Supply Theory IB Economics

Supply  At the end of this week you will be able to:  define supply  explain the Law of Supply verbally and using diagrammatic analysis  explain the determinants of supply  distinguish between a shift of the supply curve and a movement along the supply curve  HL - explain and plot a linear supply function  HL - use a linear supply function and graph to analyse changes in supply

Supply  Supply is the amount of goods or services producers plan to offer for sale at each given price level.  When you think of supply think of firms, businesses, producers – the economic agents that are producing the goods or services to sell.  Note in the definition that is says plan – just as we said with demand it is planned not actual supply. Consumers might not actually buy all of that the producers supply.  Imagine your mum had a fantastic recipe for cakes and you thought that you could make some money by selling them at school. How would you decide the amount to sell and what would make you sell more?

Supply  We made some assumptions about consumers before when we were talking about demand. We now make some assumptions again about firm’s supply  Firms’ main objective is to maximise profit – when thinking about how much to produce they will think about their production costs and the price they will receive for each unit – they will want to supply the amount that makes them most profit  Firms will be incentivised to produce more if the selling price increases – potentially more profit will be available  We will learn later that as companies produce more their costs will reduce due to economies of scale but there will come a point where the costs increase the more that is produced. If costs increase and the selling price remains the same then there will be less profit. Firms will need a higher price to make it worthwhile them supplying more  For there to be an increase in supply the market may need more firms (maybe the existing firms are all working at capacity). For new firms to be attracted to the market there will need to be higher prices  This is why we get an upward sloping curve

The Supply Curve Price Quantity Supply P1 Q1 P2 Q2 Q3 P3 Supply to the Sky!  Remember with demand there was an inverse or negative relationship between demand and price and the curve went down?  With supply there is a positive relationship between price and the amount supplied – the higher the price the higher the supply so the curve goes upwards (to the sky!)

P Q S 20 £3 0 P Q S 10 £3 0 P Q S 30 £3 0 Individual firm supplies 20 cakes Individual firm supplies 10 cakes Market supply Individual and Market Supply  Each individual firm will decide how much to supply at a given price  The example below shows two individual firms; one that produces 20 at £3 and another that produces 10 at £3  All the individual supply plans of firms at each price level can be added together to form the market supply curve

P Q S 20 £3 0 P Q S 10 £3 0 P Q S 30 £3 0 Individual firm supplies 20 cakes Individual firm supplies 10 cakes Market supply Individual and Market Supply  The last curve shows the total of both individual firms (assuming there are only 2 in the market) – that is the market supply.  The market supply therefore is the combined total of all the individual supply plans in that market. The total supply of tomato soup, for example, is the sum of all the different producers of tomato soup in the market - Heinz, Campbell's, Cross and Blackwell as well as all the other own brand labels.

Movements along the supply curve  Just as we saw in the demand curve movements along the curve are only caused by changes in price  Because there is a positive relationship the price and quantity move the same way so  If the price falls there will a fall in quantity supplied – there will be a contraction in supply  Firms will supply less because there is less potential to make profit Price Quantity Supply P1 Q1 P2 Q2 Q3 P3 extension contraction  If the price increases there will be an increase in quantity supplied – there will be an extension of supply  Firms will supply more because there is more potential to make profit

Movements along the supply curve.  See if you can write a description of an extension Price Quantity Supply P1 Q1 P2 Q2 Q3 P3 extension contraction Describing what is happening in the diagram Extension – the price has increased from P1 to P2. This has incentivised existing firms to supply more because they will make more profit or may have encouraged new entrants. The quantity supplied has increased from Q1 to Q2

Movements along the supply curve.  Now write a description of a contraction Price Quantity Supply P1 Q1 P2 Q2 Q3 P3 extension contraction Describing what is happening in the diagram Contraction – the price has fallen from P1 to P3. This has made existing firms supply less because there is less profit to be made. Some firms may have left the market. The quantity supplied has decreased from Q1 to Q3

Factors causing shifts in supply (the conditions of supply)  So what causes the supply curve to shift?  What makes a firm want to supply more (or less) at the same price?  Well, its many things but just like shifts in the demand curve it is NEVER THE PRICE!!  Think about the main assumption we make about a firm – it is a profit maximiser.  So…what do you think would make it want to supply more or less if it is still getting the same price?

Factors causing shifts in supply (the conditions of supply)  There are so many but what you need to remember is that the majority of them affect the production costs of a firm  Changes to raw material prices  Technology improvements  Labour productivity  Regulation and bureaucracy  Wage rates  Government subsidies  Indirect taxes  Expectations about future prices  Objectives of sellers in the market  Other things could be a bumper harvest, new discoveries of oil or precious metals etc

An outward shift in the Supply Curve Price Quantity S1 P1 Q1 Q2 S2 0 An outward shift or a shift to the right means that there is an increase in supply at every given price level Sometimes when we draw this diagram it visually looks like the supply curve is lower but don’t be fooled into thinking the supply is less. Always look at the affect on the quantity and remember if the curve moves to the Right the supply is moRe Again, be careful with your wording – there is an increase in supply (not quantity supplied because that is a movement along the curve

An outward shift in the Supply Curve Price Quantity S1 P1 Q1 Q2 S2 0 Describing what is happening in the diagram Lets say that this increase in supply has been caused by improvements in technology. An improvement in technology has meant that firms can produce more efficiently and at less cost. This means that they can produce more at every given price level and will do so because they will make more profit. Originally at P1 the market produced Q1. Since the technology improvement the market is producing Q2 at the same price of P1

An inward shift in the Supply Curve An inward shift or a shift to the left means that there is less supply at every given price level The curve moves to the Left so the supply is Less Price Quantity S1 P1 Q1 S2 Q2

An inward shift in the Supply Curve Describing what is happening in the diagram Lets say that this fall in supply has been caused by an increase in the costs of raw materials. An increase in the costs of raw materials has meant that the production costs of firms has increased and less profit will be made if the price remains the same. Because the firms are profit maximisers they will produce less at every given price level. Originally at P1 the market produced Q1. Since the increase in raw material costs the market is producing Q2 at the same price of P1 Price Quantity S1 P1 Q1 S2 Q2

The supply of milk

The milk supply chain

Factors affecting the market supply of milk What things do you think affect the market supply of milk The price of raw milk from farmers Productivity in milk industry The number of suppliers in the industry Costs of packaging and transportation Government subsidies to milk producers

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  If there is a rise in the supply of beef there will also be a rise in the supply of hide

Can ewe think of examples of joint supply?

Now to consolidate learning  Read from page 27 to 30  Make notes  Practice drawing diagrams by completing the student workpoint 2.3 P30  Then do some research and find an article online that talks about the price of something going up or down due to supply  Be prepared to tell the class about this and draw a diagram on the board to explain

The HL Bit!

Linear Supply Functions  We can show the relationship between the supply for a product and individual determinants of supply by using an equation  This is the supply function  A simple demand function relating the quantity demanded of a product to the price of the product is usually shown in this form  Q S = c + dP  Q s is the quantity supplied  P is the price  c is the quantity that would be supplied if the price was zero  d is the slope of the curve  Read through page 31/32  Complete the student workpoint 2.4 on page 32

Data Response Exercise  Read Smoke Shifters (P34)  Read the assessment advice  Answer the questions

Homework (for everyone!) Complete Q3&4 P33 Make sure you read the Assessment Advice (continued on P34) because it gives you important advice on how to structure your questions