Theory of Supply
Supply refers to the quantity of a commodity or service that the producers are willing and
able to offer in the market at various possible prices during a period of time.
Individual Supply refers to the supply of a good or service by one firm at different prices
other things remaining constant or equal.
Market supply is the sum of the amount of goods supplied for sales by all firms or producers
in the market at different prices during a given time.
Determinants of supply or
The factors affecting supply.
1. Cost of factors of production - The cost of factors of production such as land , labor ,
capital and the organizer etc is one of the determinant factors which influence the market
supply of a product. For instance if the price of Labour goes up then the supply of the
product will decline due to scarce resources.
2. Advanced Technology - A better technology which reduces cost of production will
increase the supply. The advancement of technology helps the firm to reduce cost of
production and increase the profit of the firm.
3. Expected change in price - In case producers expect an increase in price they will retain or
withdraw goods from the market. Consequently supply will reduce. If price is expected to
fall in future the supply will eventually increase.
4. Natural Factors - Production and supply of agricultural goods depends upon various
factors such as rain , fertility , climatic conditions etc. Production may be adversely
affected by drought ,flood etc.
5. Means of transport and communication - Scarcity of goods will be experienced in the
market if the means of transport and communication are not properly developed.
6. Taxation policy -Taxation policy do influence the supply of goods. The production of the
commodity will be discouraged if heavy duty ( excise duty) is imposed on its production.
In the same way tax concessions and subsidies will encourage producers to increase
supply.
7. Agreement among producers – Sometimes all the firms producing the same commodity
form an association or a syndicate or a pool and regulate supply of goods in such a way
that they earn more profit.
Law of Supply
Law of supply states that other things remaining same the quantity supplied of a
commodity is directly related to the price of the comnodity. The quantity offered for
sale varies directly with price. Higher the price larger the supply. Other things include
cost of production , change of technology , price of related goods , price of inputs ,govt.
policy.
Exceptions to the Law of Supply.
1. Monopoly – If the supply side of the market is controlled by small number of sellers
then the law of supply may not operate. Eg. In case of Monopoly larger quantity may
not be supplied even though the price is higher.
2. Competition - In a market facing more competition , seller may offer large quantities
at lower price negating the law of supply.
3. Perishable Goods – In case of a perishable good the supplier would offer to sell more
quantities at lower price to avoid running into losses due to damage of the product.
4. Agricultural product -Since the production of agricultural product cannot be
increased beyond a limit the supply also cannot be increased beyond this limit even
if the price is higher , the producer is unable to offer larger quantities.
5. Artistic or auction goods - The supply of such goods cannot be increased or decreased
easily. Thus , it is difficult to offer large quantities even if the price shoots up.
6. Legislation negating quantity - Suppliers cannot offer to sell more quantities at a
higher price where the govt. has put regulations on the quantity of goods to be
offered.
Ways of expressing Supply
1. Supply Function – It is the relation between quantities of the comnodity supplied and
its determinants.
2. Supply schedule is a table which shows the quantity of a commodity supplied at a
given period of time at various possible prices.
3. Supply curve is the graphical representation of the supply curve.
Supply Curve
Why does the supply curve slope downwards.
1. The Law of Diminishing Marginal Returns – The theory predicts that when employing
these extra variable factors such as labour the marginal returns ( additional output)
from each extra unit of input will eventually diminish leading to a rise in cost of
production. Thus more quantity is supplied at a higher price.
2. Goal of the firm – The aim of the producer is to maximise profit. The aim can be
achieved by receiving price of the goods. At higher price producers increase supply of
goods.
Expansion and Contraction of supply.
Change in supply due to change in price alone is called Expansion and Contraction of
supply.
Rise in supply due to rise in prise is called Expansion and fall in supply due to fall in
price is called contraction of supply.
Increase and decrease in supply
Change in supply due to change in factors other than price is called increase and
decrease in supply. The supply curve shifts rightward or downwards.
Increase in supply is caused by
1. Improvement in technology.
2. Fall in price of other commodities.
3. Fall in price of factors of production.
4. Change of the goal of the firm.
Fall in supply due to factors other than price is called decrease in supply. The
supply curve shifts upword or leftward.
Decrease in supply is caused due to
1. Deterioration of Technology used in the production of the commodity.
2. Rise in price of other commodities.
3. Rise in factors of production.
4. Change in the goal of the firm.
Elasticity of supply is defined as percentage change in the quantity supplied of a product
divided by the percentage change in price. It may vary between zero and infinity.
Elasticity of supply has a positive slope.
Ep = Percentage change in quantity demanded( divided)/ by percentage change in price.
Elasticity of Supply
Elasticity of supply is defined as percentage change in the quantity supplied of a product
divided by percentage change in price. It may vary between zero and infinity. Elasticity of
supply has a positive slope.
Ep= Percentage change in quantity supplied / Percentage change in price.
Degrees of Elasticity of Supply
1. Perfectly Elastic Supply
( Ep = Infinity)
Supply of a commodity is perfectly Elastic if a slight change in price causes an infinite change
in quantity supplied. Supply curve has a straight line parellel to x – axis.
2. Perfectly Inelastic Supply (ep=0)
Supply of a commodity is said to be perfectly inelastic if quantity of a commodity does not
change at all in response to change in price. The supply curve is a straight line parellel to x-
axis.
3. Unit Elastic Supply – (ep= 1) Supply of a commodity is said to be unit Elastic if a
proportionate change in price causes an equal and proportionate change in quantity
supplied. The supply curve is straight line passing through the origin.
4. More Elastic Supply or Relatively Elastic Supply (ep is greater than one)
Supply is said to be more Elastic if a given change in price leads to a more than proportionate
change in quantity supplied.
5. Relatively Inelastic Supply or Less Elastic Supply.(ep is less than one)
Supply of a commodity is less elastic when a given change in price leads to a less than
proportionate change in quantity supplied.
Equilibrium Price
The two factors which determine the price of any commodity in the market are
demand and supply. The equilibrium price of a commodity is the price at which
demand equals supply i… e at a given price same quantity is demanded and supplied.
This quantity is called Equilibrium quantity
In the diagram equilibrium price of a commodity is the price at which demand
intersects the supply line.
Consumers Surplus
The difference between the price that the consumers are willing to pay and the price they
actually pay. Eg. Suppose one was ready to pay Rs/- 1500 for a shirt but actual price is Rs
1200. The Rs 300/- is consumer surlus.
Producer Surplus
The difference between the price at which the producers are willing to sell a good and the
price they actually receive. Eg. The producer is willing to sell the product at Rs 50 but he
received Rs 70. The difference is 20 and that is producer surplus.
Taxation and Deadweight loss- A tax causes a Deadweight loss to the society.
Tax is a revenue for the govt. Tax on buyers will shift the demand curve leftward. Price paid
by the buyer increases and price received by the seller decreases. The buyer stops consuming
and seller stops selling on account of tax burden. Govt. also does not get [Link] is
called Deadweight Loss.
e.