Tuesday, 2 October 2012

Principles of Economics: Supply (Microeconomics)

*Disclaimer: I'm fully aware of the fact that I've already written a post on supply. However, I've decided to cover it again now I know more on the subject and can give a better coverage.* 

Okay, I'll dive straight into this one with the main principle of supply: 'When the price of a good rises, the quantity supplied will also rise'. Now, it's all well and good just stating that, however we need to know the reasons why this happens. Let's look at three of them:

  • Beyond a certain level of production for the producer costs are likely to rise at a quicker rate than previously. This could be due to having to pay overtime to staff members or increased maintenance costs for machinery. Either way, the quantity supplied by producers will only rise if the price rises so that it becomes efficient for them to raise their costs.
  • A more basic reason now: The higher the price of the good, the more profitable it is for the firm. In general terms this theory holds true. Most firms have an aim of profit maximisation, so therefore they'll increase supply when the price rises to maximise profits.  Both of these two points are short term reasons as to why supply rises when price increases.
  • A long term reason is because when price rises in an industry new firms are encouraged to join the market with the hope of profit. This increase in firms will increase the supply to the market. 

Here we have a very basic graphical presentation of the supply curve. A supply curve shows us the supply schedule. Supply schedule refers to the amount producers are able to and willing to produce at different prices at a set point in time, it is normally shown in a table and can then be presented in a graph like the one above. The supply curve will generally slope upwards from left to right, to show that the higher the price the higher the supply will be. Obviously, price elasticity of supply plays a part in the steepness of the slope but I'll get on to that point in a few blog post times, I'm keeping it very basic here. 

As with demand, there are many factors apart from just price that affect the supply of a good to the market. These are the main ones:
  • Production cost - Higher costs mean less profits means less supply and vice versa. This can be because of a change in the input prices (wages, raw materials), government policy (subsidies, taxation), organisation changes or technology changes.
  • Nature - This can include the weather, disease, natural disaster. Basically things that are out of human control.
  • Aims of the producer - The supply of a firm aiming to maximise profit will be different to a firm aiming for sales maximisation. Therefore different producer aims will cause varying levels of supply. 
  • Expectations - If prices are expected to rise, producers will hold onto stock in anticipation of this rise meaning supply will fall. This works the opposite way for if prices are expected to fall.
  • Number of suppliers - Simply put, more producers means more supply, less producers means less supply. 
  • Profitability of alternatives - If a substitute in supply is more profitable, supply for the good in question may fall. Alternatively, if a substitute in supply is less profitable, the good in questions supply may rise as the producer re-diverts resources. 
  • Profitability of goods in joint supply - Goods that are produced together mean if the profitability of the joint good rises then the supply of the good in question may also rise. Works the opposite way too.

As with demand, there can either be a movement along the supply curve or a shift in the supply curve. 

A change in price will mean a movement along the supply curve. So, the supply curve will stay at the initial place of 'Supply 1' on the diagram and the point supplied will just move up or down that curve. If any of the other determinants of supply stated above change then we can expect a shift in supply. A shift to the right, 'Supply 1' to 'Supply 2' on the diagram, shows an increase in supply. A shift to the left, 'Supply 1' to 'Supply 3' on the diagram, shows a decrease in supply. A movement along the curve is known as a change in the quantity supplied whereas a shift in the supply curve is known as a change in supply.

There we have it, a recap on the basics of supply. Next to come in terms of principles of economics will be marginal utility theory, so stay tuned for that! Thanks for reading and have a good day.


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