Supply and quantity supplied

Supply is the quantity of a good or service that producers are willing and able to offer for sale at different prices during a specified period, ceteris paribus. Both conditions count. Willingness without the productive capacity to sell isn’t supply; neither is productive capacity without the willingness to sell.

Quantity supplied is the amount of a good or service that producers are willing and able to offer at one particular price during a specified period. Supply covers the entire price–quantity relationship, whereas quantity supplied is a single point on that relationship.

Because supply is a flow, the time period has to be stated. A firm, for instance, may supply a certain number of units per week—not simply a number of units with no time dimension.

The positive causal relationship

The law of supply is an economic principle stating that, ceteris paribus, a rise in a good’s price causes its quantity supplied to rise, while a fall in its price causes its quantity supplied to fall. Price and quantity supplied therefore have a positive relationship.

Producer incentives explain this causal link. When the selling price rises, additional production becomes more worthwhile, and firms can cover the higher cost that may come with extra output. They respond by offering more per period. At a lower price, producing some units is no longer worthwhile, so quantity supplied falls.

Ceteris paribus is an analytical assumption under which all relevant influences other than the variable being examined are held constant. In this case, it isolates the effect of the good’s own price. While price changes, production costs, technology, taxes, subsidies and other supply conditions are assumed to remain unchanged.

Profit-maximizing behaviour and the short run

The law of supply assumes that firms aim to maximize profit. Producers expand output when the price they receive for an extra unit makes that unit worth producing. The law also assumes a short-run setting. At least one factor of production is fixed, so firms cannot expand capacity freely.

A fixed factor is an input whose quantity cannot be changed within the period being considered. In the short run, this could be factory space or installed machinery. A variable factor is an input whose quantity can be changed within that period. Common examples include labour hours and materials.

Diminishing marginal returns

Marginal return is the additional output generated by employing one more unit of a variable factor while other inputs are held constant.

The law of diminishing marginal returns is a short-run principle stating that, beyond some level of employment, successive additions of a variable factor to fixed factors produce progressively smaller additions to output. Consider a food-processing firm that hires more workers but keeps the same preparation area and machinery. At first, specialization may cause output to rise sharply. Eventually, workers face congestion and must compete for equipment. Each additional worker then adds less output than the worker before.

Total output does not have to fall straight away. It may keep increasing, but at a slower rate because marginal returns are diminishing.

Increasing marginal costs

Marginal cost is the addition to a firm’s total cost caused by producing one more unit of output. Suppose the price of the variable factor stays unchanged. As each additional unit of that factor produces less extra output, the firm needs more variable input to produce each further unit. Marginal cost rises as a result.

Learn the chain rather than simply memorizing it. Fixed short-run capacity eventually causes diminishing marginal returns. These diminishing returns lead to increasing marginal costs, so firms need a higher selling price before they will supply additional output. This explains the law of supply.

Representing supply

A supply curve is a graphical representation of the relationship between a good’s price and its quantity supplied per period, ceteris paribus. Price per unit goes on the vertical axis, while quantity supplied per period goes on the horizontal axis.

A typical supply curve slopes upward from left to right. At a lower point, both price and quantity supplied are lower. At a higher point, both are higher. The upward slope shows the law of supply, but it doesn’t explain why this relationship exists.

Label both axes fully when drawing the diagram, and include the time period on the quantity axis where possible. The curve also needs a label. It doesn’t have to touch either axis; the positive slope and correct economic labelling are what matter.

From one producer to the whole market

Individual supply is the quantity of a good or service that one producer is willing and able to offer at different prices during a specified period, ceteris paribus.

Market supply is the combined quantity that all producers in a market are willing and able to offer at different prices during a specified period, ceteris paribus. To find it, add the quantity supplied by each producer at every price. Economists call this horizontal summation because quantity is measured along the horizontal axis.

Imagine three firms supplying reusable bottles at a particular price. Add their three quantities to get the market quantity supplied at that price. Repeat the calculation for every price, and you can construct the market supply schedule and curve. Remember: add quantities, not prices. That’s easy to forget under exam pressure.

Three firms’ supply schedules and the market total for reusable bottles.

If the number of firms increases, market supply grows even when the individual supply of each existing firm stays the same. A change that affects just one producer, however, shifts that producer’s supply and feeds into the market total without necessarily dominating it.

What shifts supply?

A non-price determinant of supply is a condition other than the good’s own price that changes the quantity producers are willing and able to offer at every price. A favourable change increases supply, while an unfavourable one decreases it.

Costs of factors of production

Factors of production are productive resources used to create goods and services. When wages, energy charges, rent or raw-material prices rise, production costs per unit go up. At every possible selling price, production becomes less profitable and supply decreases. A fall in input costs does the reverse: supply increases.

Prices of related goods

The effect of related goods depends on the way they’re produced.

Joint supply is a production relationship in which two or more goods emerge from the same production process. Processing timber, for instance, may produce boards as well as wood residue used for fuel pellets. A rise in the price of boards leads firms to increase the quantity supplied of boards. As more timber is processed, more residue is created, so the supply of fuel pellets also increases.

Competitive supply is a production relationship in which different goods compete for the same productive resources. A furniture workshop may use the same workers and machines to make either desks or cabinets. If desks rise in price, the firm has an incentive to shift more resources towards desk production. That leaves fewer resources for cabinets, decreasing their supply.

There are two stages here. The price change causes a movement along the supply curve of the good whose price changed. For the related good, however, the supply curve shifts.

Indirect taxes and subsidies

An indirect tax is a compulsory government charge imposed on expenditure on a good or service. The tax increases the firm’s cost of supplying that product. Producers need a higher price to offer each quantity, so supply decreases.

A subsidy is a government payment to a producer that lowers the firm’s cost of supplying a good or service. Production becomes more profitable at every price, increasing supply. Subsidies and indirect taxes therefore shift supply in opposite directions.

Future price expectations

Producers who expect the market price of a storable good to rise may hold back some current stocks and sell them later at the expected higher price. As a result, current supply decreases. If they expect the future price to fall, they may release stocks earlier, which increases current supply. This can happen only when producers are able to postpone sales.

Technology

Technology is the body of methods, processes and equipment used in production. An improvement in productivity lets firms produce more output from the same resources, or the same output at a lower cost. Supply therefore increases. By contrast, a technological disruption that lowers productivity can decrease supply.

Number of firms

When new firms enter a market, their output is added to the market total, increasing market supply. If firms leave, their output is removed and market supply decreases. This determinant applies to market supply; it isn’t a movement by one unchanged firm along its own supply curve.

Changes in quantity supplied: movement along the curve

A change in quantity supplied is a change in the amount producers offer for sale caused solely by a change in the good’s own price, ceteris paribus. On a diagram, this appears as movement from one point to another along the same supply curve.

When price rises, there is an upward movement along the curve to a larger quantity supplied. This is often called an extension of quantity supplied. When price falls, movement is downward to a smaller quantity supplied, often called a contraction of quantity supplied. The supply curve doesn’t shift because the underlying supply conditions haven’t changed.

Changes in supply: shift of the curve

A change in supply is a change in the quantities producers are willing and able to offer at every price because a non-price determinant has changed. It appears as a shift of the entire supply curve.

An increase in supply shifts the curve to the right. Producers now offer a greater quantity at every given price or, equivalently, are willing to offer any given quantity at a lower price. This shift can result from lower production costs, improved technology, a subsidy or more firms.

A decrease in supply shifts the curve to the left. Producers offer a smaller quantity at every given price or, equivalently, require a higher price to offer any given quantity. Higher input costs, an indirect tax or fewer firms can cause this shift.

Use the terms precisely. “Quantity supplied increases” describes movement along one curve after a rise in the good’s own price. “Supply increases” describes a rightward shift of the entire curve because something other than that price has changed.