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Principle of supply


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Principle of supply

  1. 1. Lesson 11. THE PRINCIPLE OF SUPPLY Learning outcomesAfter studying this unit, you should be able to: Meaning of supply Difference between supply and stock Relationship between supply and price Define the concept of elasticity of supply locate the determinants of elasticity of supplyIntroduction: Friends after knowing the meaning and purpose of demandand law of demand, elasticity of demand, know I think you should know whatsupply 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 theordinary language. Supply of a commodity is often confused with the stockof that commodity available with the producers. Stock of a commodity, moreor less, will equal the total quantity produced during a period less thequantity already sold out. But we know that the producers do not offer wholeof their stocks for sale in the market, A part of industrial produces is kept back ingodowns and is offered for sell in the market when It can fetch better prices, In otherwords the amount offered for sale may be less (or at the most in rarecircumstances equal to) than the stocks of the commodity. The term supplyshows a relationship between quantity and price. By supply we meanvarious quantities of a commodity which producers will offer for sale ata particular time at various corresponding prices. In simple words,supply ( like demand ) refers to the quantity of commodity offered for saleat some price during a given period of time. FACTORS ON WHICH SUPPLY OF A COMMODITY DEPENDSIt is also known as the determinants of supply. The Important determinants ofsupply 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 acommodity (say N) and other determinants of supp1y, i.e., price of thecommodity (PN), price of a related commodity (P R), prices of the factors ofproduction (F), technical know-ho" (T) and goals or general objectives of theProducer. Each of the_ factors influences supply in a different way. To isolatethe effect of other factors we take these other factors as constant whileconsidering the relationship between supply and one of the above variables. Forexample, if we want to study the relationship between price and supply of
  2. 2. commodity, N, we shall assume other factors PR, F, T and G to remain constantor 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
  3. 3. Meaning: It’s different from law of demand. Law of supply explains therelationship between price of a commodity and its quantity supplied. Priceand supply are directly related. A rise in price induces producers to supplymore quantity or the commodity and a fall Prices, makes them reduce thesupply. The higher is the price of the commodity the larger is the profit that canbe earned, and, thus the greater is the incentive to the producer toproduce more of the commodity and offer It in the Market. Likewise atlower prices, profit margin shrinks and hence producers reduce the sale .Supply schedule and supply curveLaw of supply can be illustrated with the help of a, schedule and supply curve. Asupply schedule is a tabular statement that gives a full account of supply of anygiven commodity in a given market at a given timeIt states what the volume of goods offered for sale would be at each of a series ofprices. SupplySupply schedule, types: (1) individual schedule is of two2) market supply schedule.Individual supply schedule states the quantities of a commodity a producer wouldoffer for sale at various prices. Suppose M/s. A.B.C. Ltd. are willing to sell 10,000units of their product per week at price of Rs- 4 each. If the price goes up to Rs. 5each, they may be willing to sell 12,000 units, and at Rs. 6 each, 15,000 units.We record this relationship in Table 148. With the increase in price, the quantitysupplied increases and vica versa. A market supply schedule1 furnishes exactlythe same information.A market supply schedule for a given commodity is the sum of individual supplyfor all those firms which are engaged in the production of a givencommodity during a given period.The market supply curve can be obtained by aggregating the individualsupply curves of the commodity.The market supply curve also shows the same relationship between theprice and the quantity supplied the quantity supplied increases proportionatelywith the increase in the/priceActivityQs=20p-100So that at the price Rs. 1O/ per unit quantity supplied equals 20 x 10 - 100=100at the price Rs 9 per unit 80 units will be supplied; Similarly different quantitiescorresponding to different prices can be calculated. SHIFT IN SUPPLY
  4. 4. 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 be 7 and 40 respectively.Suppose, the new demand equation, exhibiting an increases in demand is Qd=140 - 10p and the supply equation remains unchanged. The new equilibrium will be determined as fol1ows : 140 - 10p=20p-100 OR 30p=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 - 40 And the demand equation remains unchanged Qd=110 - 10p
  5. 5. (2) Shirt in the supply curve to left ( fall in supply ) increases the equilibriumprice. The quantity sold and purchased diminishes.Simultaneous change in the Demand and the SupplySo far we have been discussing the effect of change either in demand orin supply on the equilibrium price and the quantity sold and purchased. Itis 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 demandand 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 andsupplied increase.QUESTIONS1. Distinguish between substitution and income effects of a price change.2. Why does demand curve always slope downwards from left to right ? Are thereany exceptions to it ? Explain with example.3. Distinguish between change in demand and change io quantity demandedBring out the factors which cause change in demand. .4. Discuss the, law of supply with the help of a schedule, and a curve. What arethe factors on which the supply of a commodity depends?5. Is the equilibrium price always stable 1 What is the effect of thefollowing changes on the equilibrium price: (1) When the demand of a commodity alone increases. (2) When the supply of a commodity alone increases.
  6. 6. (iii) When the demand and supply both increase.Meaning of ELASTICITY OF SUPPLYMeaning : Like demand, quantity supplied of different commodities respondsin different proportions to the price changes. For example, if the price ofwheat rises. the farmers may be tempted to sell more in the market, and keepless for themselves. On the other hand, if the price of cars rises, the carmanufacturers 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 mayincrease in response to the increase in prices and so on. Elasticity of supply of acommodity measures changes in the quantity supplied as a result ofa change in the price of commodity. Elasticity of supply is measured as a percentage change in amount supplieddivided 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 ∆pand ∆q the change in price and quantity supplied.This method of measurement of the elasticity of supply can be illustratedas follows: Suppose, a producer is willing to supply 100 quintals of wheat at the price ofRs. 110 per quintal If the price increases to Rs. 120 per quintal, he is willing tosupply 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 ) = 2.75Es=2.75 will mean that if the price of wheat goes up by one per cent supplyof wheat will increase by 2.75 per cent. The value of elasticity coefficientvaries between zero and infinity. The various results are tabulated below:
  7. 7. Elasticity of Supply Elasticity Terminology Description Less than1. Es=Zero Perfectly inelastic unit2.Es<lelastic or inelasticUnit elastic3.Es=l4.E s>lMore than unit elasticPerfectly 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
  8. 8. commodity. Commodities on the basis of their nature can beclassified as (1 ) perishable, ,and (ii) durable. Perishableproducts cannot be stored, and hence their supply does notrespond 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 isgenerally elastic, i,e., supply responds to the change inprices.2.Time. Supply of a commodity, in the ultimate analysis,depends upon its production. Production always involves atime-lag which may. vary from a few days 10 a few years,Moreover, increased production of a commodity maycontemplate a change in the very size (If the plant, which inturn 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.
  9. 9. 3. Techniques of Production. Simple techniques of production are, by andlarge, less expensive in nature, If demand conditions so require, the productionand the supply of such commodities as involve simple: techniques of productioncould be easily increased. In other words, supply of such like commodities isgenerally elastic in nature, On the other hand, if the technique of production of acommodity is cumbers me, complex and time-consuming in nature it may notbe possible to change the supply in response to varying price-demandconditions. Supply of such commodities would generally be Jess elastic, 4. Estimates of Future Prices. Future expectations of price changes mayalso inl1ucllcc supply of a commodity. If the producers expect the pricesto, rise in future they may hold on to the stocks or the commodities and
  10. 10. POINTS TO PONDERSlide 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 commodityco ___________________________________ Pn = 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 goods ___________________________________ Prices ofof the factors of production Technical know how ___________________________________ Goals oror general objectiveje ofof theth firm Natural factorsct ___________________________________ TaxationTax policies Future expectation of rise in price Means of transportation andan communicationat
  11. 11. Slide 4Law of supplyit explainsns thethe relationshiptiobetween price ofa ___________________________________commodityity and itsit quantity suppliedlie.Slide 5Assumptionstion of law of Slide 7Supply curvesupply curve exhibitssupplyBased on theth assumption thatat thereth is directrelationship betweentw priceice theth informationgraphicallyhiinsteadinsofand supply.i.e. with increaseinin priceice supply isincreasingng and withwi decreasedein arithmeticallyithmically. Itshows thethpriceprisupply is decreasing.Slide 6Supply schedulesca supply schedule relationshiptibetweentwprice andanthethis a tabulartastatementthat gives a full account of supply of anyangiven commodity quantityantity supplied.Slide 8Shiftif ininin a given marketet atat agiven supply curveA shift in supplypp curvecurtime___________________________________ occursccu when theproducersuc are willingillin to offerfe more or lessleof a___________________________________ commodity because of reasons otherthan___________________________________ the priceic ifif thethe commodityity.It is also known as the increase or decreasein___________________________________ supply._________________________________________________________________ ________________________________________ ______________________________________________________________________ ___________________________________ ___________________________________ ___________________________________ ___________________________________ _______________________________________________________________________________________________________________________________________________________________________________ ______________________________________________________________________ ______________________________________________________________________ ______________________________________________________________________ ___________________________________ ___________________________________ ___________________________________ _____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________