1.
Example (Using the Midpoint Method):
To illustrate this concept, consider a hypothetical handicraft workshop where artisans can
easily scale their production up or down based on market prices. Suppose the price of a
handcrafted wooden chair increases from $10 to $20. In response, the workshop hires
additional part-time artisans and increases production from 100 chairs to 200 chairs.
SOLUTION
Original Price (P1): $10
New Price (P2): $20
Original Quantity (Q1): 100 units
New Quantity (Q2): 200 units
We apply the Midpoint Method (Arc Elasticity) to ensure accuracy regardless
of direction:
The Percentage Change in Quantity (using Midpoint)
2 00−100 100
=
100+200 150 =0.6667
( )
2
The Percentage Change in Price (using Midpoint)
20+10 10
= =0.6667
10+20 15
( )
2
0.6667
=1
0.6667
4) Relatively Elastic Supply (Es > 1)
relatively elastic supply occurs when the percentage change in quantity supplied is greater
than the percentage change in price. This indicates that producers are highly responsive to
price fluctuations, meaning they can easily increase or decrease production without
significant delays or cost increases. In this case, the numerical value of elasticity of supply
(Es) is greater than one ($Es > 1$). Graphically, this is represented by a flat (gradually
sloping) upward-sloping supply curve, showing that even a small change in price leads to a
relatively large change in quantity supplied.
Example (Using the Midpoint Method):
To illustrate this concept, consider the market for smartphone accessories like phone cases
or screen protectors. These goods are mass-produced using automated machinery, and
manufacturers can easily ramp up production by running extra shifts or sourcing more raw
materials. Suppose the price of a popular phone case increases from $10 to $15. In response,
manufacturers quickly increase production from 100,000 units to 160,000 units.
Solution
Original Price (P1): $10
New Price (P2): $15
Original Quantity (Q1): 100,000 units
New Quantity (Q2): 160,000 units
We apply the Midpoint Method (Arc Elasticity) to ensure accuracy regardless of
direction:
The Percentage Change in Quantity (using Midpoint)
160,000−100,000 60,000
= =0.4615
( 100,000+160,000
2 )130,000
The Percentage Change in Price (using Midpoint)
15−10 5
= =0.40
10+15 12.5
( )
2
0.4615
=1.15
0.40
5) Perfectly Elastic Supply (Es = ∞)
Perfectly elastic supply occurs when producers are willing to supply any quantity at a specific
price but will supply zero at a price even slightly lower. This represents the most extreme
responsiveness imaginable: the slightest decrease in price causes supply to disappear entirely,
while the slightest increase in price (though theoretically possible) is irrelevant because firms
already supply unlimited amounts at the existing price. In this case, the numerical value of
elasticity of supply (Es) is infinity (∞). Graphically, this is represented by a horizontal straight
line parallel to the quantity axis, indicating that the same price rules for all quantities supplied.
Example (Using the Midpoint Method):
To illustrate this concept, consider a wheat farmer selling their crop in a massive global
commodities market. The market price is set by worldwide supply and demand forces, and the
individual farmer is a "price taker" they cannot influence the price. Suppose the global market
price for wheat is fixed at $5 per bushel. At this price, our farmer is willing to supply any amount
they can grow. Now, imagine the price increases slightly from $5.00 to $5.01. At $5.00, the
farmer supplies 10,000 bushels (their maximum capacity). At $5.01, the farmer still supplies
10,000 bushels (they cannot grow more than their maximum). This doesn't look perfectly elastic
yet! To see true perfect elasticity, we must look at what happens if the price drops below the
market rate. Now price drop from $5.00 to $4.99
Solution
Original Price (P1): $5.00
New Price (P2): $4.99
Original Quantity (Q1): 10,000 bushels
New Quantity (Q2): 0 bushels (the farmer will not sell at a loss or below market
rate)
We apply the Midpoint Method (Arc Elasticity):
The Percentage Change in Quantity (using Midpoint)
0−10,000 10,000
= =2
10,000+0 5,000
( )
2
The Percentage Change in Price (using Midpoint)
4.99−5.00
5+4.99
( )=0.002 ¿
2
¿
2
=1,000
0.002
Technically, the formula gives a very high number (like 1000), but theoretically, this value
approaches infinity (∞). The key insight is that an infinitesimally small change in price (0.2%)
caused an enormous change in quantity supplied (200%). The supplier is infinitely responsive to
any deviation from the market price. This confirms Perfectly Elastic Supply: at the prevailing
market price, they supply everything; below it, they supply nothing.
3.8. Factors Affecting Elasticity of Supply
Time Period: The time period influences supply elasticity because supply is generally more
elastic in the long run. Producers have more time to adjust production, invest in new
resources, or enter the market in response to price changes.
Spare Capacity: Spare capacity refers to the unused production potential of a firm. Firms
with spare capacity can increase output quickly when prices rise, making supply more elastic,
while fully utilized capacity limits responsiveness.
Stock Availability: Stock availability affects supply elasticity as firms with large inventories
can meet sudden increases in demand, whereas limited stock makes supply less flexible.
Ease of Switching Production: The ease with which resources can be redirected to produce
different goods also impacts elasticity. If switching production is easy, supply becomes more
elastic, but if it is difficult or costly, supply remains inelastic.
Mobility of Factors: The mobility of factors such as labor and capital determines how
quickly inputs can move between production uses. Highly mobile factors increase supply
elasticity, while limited mobility restricts it
3.9. MARKET EQUILIBRIUM AND DISEQUILIBRIUM
Market equilibrium and disequilibrium are central concepts in microeconomics. They describe
how prices and quantities of goods and services are determined in a market. Markets are
dynamic, and the interaction between supply and demand forces leads to changes in price and
output until an equilibrium is reached. Disequilibrium occurs when market forces are not
balanced, leading to shortages or surpluses.
3.9.1. Market Equilibrium
[Link]. Meaning of Market Equilibrium
Market equilibrium occurs when the quantity demanded (Qd) of a good or service equals the
quantity supplied (Qs) at a certain price, resulting in no surplus (excess supply) or shortage (excess
demand). At this point, the market “clears,” meaning all buyers and sellers are satisfied, with the
equilibrium price (PE) being the price at which demand equals supply, and the equilibrium quantity
(QE) being the quantity bought and sold at that price.
[Link]. Conditions for Equilibrium
Quantity Demanded equals Quantity Supplied (Qd = Qs)
The market experiences no surplus (excess supply)
The market experiences no shortage (excess demand)
There is no upward or downward pressure on price
If the price is set above equilibrium, a surplus emerges, leading to a downward
adjustment in price
If the price is set below equilibrium, a shortage occurs, resulting in an upward adjustment
in price
Market forces naturally restore the price to its equilibrium level
[Link]. Determination of Equilibrium
Market equilibrium is determined at the point where the demand curve and the supply
curve intersect. This intersection represents the price at which quantity demanded equals
quantity supplied (Qd = Qs). At this point, there is neither excess demand nor excess
supply, and the market clears. The corresponding price is known as the equilibrium
price (Pe), while the corresponding quantity is referred to as the equilibrium quantity
(Qe).
Equation Form:
If the demand function is:Qd=a−bP
the supply function is :Qs=c+ dP
Then equilibrium occurs when:Qd=Qs
a−bP=c+ dP
a−c
Pe= (Equilibrium Price)
b+ d
Qe=c+ dPe(Equilibrium Quantity )
Example
Demand Function:Qd=100−2 PQ d=100−2 PQd=100−2 P
Supply Function :Qs=20+ 3 PQ s=20+3 P Qs=20+3 P
Set Qd=QsQ d=Q s Qd=Qs :100−2 P=20+ 3 P
100−20=3 P+2 P
80=5 P
Pe=16
Equilibrium quantity :Qe=100−2(16)=68
Equilibrium Price=16 , Equilibrium Quantity=68 units
Equilibrium Table
Price (P) Quantity Demanded (Qd) Quantity Supplied (Qs)
10 80 50
14 72 62
16 68 68
18 64 74
20 60 80
[Link]. Graphical Representation
The demand curve slopes
downward from left to right,
indicating an inverse
relationship between price and
quantity demanded.
The supply curve slopes
upward from left to right,
reflecting a direct relationship
between price and quantity
supplied.
Equilibrium occurs at the
point where the demand and
supply curves intersect (Qd =
Qs).
Shortage: When Price < Pe,
quantity demanded exceeds
quantity supplied (Qd > Qs),
creating upward pressure on
price.
Surplus: When Price > Pe,
quantity supplied exceeds
quantity demanded (Qs > Qd),
creating downward pressure on price.
3.9.2. Market Disequilibrium
[Link]. Meaning market disequilibrium
Market disequilibrium occurs when the quantity demanded of a good or service does not
equal the quantity supplied at a given price, resulting in an imbalance in the market. This
situation creates pressure on prices to adjust until equilibrium is restored, ensuring efficient
allocation of resources and satisfaction for both buyers and sellers.
[Link]. Types of disequilibrium
Shortage (Excess Demand): A shortage arises when quantity demanded exceeds
quantity supplied (Qd > Qs). Consumers compete for the limited supply, which pushes
prices upward. As prices rise, demand gradually decreases while producers are
incentivized to increase supply.
o Price Adjustment: Prices tend to rise until equilibrium is restored.
o Market Response: The market naturally moves toward equilibrium as the excess
demand is eliminated and supply adjusts.
Surplus (Excess Supply): A surplus occurs when quantity supplied exceeds quantity
demanded (Qs > Qd). Excess goods create downward pressure on prices, prompting
consumers to purchase more while producers reduce output.
o Price Adjustment: Prices tend to fall until equilibrium is restored.
o Market Response: The market naturally moves toward equilibrium as the excess
supply is absorbed and demand adjusts.
[Link]. Causes of Disequilibrium
Market disequilibrium occurs when forces in the market prevent quantity demanded from
equaling quantity supplied. Several factors can cause such imbalances:
Price Controls: Government interventions in the form of price ceilings or price floors
can disrupt equilibrium. A price ceiling sets a maximum price below the equilibrium,
leading to a shortage as demand exceeds supply. Conversely, a price floor sets a
minimum price above the equilibrium, causing a surplus as supply exceeds demand.
Sudden Changes in Demand or Supply: Unexpected events such as natural disasters,
technological innovations, or policy changes can shift the demand or supply curves
abruptly, creating temporary shortages or surpluses in the market.
Market Frictions: Imperfect information, rigidities in production, or delays in response
to price changes can prevent the market from adjusting smoothly, resulting in periods of
disequilibrium.
[Link]. Graphical Representation
Shortages and surpluses can be
illustrated on a supply and demand
graph as horizontal gaps between the
supply and demand curves at prices
that differ from the equilibrium
price.
A shortage occurs when the price is
below equilibrium, and the quantity
demanded exceeds the quantity
supplied, represented by the
horizontal distance between the
demand and supply curves.
A surplus occurs when the price is
above equilibrium, and the quantity
supplied exceeds the quantity
demanded, also shown by the
horizontal gap between the curves.
These gaps visually demonstrate the imbalance in the market and the resulting pressure
on prices to move toward equilibrium.
[Link]. Shifts vs. Movements
Movement along the curve: This occurs when the quantity demanded or supplied
changes in response to a change in the good’s own price, while all other factors remain
constant. For example, an increase in price leads to a decrease in quantity demanded
(movement up the demand curve) or an increase in quantity supplied (movement up the
supply curve).
Shift of the curve: This occurs when the entire demand or supply curve shifts due to
non-price factors such as changes in income, consumer preferences, technology, taxes, or
expectations. A rightward shift indicates an increase in demand or supply, while a
leftward shift indicates a decrease, independent of the current price.