In an earlier lesson, we introduced one of the most fundamental relationships in economics: supply and demand. In order to best make sense of the relationship between supply and demand, it is important to understand each element individually. Previously, we covered demand, which is defined as the level of desire for a good or service by consumers. In this lesson, we will look at the market from the perspectives of producers, focusing on supply.
What exactly is supply? The definition of supply is similar to the definition of demand, but instead of looking at consumers and their desires and abilities to purchase goods, supply is controlled by producers. Specifically, supply is defined as the desire by producers to provide a good or service. The supply curve, which is the graphical representation of supply, shows supply as a direct relationship between the price of an item and the quantity supplied of that item.
Law of Supply
Just as the Law of Demand can be used in understanding why the demand curve is downward sloping, the Law of Supply explains the upward sloping nature of the supply curve. Simply put, the Law of Supply explains that as the price of a good or service rises, the quantity of said item will rise as well. The Law of Supply makes sense when better understood from the perspective of a producer. As prices increase, producers are eager to maximize their profits, so they provide a greater amount of goods or service in question. This is demonstrated by the curve below.
When the price of an item increases, the quantity supplied of that item will increase. Similarly, if the price of an item, the quantity supplied of that item will decrease. However, just because the price of an item changes, it does not mean that the supply of that item will also change.
Changes in Supply
Supply itself can also increase and decrease, but not as the result of a change in price. These shifts in supply occur as the result of one of the “determinants” of supply, which include changes in production costs, number of sellers, technology, or future expectations. An increase in supply is shown by a rightward shift of the supply curve, while a decrease in supply is depicted by a leftward shift.
The Determinants of Supply
Cost of Production
There are a number of factors that can impact the costs of production, both positively and negatively. Such production costs include the costs of raw materials or other items used in the production of the final good or service (input prices), wages, taxes, and government-controlled rules and regulations. If any of these costs increase, it will be more expensive for a company to produce final goods, so supply will decrease. Likewise, if costs decrease, producers will be able to make more final products than before, and supply will decrease.
Changes in technology always affect supply positively, making for a more efficient production process. Such technological advances can span a range of developments, including everything from the invention of a new pesticide to improve harvest yield to improved systems of business management. Rarely, however, are practices adopted in which technological progress is reversed. Thus, changes in technology will (almost) always cause an increase in supply.
Changes in future expectations of producers can have complicated effects on supply, depending on whether those supplying the product are the sellers or manufacturers of the products. At its simplest, when producers believe that they can sell their products for higher prices in the future, they will withhold their inventory. In the present, this results in a decrease in supply. The opposite occurs when suppliers expect that prices will drop.
Number of Sellers
If the number of sellers in a market increases, so will the supply. Likewise, when the quantity of producers decreases, supply does as well.
There are a few other determinants of supply, including the prices of related or joint goods and services that can impact supply both positively and negatively.
In conclusion, supply is the level at which producers want to provide a good or service at varying price levels. The Law of Supply helps illustrate the direct relationship between price and quantity supplied. Additionally, the determinants of supply can be used to explain shifts in demand.
Now that you have understood both supply and demand, you are ready to understand the interaction between the two, and how together, they form the market mechanism.