Unit 4 Supply Objectives: After going through this unit, you will be able to explain: Meaning and factors influencing supply Concept elasticity of supply Structure: 1.1 Introduction 1.2 Concept of Supply 1.3 Law of supply 1.4 Factors affecting Supply 1.5 Changes in Supply 1.6 Elasticity of Supply 1.7 Price Elasticity of Supply 1.8 Factors affecting elasticity of supply 1.9 Summary 1.10 Key words 1.11 Self assessment questions1.1 Introduction:Demand and Supply are the pillars of contemporary market economies. Supply is onehalf of the market exchange process; the other is demand. This supply side of the marketis directly connected to the limited resources dimension of the scarcity problem. Firmshaving ownership and control over resources (labor, capital, land, and entrepreneurship)use them to produce the goods and services that satisfy other’s wants and needs.
Ownership and control of resources is the ultimate source of supply. This section talksabout supply and supply concepts.1.2 Concept of SupplySupply can be defined as the willingness and ability to sell various quantities of a good atparticular prices, during a given time period. Quantity supplied can be defined as thequantity of a goods or services that sellers are willing and able to sell at a specific supplyprice.1.3 Law of SupplyAccording to the Law of supply at higher prices, a larger quantity will be supplied than atlower prices, all other things being equal. This relationship between supply and price ofthe commodity can be expressed through the supply curve, which is upward slopingshowing the positive relationship between quantity supplied and price. Consider thefollowing diagram showing the supply curve. Price Supply 0 Quantity
The positive relationship between supply and price of a commodity is because whenprices rise, costs take a longer time to adjust as compared to prices. In the meantime perunit profit increases which further acts as an incentive for the producer.1.4 Factors influencing supplySellers’ ability and willingness to supply goods and services depends on a variety offactors. Consider some of the: a) Price: The impact of price on supply of the commodity has already been described in the law of supply. Quantity supplied is directly proportional to its price. b) Factor costs: The prices of inputs used to produce the product, viz., wages, rent, interest, and normal profit put together have an inverse relationship with price of the final product. This is because higher costs imply lower margins c) Technology: Technological advancements have caused tremendous improvements in manufacturing capabilities and hence have had a positive impact on supply. d) Government policy, Taxes and subsidies: Taxes behave as a cost and by increasing, cause supply to decrease. Subsidies reduce costs and have a positive relationship with supply. Government policy may also restrict or prohibit the supply of goods and services in the economy. e) Price Expectations: Anticipation about price movements in the future also impact quantity supplied of a commodity in the current time period. f) Number of Firms: More the number of firms or suppliers in the market, greater is the supply. As is evident in India post-liberalization entry of foreign firms and opening of various sectors for private firms have increased the supply.1.5 Changes in SupplyWe now know various factors that influence supply in the market. All this factorscategorized into price and non-price factors can cause supply to,
a) Expand/Contract b) Increase/Decrease Depending on what underlying factors are triggering a change in supply, it can change in any of the above two ways. The following table and figure describe these two aspects of changes in supply. Changes in supply Criteria Expansion /Contraction Increase/Decrease Reason Supply expands or contracts because of Supply increases or decreases a change in price. because of non-price factors. Expression Expansion /Contraction in supply are Increase/Decrease in supply is expressed by a movement along the expressed by a shift of the supply curve. supply curve itself. Diagram The following figure describes the two kinds of changes in supply.Price Price Expansion Decrease Contraction Increase Quantity Quantity 1.6 Elasticity of Supply We know from our earlier section on elasticity of demand that elasticity measures the degree of dependence of one variable on another. Elasticity of supply talks of the dependency of quantity supplied of a commodity on various factors. We will discuss in detail about Price Elasticity of Supply.
1.7 Price Elasticity of SupplyPrice elasticity of supply can be defined as the degree to which a price change for acommodity results in a change in its supply. It can be calculated as,Es = Proportionate change in quantity demanded Proportionate change in PriceWhere Es is the coefficient of price elasticity of supply.The coefficient of elasticity of supply is positive, because an increase in price is likely toincrease the quantity supplied to the market and vice versa. Besides the greater the slopeof the supply the greater is the elasticity of supply. Consider the following diagram whichexhibits price elasticity of supply. Price S1 S2 0 QuantityIn the above figure there are two supply curves: a) S1 which relatively inelastic, and b) S2 which relatively elastic
The greater the elasticity of supply the greater is the producer’s ability to respond to achange in the demand in the market. Contrary to this if the elasticity of supply is less theproducer’s response to a change in demand is constrained to that extent.1.8 Factors that determine elasticity of supplyIt is important for the seller to respond to changes in demand in the market. This isfurther dependent on the elasticity of supply. The elasticity of supply further depends onthe factors highlighted in the following table,S.N. Factor For relatively elastic For relatively supply inelastic supply 1. Idle capacity Plenty of spare Lack of spare capacity capacity 2. Level of stocks or inventories Stocks of raw Stocks of raw materials, components materials, and finished products components and are high finished products are low 3. Ease of factor substitution Resources are Resources are occupationally mobile occupationally not and production mobile and process is fairly production process flexible is fairly inflexible 4. Time Long run Short run1.9 SummaryThis unit discussed the other important force that influences the existence of markets –the Supply. Various factors affect supply in the market and producers’ capability andwillingness to supply in the market. These include the price of the product, cost ofproduction, government policy, state of technology, producers’ anticipation about futureprice movements, and number of sellers in the market. How much does the seller respondto a change in these factors further depends on the elasticity of supply. Availability of
idle capacity, higher inventory and stock levels, and mobility of factors of productionmake supply relatively elastic. In the long run supply tends to be more elastic than in theshort run.1.10 Key words a) Supply: The willingness and ability to sell various quantities of a good at particular prices, during a given time period. b) Law of supply: At higher prices, a larger quantity will be supplied than at lower prices, all other things being equal. c) Factor costs: The prices of inputs used to produce the product, viz., wages, rent, interest, and normal profit put together. d) Elasticity of supply: Dependency of quantity supplied of a commodity on various factors. e) Price elasticity of supply: The degree to which a price change for a commodity results in a change in its supply.1.11 Self assessment questions 1. Explain the concept of supply and law of supply. 2. Distinguish between expansion/contraction and increase/decrease in supply. 3. Write short notes on: a) Ease of factor substitution b) Resource costs 4. Explain the concept of elasticity of supply. Based on your knowledge of elasticity supply show in following diagram which supply curve is more elastic and why? Price S1 S2 0 Quantity
5. Discuss various factors that make supply more responsive in the market.6. According to the Law of supply at higher prices, a larger quantity will be supplied than at lower prices, all other things being equal. a) True b) False c) Neither true nor false d) None of the above7. The positive relationship between supply and price of a commodity is because when prices rise, a) Costs take a shorter time to adjust as compared to prices b) Costs take a longer time to adjust as compared to prices c) Costs take as much time to adjust as prices d) None of the above8. Technological advancements have caused tremendous improvements in manufacturing capabilities causing supply to, a) Increase b) Decrease c) Not change d) Can’t say
9. Taxes behave as a cost and by increasing, cause supply to, a) Decrease b) Increase c) Not change d) None of the above10. Subsidies reduce costs and have a positive relationship with supply. a) True b) False c) Neither true nor false d) Both true and false11. Fill in the blanks: a) More the number of firms in the market ____________ is the supply. b) Supply expands or contracts because of a change in ____________. c) Increase/Decrease in supply is expressed by a ____________ of the supply curve itself. d) Price elasticity of supply can be defined as the degree to which a ____________ change for a commodity results in a change in its ____________. e) The coefficient of elasticity of supply is____________, because an increase in price is likely to increase the quantity supplied to the market. f) In the ____________ run supply tends to be more elastic than in the____________ run.