Chapter 4: Supply Flashcards
What is Supply?
Quantity of goods/services that firms are willing + able to sell at any given price in a time period
What is the law of supply?
There is a positive relationship between price and quantity supplied. More firms are able and wiling to supply their products owing to higher profit margins. Law only holds if price changes while all other facts remain unchanged. Opposite happens fi price falls.
Reasons for the positive relationship between price and quantity supplied?
Existing firms in market can earn higher profit margins if they supply more when price increases.
New firms enter the market attracted by the higher prices + profit margins, enabling them to cover cost of production and the potential to earn profits.
Assumptions underlying law of supply (HL)
Two key assumptions of the law of supply are the law of diminishing marginal returns and increasing marginal costs.
What is the law of diminishing marginal returns?
States that by employing additional variable factors of production, the marginal returns for each additional unit of input will eventually decline. This only applies in short term, as FOP is variable in long run.
Usually assumed that capital is fixed in the short run, as real capital does not usually change in a short period of time.
Example of Diminishing marginal returns
Addition of workers creates benefits for firms, prioritising teamwork and division of labour is possible, improving efficiency. There are increasing marginal returns for each worker, however they will eventually diminish, as each worker will contribute less than the one before as work cannot be efficiently divided so well. Additional workers would also get in each others way, diminishing the productivity and effectiveness of each worker. This leads to higher production cost, thus requiring a higher price to create incentives to produce.
What is increasing marginal costs?
Marginal cost refers to cost of producing an additional unit of output. Generally, costs rise with each successive unit produced owing to diminishing marginal returns. Firms are only willing/able to increase production only if they receive a higher price for additional units of output.
If market price falls, cost of producing additional units will be greater than price received by firms, cutting back supply.
Supply curve
Diagrammatically upward sloping line, price y axis, x axis is quantity supplied
Supply curve slopes upward as higher prices are needed to cover higher marginal costs of production when a firm increases its output.
if price increases, creates an incentive for firms to supply more, shown by movement along supply curve. This also applies to labour market.
Relationship between individual producer’s supply and market supply
Market supply curve, Sum of all individual supply of a product at each price level, found by adding up all individual supply of producers at each price level
Non-price determinants of supply
Factors other than price that affect supply of product These shift the supply curve.
- change in costs of FOP
- Prices of related goods (joint and competitive supply)
- indirect taxes and subsidies
- future price expectations
- changes in technology
- number of firms in a industry
Changes in cost of factors of production
changes to cost of production or to cost in FOP, will cause shift of the supply curve, if costs of FOPs increases (e.g rise in wages), supply curve will shift to the left, ceterius paribus.
Cannot produce same quantity as before, fewer firms are willing and able to supply output.
opposite is true if there is a fall in costs of FOP.
Price of related goods - competitive supply
For competitive supply, output of one product prevents output of alternative products, due to competing resources. Producers have limited resources, so cannot supply more of one product without producing less of another. Relative price and profitability of two products determines level of supply for each product.
If price of product A increases, while price of product B stays the same, producers allocate more resources to product A, hence price of PA reduces supply of PB, ceterius paribus.
Price of related goods - joint supply
for joint supply, increase in production of one product automatically increases supply of at least another joint product.
e;g cows, milk, leather or lamb and wool.
Less important product the by-product, mutton being main product of sheep, and by products being wool, milk and cheese.
When supply of main product changes, supply of by products is affected in the same way.
Indirect Taxes and Subsidies
Indirect taxes are government levies or charges on expenditure, and are imposed on products, adding to cost of production. Indirect taxes reduce profitability of firms, so tend to reduce market supply. Inward shift in supply curve is caused at each price level.
Subsidies used to help encourage output by reducing costs of production. Shifting supply curve of a product to the right. Usually given to producers deemed beneficial to society.
Future Price expectations
Price acts as a signal to allocate resources to production of products with greater profitability. Expectations of price changes in foreseeable future can shift curve.
If firms foresee that price will increase, they will seek to increase supply, rightward shift, this will be the opposite if price falls, leftward shift
