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Supply

- Why Should I Care?

Producers come to the market with a completely different mindset than do buyers. Producers want more money for fewer products. How can they agree with buyers, who want more products for less money? Understanding the supply-side of the story helps us understand how markets work, because without producers, no one gets products.

- This Lecture Has 3 Parts

  • Law of Supply
  • Perfect Competition Theory
  • Supply and Quantity supplied
  • Supply shifters

- What is Supply?

When producers sell their final products, they are supplying the market with goods and services. Their ability to do so affects prices and quantities. This mostly has to do with how they manage their costs, and what technology they use.

In economics, the formal concept of “supply” refers to a set of possible, hypothetical, and technologically consistent transactions suppliers would be ready to accept on a market.

  • Law of Supply

As production grows, so do costs, so we should expect suppliers to ask for higher prices at higher production levels.

A supply curve represents the various quantities of a good or service that sellers are willing to produce at various price points over a specific period of time. Supply represents a flow, not a stock, of goods. We measure output over time, such as Quantity supplied per week. Quantities can be measured by unit, such as the number of chairs produced per week, or by dollar value, such as total sales per week.

Why? Because we wish to explain production that is supplied to market, not production that is idle. Stocks of goods are not necessarily consumed; they are often sitting in a warehouse. Goods are flowing because they are sold and consumed over time.

Supply: Quantity is a positive function of prices               Qs = f (P)

If Price INCREASES, then Quantity INCREASES.

If Price DECREASES, then Quantity DECREASES.

Higher prices serve as a necessary condition to produce more goods and services. If Price increases, then Quantity supplied will increase as well, and vice-versa.


Why? Two reasons:


First, suppliers have to deal with increasing costs of labour and resources.


Second, suppliers may have other more profitable ventures in other industries. They expect higher prices not to leave this market and look for other ventures.

 

  • Perfect Competition Theory
  • Supply and Quantity supplied
  • Supply shifters


To chart a supply curve, we have to assume a very critical and controversial idea: perfect competition.

In economics, the idea of a competitive group of suppliers is characterized by the supply curve. But the existence of a supply curve depends on the assumption of perfect competition. That is: there are enough producers to keep prices as low as possible. Also, the product is not unique and can be easily copied and substituted.

In this scenario, economists assume that no one supplier has an “edge” in the market to draw clients, other than prices. Every one’s product is the same quality, the customer service is the same, the locations are the same, etc.


 



 


A point on the Supply Curve is called Quantity supplied.


A shift in price will move Qs on the Supply Curve (SS).



    1. Theory of Perfect Competition


    • Definitions
      1. Producers are called suppliers.
      2. Suppliers must sell at a price that covers production costs.
      3. The market is open (arbiter sets price).


    • Assumptions
      1. Suppliers are numerous and very competitive.
      2. Suppliers cannot “Cherry-Pick” price-quantity combinations.
      3. The product is a homogenous commodity (not differentiated)


    • Hypotheses
      1. Suppliers require higher prices to increase production


    • Predictions
      1. The intersect of the demand and supply curves sets the open-market price
      2. Any producer who does not conform to market price will not cover production costs because of lower sales or excessive costs.
      3. The equilibrium is stable.



     

    Scenario: The 100 villagers of VillageTown like ice-cream. Grandma Jones is confronted to some stiff competition from her bridge friends Grandma Mimi, Mrs. Cupcake and Mama Roberta. Together, they make up a perfectly competitive ice cream industry.


    VillageTown’s weekly supply of 1 liter tubs of ice cream

     

    Situation

     

    Price ($)

     

    Quantity supplied (Q/w)

    Price

    Quantity of ice cream

    Potential sales ($/w)

     


    A

    $ 6

    600 tubs

    $ 3,600


    B

    $ 5

    500 tubs

    $ 2,500


    C

    $ 4

    300 tubs

    $ 1,200


    D

    $ 3

    150 tubs

    $ 450


    E

    $ 2

    50 tubs

    $ 100



    BONUS: draw the area that represents Situation A and E. This area shows the potential sales for the ladies.

    Which rectangle provides more revenue (sales)?               A


    If the market price is $2, the industry won’t want to make more than 50 tubs, because it takes a lot of time for the initial setup. It’s not worth spending hours preparing a batch, only for $100 sales. The ladies would rather have some time to play bridge together.


    But if the price rises to 6 $, the old ladies will dump their mutual bridge game and make 600 tubs because they will make 36 times more money.

     

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