Principle of supply

Lesson 11. THE PRINCIPLE OF SUPPLYLearning outcomes

After studying this unit, you should be able to:

Meaning of supply Difference between supply and stockRelationship between supply and priceDefine the concept of elasticity of supply locate the determinants of elasticity of supply

Introduction:Friends after knowing the meaning and purpose of demand

and law of demand, elasticity of demand, know I think you should know what supply is. Producers are going to produce on the basis of demand only. Goods are needed to be supplied to meet the demand for the product.Difference between Stock & Supply:

Like the term 'demand', the term 'supply' is also often misused in the ordinary language. Supply of a commodity is often confused with the 'stock' of that commodity available with the producers. Stock 'of a commodity, more or less, will equal the total quantity produced during a period less the quantity already sold out. But we know that the producers do not offer whole of their stocks for sale in the market, A part of industrial produces is kept back in godowns and is offered for sell in the market when It can fetch better prices, In other words the amount offered for sale may be less (or at the most in rare circumstances equal to) than the stocks of the commodity. The term 'supply' shows a relationship between quantity and price. By supply we mean various quantities of a commodity which producers will offer for sale at a particular time at various corresponding prices. In simple words, supply ( like demand ) refers to the quantity of commodity offered for sale at some price during a given period of time.

FACTORS ON WHICH SUPPLY OF A COMMODITY DEPENDS

It is also known as the determinants of supply. The Important determinants of supply can be grouped together in a supply function as follows: ..

SN=f (PN,PR,F,T,G )Supply function describes the functional relationship between supply of a commodity (say N) and other determinants of supp1y, i.e., price of the

commodity (PN), price of a related commodity (PR), prices of the factors of production (F), technical know-ho" (T) and goals or general objectives of the Producer. Each of the_ factors influences supply in a different' way. To isolate the effect of other factors we take these other factors as constant while considering the relationship between supply and one of the above variables. For example, if we want to study the relationship between price and supply of

commodity, N, we shall assume other factors PR, F, T and G to remain constant

or unchanged. We study below these relationships

(1) Price of the commodity, expressed as SN ft PN), i. e. other things being equal, supply of commodity N depends upon the price of commodity N. This sort of relationship is studied in what has' come to be popularly known as the Law of Supply'. It implies that if the price of a commodity goes up, its supply shall expand and vice versa.

(2) Prices of related goods, expressed as SN = f(P R), 'j e., other things being equal, supply of commodity N depends upon the prices of the related goods. If the price of a substitute goes up, producers would, be tempted to divert their available resources to the production of that substitute.

(3) Prices of factors of production, expressed as SN f(F), i, e, other things being equal, supply of a commodity depends upon the prices of factors of production. A rise in the price of one factor of production, will cause a consequent increase in the cost of producing those com- modities which use a great deal of that factor and only a small increase in the costs of producing those commodities that use a small amount of the factor.

(4) State of technology, expressed as SN=f(T), i,e., the supply of a commodity depends upon the state of technology. Over the the time the technical know-how changes. Goals of firms, expressed as SN 1(6), j e., other things being equal the supply of a commodity depends upon the ,goals of firms producing that commodity. Ordinarily; every firm tries to attain. Maximum profits. Natural factors. The supply of the agricultural' goods to a great extent depends upon the natural conditions. Adequate rain, fertility of land irrigation facilities, favorable climatic conditions etc., help in raising the supply of agricultural produce., Contrary to that, heavy rains, floods, drought conditions, etc., adversely affect the agricultural production.

(5) Means of transportation and communication. Proper development of means of transportation and communication helps in maintaining adequate supply of the commodities. In case of short Supply, goods can be rushed from the, surplus areas to the deficient areas. But if the developed means of transportation are used to export goods, it will create scarcity of goods .In the domestic market.

(6) Taxation Policy. Imposition of heavy taxes on a commodity discourages its production, and as a remit its supply diminishes. On the other, hand, tax concessions of various kinds induce producers !o raise the supply.

(7) Future expectations of rise in prices. If the producers expect, an increase in the price in the near future, then they will curtail the current supply, so as to offer more goods in future at higher prices.

LAW OF SUPPLY

Meaning:It’s different from law of demand. Law of supply explains the

relationship between price of a commodity and its quantity supplied. Price and supply are directly related. A rise in price induces producers to supply more quantity or the commodity and a fall Prices, makes them reduce the supply. The higher is the price of the commodity the larger is the profit that can be earned, and, thus the greater is the incentive to the producer' to produce more of the commodity and offer It in the Market. Likewise at lower prices, profit margin shrinks and hence producers reduce the sale .

Supply schedule and supply curve

Law of supply can be illustrated with the help of a, schedule and supply curve. A supply schedule is a tabular statement that gives a full account of supply of any given commodity in a given market at a given time

It states what the volume of goods offered for sale would be at each of a series of prices. Supply schedule is of two types:(1) individual Supply schedule,

(2) market supply schedule.

Individual supply schedule states the quantities of a commodity a producer would offer for sale at various prices. Suppose M/s. A.B.C. Ltd. are willing to sell 10,000 units of their product per week at price of Rs- 4 each. If the price goes up to Rs. 5 each, they may be willing to sell 12,000 units, and at Rs. 6 each, 15,000 units.We record this relationship in Table 14'8. With the increase in price, the quantity supplied increases and vica versa. A market supply schedule1 furnishes exactly the same information.A market supply schedule for a given commodity is the sum of individual supply for all those firms which are engaged in the production of a given commodity during a given period.

The market supply curve can be obtained by aggregating the individual supply curves of the commodity.

The market supply curve also shows the same relationship between the price and the quantity supplied the quantity supplied increases proportionately with the increase in the/priceActivityQs=20p-100So that at the price Rs. 1O/ per unit quantity supplied equals 20 x 10 - 100=100 at the price Rs 9 per unit 80 units will be supplied; Similarly different quantities corresponding to different prices can be calculated.

SHIFT IN SUPPLY

Movement along the same supply curve represents contraction or expansion in supply as a result of a change in the price of a commodity. A shift in supply curve occurs\ when the producers are wi1ling to offer more or less of a commodity because of reasons other than the price of the commodity.

For example. An innovation or the discovery of a cheap raw material may result in increased supplies of a given commodity. Increase in the supply of plastic footwear in recent years is glaring illustration.

This change in supply which occurs because of a change in any of the determinants of supply, other than the price, is known as increase or decrease in supply,

(1 ) Increase in demand also increases the price the quantity sold and purchased also increases(2) Fall in demand brings down the equilibrium price and the quantity sold and purchased also declines.

Increase in Supply.

(1) Shift in the supply curve to the right (increase in supply). brings down the equilibrium price; the amount sold and purchased increases.Activity:

I. Mathematically, the effect of the shift in demand can be presented as follows: Suppose, the original demand equation is Qd=110-lOp and, the original supply equation is Q.=10p-l00 The equilibrium price and the equilibrium quantity will be7 and 40 respectively.

Suppose, the new demand equation, exhibiting an increases in demand isQd=140 - 10p

and the supply equation remains unchanged. The new equilibrium will be determined as fol1ows :

140 - 10p=20p-100

OR30p=240 . :.

p=8

.-'.Substituting p=8 to either the demand or supply equation we get the equilibrium quantity as 60.

2. Mathematically, this effect can be shown as follows: Suppose the supply equation changes to

Qs=20p - 40And the demand equation remains unchanged

Qd=110 - 10p

(2) Shirt in the supply curve to left ( fall in supply ) increases the equilibrium price. The quantity sold and purchased diminishes.

Simultaneous change in the Demand and the Supply

So far we have been discussing the effect of change either in demand or in supply on the equilibrium price and the quantity sold and purchased. It is also possible that demand and supply may change simultaneouslyWe may discuss the change in both the demand and the supply as follows:

(1) If the increase or decrease in the demand and the supply is pf equal magnitude, then the price at old and new equilibrium will remain equal.

(2) If the increase in the demand is of greater magnitude than in supply, then the new equilibrium price will be higher than the old equilibrium price, and vice versa.

(3) If the supply increases in greater proportion than the demand, the new equilibrium price will be lower than the old equilibrium price.

It may be observed in all the conditions that the price mechanism brings demand and supply in equilibrium.

The new equilibrium price will be110-10p=20p-40Or 30p= 150

Or p=5Substituting p=5 in either of the equations we get the equilibrium quantity as 60, i.e. increase in supply leads to a fall in price, but the quantity demanded and supplied increase.

QUESTIONS

1. Distinguish between substitution and income effects of a price change. 2. Why does demand curve always slope downwards from left to right ? Are there any exceptions to it ? Explain with example. 3. Distinguish between 'change in demand' and 'change io quantity demanded' Bring out the factors which cause change in demand. .4. Discuss the, law of supply with the help of a schedule, and a curve. What are the factors on which the supply of a commodity depends? 5. Is the equilibrium price always stable 1 What is the effect of the following changes on the equilibrium price:

(1) When the demand of a commodity alone increases. (2) When the supply of a commodity alone increases.

(iii) When the demand and supply both increase.

Meaning of ELASTICITY OF SUPPLY

Meaning :Like demand, quantity supplied of different commodities responds

in different proportions to the price changes. For example, if the price of wheat rises. the farmers may be tempted to sell more in the market, and keep less for themselves. On the other hand, if the price of cars rises, the car manufacturers may not probably be in a position to offer more cars for sale, because they may not be keeping stocks of cars. Similarly, supply of cloth may increase in response to the increase in prices and so on. Elasticity of supply of a commodity measures changes in the quantity supplied as a result of a change in the price of commodity.

Elasticity of supply is measured as a percentage change in amount supplied divided by the percentage change in price of the commodity. In short,

Es= Percentage change in quantity supplied. Percentage change in price

Es= ( ∆q / q ) X ( p / ∆p ) OR (∆q/∆p) X ( p/q )

where p and q are the original price and quantity supplied respectively, and ∆p and ∆q the change in price and quantity supplied.This method of measurement of the elasticity of supply can be illustrated as follows:

Suppose, a producer is willing to supply 100 quintals of wheat at the price of Rs. 110 per quintal If the price increases to Rs. 120 per quintal, he is willing to supply 25 quintals of wheat. Calculate the elasticity of supply of wheat.Elasticity of supply of wheat will be calculated as fol1ows :

Es= (∆q/∆p) x ( p/q ) = (25/10) x ( 110/100 ) = 2.75

Es=2.'75 will mean that if the price of wheat goes up by one per cent supply of wheat will increase by 2.'75 per cent. The value of elasticity coefficient varies between zero and infinity. The various results are tabulated below:

Elasticity of Supply

Elasticity Terminology Description

1. Es=ZeroPerfectly inelastic

Less than unit

2. Es<l elastic or inelastic

Unit elastic

3. Es=l

4. Es>lMore than unit elastic

Perfectly elastic5. Ese;:

Quantity supplied does not change.

Quantity supplied changes by a smaller percentage change than price.

Quantity supplied

changes in the same proportion as price.

Factors Influencing Elasticity of Supply

Elasticity of supply depends upon a number of factors, some of which are as follows:

1.Nature of the Commodity. The first and foremost determinant of the elasticity of supply

is the nature of the commodity. Commodities on the basis of their nature can be classified as (1 ) perishable, ,and (ii) durable. Perishable products

cannot be stored, and hence their supply does not

' respond in an effective manner to the change in their price. Hence, their supply is inelastic in nature. Durable products, on the other hand, can be stored; hence, their supply is generally elastic, i,e., 'supply responds to the change in prices.

2.Time. Supply of a commodity, in the ultimate analysis, depends upon its production. Production always involves a time-lag

which may. vary from a few days 10 a few years, Moreover, increased production of a commodity may contemplate a change in the very size (If the plant, which in turn may be a long, time-consuming process. Hence, supply of a commodity may be less elastic in the short run, as time progresses supply may become more elastic.

3. Techniques of Production. Simple techniques of production are, by and large, less expensive in nature, If demand conditions so require, the production and the supply of such commodities as involve simple: techniques of production could be easily increased. In other words, supply of such like commodities is generally elastic in nature, On the other hand, if the technique of production of a commodity is cumbers me, complex and time-consuming in nature it may not be possible to change the supply in response to varying price-demand conditions. Supply of such commodities would generally be Jess elastic,

4. Estimates of Future Prices. Future expectations of price changes may also inl1ucllcc supply of a commodity. If the producers expect the prices to, rise in future they may hold on to the stocks or the commodities and

POINTS TO PONDER

Slide 1

supplysuppl

Meaning:g: by supplyly we mean various quantities of commoditiesco

which producers will offer for sale at a particular time at variousva

correspondingpoi pricesi.

Slide 2

Supply functiontion

Sn = f ( Pn, Pr, F, T, G)G) Where

Sn = supply of a commoditycoPn = price of a commodity

Pr = pricepr of related

goods F = factorsor of

productionstion T =

technical know how

G = goals or general objective of producers

Slide 3

DeterminantsDe of supply

Price of the commodity Price of related goodsPrices ofof the factors of production Technical know howGoals oror general objectiveje ofof theth firm Natural factorsctTaxationTax policies Future expectation of rise in priceMeans of transportation andan communicationat

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Slide 4Law of supply

it explainsns thethe relationshiptio

between price of

a commodityity and itsit quantity suppliedlie.

Slide 5Assumptionstion of law of supply

Based on theth assumption thatat thereth is direct

relationship betweentw priceice and supply.i.e. with increasein in priceice supply is

increasingng and withwi decreasede in pricepri

supply is decreasing.

Slide 6Supply schedulesc

a supply schedule is a tabularta

statement

that gives a full account of supply of anyangiven commodity in a given marketet atat a

given time

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Slide 7Supply curve

supply curve exhibits theth informationgraphicallyhi insteadins of arithmeticallyithmically. It

shows theth relationshipti

betweentw price andan

theth quantityantity supplied.

Slide 8Shiftif inin supply curve

A shift in supplypp curvecur occursccu when the

producersuc are willingillin to offerfe more or lessle

of a commodity because of reasons otherthan the priceic ifif thethe commodityity.

It is also known as the increase or decrease

in supply.

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