Theory of supply

Theory of supply

The theory of supply explains the relationship between the price of a good or service and the quantity that suppliers are willing and able to offer for sale in the market. It focuses on the behavior of producers, manufacturers, and sellers in response to changes in price. This theory is crucial for understanding how producers make decisions based to market conditions and pricing.

Meaning of supply and quantity supplied

Supply: Supply refers to the willingness and ability of sellers or producers to offer goods or services for sale at different prices in a given period. It involves the production side of the economy, focusing on how suppliers react to changes in price.

Quantity Supplied: Quantity supplied is the specific amount of a good or service that producers are willing and able to sell at a given price within a specified period. It is measured in units and can change when the price changes.

The law of supply

The Law of Supply states that there is a direct relationship between the price of a good and the quantity supplied. Specifically, when the price of a good increases, suppliers are willing to supply more of it, and when the price decreases, they supply less.

Assumptions of the law of supply

The law of supply operates under certain assumptions. These assumptions must hold for the law to work as expected:

1. No change in technology: The law assumes that technology does not change. If technology improves, it can reduce the cost of production, and suppliers may increase the quantity supplied, even if prices are low.
2. No change in the price of factors of production: The law assumes that the prices of factors of production (such as labor, raw materials, and capital) remain constant. If these prices rise, the cost of production increases, making it less profitable to supply more, even if prices are high.
3. No change in government policies: The law assumes that government policies, such as taxes, subsidies, and tariffs, do not change. For example, new taxes or increased tariffs on raw materials can raise production costs, causing suppliers to supply less, even if prices are rising.
4. No change in the price of related goods or services: The law assumes that the prices of related goods or services (like substitutes or complementary goods) remain stable. If the price of a related good increases, suppliers may shift their resources to produce that good, reducing the supply of the original good.
5. No change in the scale of production: The law assumes that the production capacity remains constant. If the production scale changes (e.g., due to investment or resource constraints), the supply will also change, regardless of price.
6. No expectations about future price changes: The law assumes that suppliers do not expect changes in future prices. If suppliers anticipate that prices will rise, they may reduce current supply to wait for higher prices.

Supply schedule and supply curve

The supply schedule and supply curve are essential tools for understanding how suppliers respond to price changes in the market. These concepts help demonstrate the relationship between price and quantity supplied, both for individual suppliers and the market as a whole.

Supply schedule

A supply schedule is a table that shows the relationship between the price of a good or service and the quantity supplied by a supplier at different price levels, while holding other factors affecting supply constant. It provides a clear numerical representation of how supply changes in response to price changes.

Example: The table below shows the supply schedule for mango juice from Supplier A:

Price per Packet (TShs)	Quantity Supplied by Supplier A (Packets)
500	0
600	4
700	5
800	7
900	9
1,000	11

Explanation: When the price per packet is TShs 500, Supplier A is not willing to supply any mango juice. As the price increases, the quantity supplied also increases, illustrating the positive relationship between price and quantity supplied according to the Law of Supply.

Supply curve

A supply curve is a graphical representation of the supply schedule. It shows the relationship between the price of a good and the quantity supplied by a supplier, with the price typically plotted on the vertical axis and quantity supplied on the horizontal axis. The supply curve slopes upwards from left to right because, as the price increases, suppliers are willing to offer more goods for sale.

Supply curve

Market supply schedule

A market supply schedule shows the total quantity of a good that all suppliers in the market are willing to supply at different prices. It is the sum of individual suppliers' quantities supplied at each price.

Example: The table below shows the supply schedules for mango juice from two suppliers, A and B, and the market supply for each price:

Price per Packet (TShs)	Quantity Supplied by Supplier A (Packets)	Quantity Supplied by Supplier B (Packets)	Market Supply (Packets)
500	0	2	2
600	4	3	7
700	5	4	9
800	7	6	13
900	9	8	17
1,000	11	9	20

Explanation: At each price point, the market supply is the sum of the quantities supplied by both Supplier A and Supplier B. For example, when the price is TShs 500, the total market supply is 2 packets, as Supplier A supplies 0 and Supplier B supplies 2.

Market supply curve

A market supply curve is a graphical representation of the market supply schedule. It shows the total quantity of a good supplied by all suppliers in the market at various price levels. The curve is derived by summing the quantities supplied by all individual suppliers at each price.

Supplier A's curve

Supplier B's curve

Market supply curve

Interrelated supply

Interrelated supply refers to the relationship between the supply of two or more goods in the market. This relationship can be either positive or negative, meaning that the supply of one good can either increase or decrease as a result of a change in the supply of another good.

There are three main types of interrelated supply:

1. Joint Supply: Joint supply involves the supply of goods that are produced together. When the production of one good increases, it also leads to an increase in the supply of another good, as both goods are produced simultaneously. Example: Beef and leather are examples of goods produced together. If the price of beef increases, it leads to an increase in the supply of beef. Since beef and leather are jointly produced, the supply of leather will also increase as a result.
2. Composite Supply: Composite supply refers to goods that are produced together but are sold in combination. These goods cannot be considered separately, as they are typically consumed or used together. Example: Soft drinks, which consist of both the drink and the bottle. When the supply of soft drinks increases, the supply of bottles also increases since they are a necessary component of the drink.
3. Competitive Supply: Competitive supply involves goods that compete for the same production resources, such as land, labor, and capital. If more resources are allocated to the production of one good, it results in a decrease in the supply of the competing good. Example: Land can be used to grow either beans or maize. If more land is used for bean production, less land is available for maize production, leading to a decrease in the supply of maize.

Change in quantity supplied and change in supply

There is a difference between a change in quantity supplied and a change in supply. The key distinction lies in the factors causing the change:

Change in quantity supplied

Definition: A change in quantity supplied refers to a movement along the same supply curve, caused by a change in the price of the good, with all other factors held constant.

Table: Hypothetical Individual Supplier's Supply Schedule for Pencils:

Price of a Pencil (TShs)	Quantity Supplied by Supplier (Pencils)
200	29
300	35
400	37

Change in supply

A change in supply refers to a shift of the entire supply curve, which occurs when factors other than the price of the good change (e.g., changes in production costs, technology, or the prices of related goods). Example: A technological improvement that reduces production costs will increase the supply of pencils, shifting the supply curve to the right.

Factors that cause a shift in the supply curve

The supply curve represents the relationship between the price of a good and the quantity supplied by producers. Various factors, also known as the determinants of supply, cause shifts in the supply curve. These factors include:

1. Change in Technology: Technological advancements can lead to improvements in the production process, reducing the cost of production. Impact: When technology improves, producers can supply more goods at a lower cost, causing the supply curve to shift outward (to the right). Example: A new technology in farming equipment that reduces labor costs can increase the supply of crops.
2. Change in Input Prices: The cost of factors of production such as wages, rent, and interest rates affects production costs. Impact: If input prices fall (e.g., lower wages or reduced costs of raw materials), the supply curve shifts outward (to the right). If input prices rise, the supply curve shifts inward (to the left). Example: A decrease in the price of oil leads to lower transportation costs, thus increasing the supply of goods.
3. Change in Regulations: Changes in government regulations (taxes, subsidies, labor laws, etc.) can affect the cost and ease of production. Impact: A favorable regulatory change (e.g., tax cuts or less stringent laws) encourages more production, shifting the supply curve outward. Conversely, unfavorable regulations (e.g., higher taxes) shift the supply curve inward. Example: If the government reduces taxes on the production of solar panels, this will encourage producers to supply more, shifting the supply curve to the right.
4. Change in the Number of Suppliers: The number of sellers in the market impacts the overall market supply. Impact: An increase in the number of suppliers leads to an increase in the total supply, shifting the supply curve outward. A decrease in the number of suppliers results in a reduction in supply, shifting the supply curve inward. Example: If more firms enter the market for smartphones, the supply of smartphones increases, shifting the supply curve to the right.
5. Future Expectations about Price: Suppliers base their decisions on their expectations about future market conditions. Impact: If producers expect higher prices in the future, they may reduce supply now in anticipation of selling at a higher price later. This shifts the supply curve inward. If producers expect prices to drop, they might increase supply now, shifting the supply curve outward. Example: Farmers may reduce the supply of wheat during the current season if they expect higher prices in the future.
6. Change in Tax Rates: Changes in the tax rates on production or sales affect the cost of production. Impact: An increase in taxes on goods or inputs leads to higher production costs, causing the supply curve to shift inward (to the left). A decrease in taxes reduces production costs, shifting the supply curve outward (to the right). Example: A new tax on carbon emissions might increase the cost of producing fossil fuels, shifting the supply curve for oil inward.

Price elasticity of supply (PES)

Price elasticity of supply measures how much the quantity supplied of a good changes in response to a change in its price, holding all other factors constant. The formula for calculating PES is:

$\text{PES} = \frac{\% \text{Change in Quantity Supplied}}{\% \text{Change in Price}}$

Where:

• $\Delta Q_s$ = Change in quantity supplied
• $\Delta P$ = Change in price
• $P_0$ = Original price
• $P_1$ = New price
• $Q_0$ = Original quantity supplied
• $Q_1$ = New quantity supplied

Elasticity Categories:

1. Perfectly Elastic: If PES is infinite, a small change in price leads to an infinite change in quantity supplied.
2. Elastic: If PES > 1, a 1% change in price leads to a greater than 1% change in quantity supplied.
3. Unitary Elastic: If PES = 1, a 1% change in price leads to a 1% change in quantity supplied.
4. Inelastic: If PES < 1, a 1% change in price leads to a less than 1% change in quantity supplied.
5. Perfectly Inelastic: If PES = 0, a change in price has no effect on the quantity supplied.

Relationship between demand curve and supply curve

A relationship exists between the quantity of products that suppliers are willing and able to offer and sell at various prices and the amount that buyers are willing and able to purchase. This relationship is explained by the interaction of buyers and sellers in exchanging goods or services in a market. The interaction of demand and supply creates market equilibrium, which is a state of balance between the forces of demand and supply.

Market equilibrium ensures that goods and services are neither over-supplied nor under-supplied. At equilibrium, the quantity demanded equals the quantity supplied at a given price level. The equilibrium point occurs where the demand curve intersects the supply curve.

In market equilibrium:

1. The demand curve shows the quantity demanded of a good at each price level.
2. The supply curve shows the quantity supplied of a good at each price level.

The equilibrium price is the price at which the demand curve and supply curve intersect, and the equilibrium quantity is the quantity at that price level.

For example, in a hypothetical market schedule for socks:

Price (TShs)	Quantity Supplied of Pairs of Socks	Quantity Demanded of Pairs of Socks
200	0	500
1,000	1	1,500
2,000	7	7
2,500	10	10