2.4 Supply

2.4.1. definition of supply

2.4.2. price, supply and quantity

2.4.3. individual and market supply

2.4.4. conditions of supply

By the end of this chapter, students should be able to:

★ defi ne supply

★ draw and interpret appropriate supply diagrams

★ explain movements (contractions and extensions) along a supply curve

★ explain the link between individual and market supply

★ explain the causes of shifts in a supply curve.

Supply

Supply is the ability and willingness of fi rms to provide goods and services at given price levels. Firms will have more incentives to supply their products at higher prices — the higher the price, the greater supply tends to be. There are two reasons for this positive relationship between price and supply:

» Existing firms can earn higher profi ts if they supply more.

» New firms are able to join the market if the higher price allows them to cover their production costs.

Determinants of supply

Although price is regarded as the key determinant of the level of supply of a good or service, it is not the only factor that affects the quantity supplied. Non-price factors that affect the level of supply of a product can be remembered by the acronym TWO TIPS:

» Time — the shorter the time period in question, the less time suppliers have to increase their output, so the lower the supply tends to be. For example, it is not possible for a farmer to increase the supply of agricultural products in a short time period, even if they are offered a higher price. Over time, output can be increased.

» Weather — the supply of certain goods and services can depend on the weather: for example, favourable weather conditions will shift the supply of

agricultural output to the right. Some service providers, such as airline carriers, may also limit or close their operations during adverse weather conditions, thereby shifting the supply curve to the left.

» Opportunity cost — price acts as a signal to producers to allocate their resources to the provision of goods and services with a greater level of profi ts. For example, if the market price of corn falls while the price of apples increases, then farmers are likely to reduce their supply of corn (due to the higher opportunity cost) and raise their supply of apples.

» Taxes — taxes imposed on the supplier of a product add to the costs of production. Therefore, the imposition of taxes on a product reduces its supply, shifting the supply curve to the left.

» Innovations — technological advances such as automation and wireless internet technologies mean that there can be greater levels of output at every price level. Hence, innovations will tend to shift the supply curve to the right.

» Production costs — if the cost of raw materials and other factors of production falls, then the supply curve will shift to the right, ceteris paribus. Hence, there is an increase in supply at each price level. A rise in production costs will reduce supply at each price.

» Subsidies — subsidies are a type of fi nancial assistance from the government to help encourage output by reducing the costs of production for fi rms. Subsidies are usually given to reduce the costs of supplying goods and services that are benefi cial to society as a whole, such as education, training and healthcare.