Factors that Govern Supply

Definition Supply is the number of units of a good or service made available for sale at any given market price at any given time.

A Supply Schedule or Table A supply schedule is a table showing the number of units of a good or service supplied – that is, made available for sale – at any given market price at any given time. A supply schedule Price €1 €2 €3 €4 Quantity 1 2 3 4

A Supply Curve A supply curve is a graph showing the number of units of a good or service supplied at any given market price at any given time. €1 1 2 3 4 €4 €3 €2 Price Quantity s Supply curve

The Factors Governing Supply: The price of the product (P1) The price of other goods (Pog) The cost of production (C) The state of technology (Tch) The level of taxation (Tx) Unforeseen circumstances (U)

Factors Governing Supply To summarise we can say that: S = f (P1, Pog, C, Tch, Tx, U)

Price As price increases it becomes more profitable to supply goods, therefore more firms will be attracted into the industry and existing firms may supply more goods. Extension in supply Price Quantity P1 Q1 S P2 Q2

Price As price decreases it becomes less profitable to supply goods, therefore some firms – the marginal firms – will leave the industry and the remaining firms may supply fewer goods. Contraction in supply P1 Q1 Price Quantity S P2 Q2

The Price of Other Goods (Pog) “Pog” Refers to other goods that the producer (supplier) could produce as an alternative to the goods he or she is currently producing. For example: It is possible for a farmer to switch from dairy stock to dry stock. It is easy to switch from the production of one type of mineral drink to the production of a different mineral drink.

The Price of Other Goods – Example Beef This example looks at cattle farmers (beef and milk). Price Quantity P1 Q1 S P2 Assumptions: The price of beef rises, and the price of milk is unchanged. The price increase makes the supply of beef more profitable than the supply of milk. Q2 S2 Milk Result of the price change: The supply of milk will decrease as many farmers will switch to the production of beef. The increase in the price of beef has resulted in a decrease in the supply of milk. Price Quantity S1 P Q1 Q2

Cost of Production As the cost of production increases it becomes less profitable to supply goods. Some marginal firms will cease production causing a decrease in supply. Therefore, an increase in the cost of production causes a decrease in supply. S2 Price Quantity S1 P Q1 Q2

Cost of Production As the cost of production decreases it becomes more profitable to supply goods. This will attract more firms into the industry resulting in a greater supply of the good. The result is, therefore, a decrease in the cost of production. Q1 S1 Price Quantity P S2 Q2

The State of Technology As technology improves more goods can be produced for the same or a lower total cost, making it more profitable to supply more goods. More firms will be attracted into the industry and existing ones may increase their production, causing a greater supply of the good. Therefore, improvements in technology cause an increase in supply. Q1 S1 Price Quantity P S2 Q2

Taxation As the level of taxation increases, supply decreases as the producer (supplier) of the goods now gets less of the market price (that is, less profit). As taxation decreases it becomes more profitable to supply more goods thus supply increases.

Unforeseen Factors These can be positive or negative. Examples: If workers go on strike, then the producer cannot supply any goods. This is a negative affect causing a decrease in supply. Unusually favourable weather conditions may cause the average yield for a particular crop to increase resulting in an increase in supply of that crop. This is a positive affect.

Notes The number of sellers in the market. This is usually listed as a separate item. However, this is influenced by the level of profit available in the industry. We have already referred to this. Government regulations can also influence the supply of a good. The government may ban a product or place a quota on its supply.

Joint Supply This is a situation where the supply of one product automatically creates a supply of another product. For example: The classical example of this in Ireland is the rearing of cattle in order to create a supply of beef, which automatically creates a supply of hides (that is, leather).

Exceptional Supply Curves (1) Fixed supply – that is, the supply cannot react to changes in price, e.g. crops on today’s market: S Price Quantity

Exceptional Supply Curves (2) Supply restricted by limited capacity: Price Quantity €10 S Q1

Exceptional Supply Curves (3) Supply restricted by a minimum market price: S Price Quantity €10 100

Elasticity of Supply

Price Elasticity of Supply (PES) Price elasticity of supply measures the relationship between the change in the market price of a product and the resulting change in supply of that product. Formula: P1 + P2 Q1 + Q2 Q P 

Result of Applied Formula (PES) The application of the formula normally gives a positive number because as price increases supply also increases, or if price decreases supply also decreases, thus in the formula there will be a: Each of these gives a positive number + change in quantity + change in price – change in quantity – change in price or If the answer is > 1 then PES is elastic. If the answer is < 1 then PES is inelastic. If the answer is = 1 then PES is equal to unity.

Factors Governing PES (1) The degree of specialisation of capital and labour used in producing the goods This is an inelastic supply curve A producer that uses highly specialised labour and machinery will find it difficult to increase production in the short run. In these circumstances elasticity of supply will be inelastic and vice versa. P1 Price Quantity Q1 S P2 Q2

Factors Governing PES (2) Is the firm operating at full capacity? If all a firm’s resources are being fully utilised, it can’t react quickly to the price change. Thus PES would be inelastic. However, if a firm has under-used resources then it can respond quickly to any rise in price and increase its production. In this case the PES would be elastic. P1 Price Quantity Q1 S This is an elastic supply curve P2 Q2

Factors Governing PES (3) The degree of mobility of capital and labour used in producing the goods Firms allocate resources to the most profitable use. Thus if factors are mobile then PES will be elastic for goods whose prices have increased and vice versa.

Factors Governing PES (4) The time period available to the producer to change production levels The shorter the time period available to the producer to change production levels the more inelastic the supply will be and vice versa. For example: The production of ore can be increased only if a new mine is discovered. This may take years.

Factors Governing PES (5) The nature of the product Many products are perishable, fixed in supply and take a long time to produce so their production takes place in anticipation of consumption. These products cannot respond to price changes. That is, their supply is inelastic. For example: Crops.