UNIT – 3 : SUPPLY

 LEARNING OUTCOMES
At the end of this Unit, you should be able to:
 Explain the meaning of supply.
 List and provide specific examples of determinants of supply and elasticity of supply.
 Describe the law of supply.
 Describe the difference between movements on the supply curve and shift of the supply curve.
 Explain the concept of elasticity of supply with examples.
 Illustrate how the concepts of demand and supply can be used to determine

 Meaning of Supply
The term ‘supply’ refers to the amount of a good or service that the producers are willing and able to offer
to the market at various prices during a given period of time.
The term supply shows the following features:
(1) Supply of a commodity is always with reference to a Price.
(2) Supply of a commodity is to be referred to In a given period of time.
(3) Supply of a commodity depends on the Ability of seller to supply a commodity However, ability of
a seller to supply a commodity depends on the stock available with him.
(4) Supply of a commodity also depends on the Willingness of seller to supply a commodity. A seller’s
willingness to supply a commodity depends On the difference between the reservation price and the
prevailing market price.

 Three important points apply of supply:

(i) Supply refers to what a firm offer for sale in the market, not necessarily to what they succeed in
selling. What is offered may not get sold.
(ii) Supply requires both willingness and ability to supply. Production cost is often the primary
influence on ability.
(iii) Supply is a flow. Supply is identified for a specified time period. The quantity supplied is ‘so much’
per unit of time, per day, per week, or per year.

1 Supply
 Questions for Practice

Question The quantity supplied of a good or service is the amount that

(a) is actually bought during a given time period at a given price
(b) producers wish they could sell at a higher price
(c) producers plan to sell during a given time period at a given price
(d) people are willing to buy during a given time period at a given price

Question Supply is a _________ concept.

(a) Stock (b) Flow and Stock (c) Flow (d) None of the above

 Determinants of Supply :
Although price is an important consideration in determining the willingness and desire to part with
commodities, there are many other factors which determine the supply of a product or a service. These are
discussed below:

 Price of the Commodity:

 Other things being equal the supply of a commodity is DIRECTLY related with its price.
 It means that, larger quantity of a commodity is offered for sale at higher price and vice versa.
 This is because the profits of the firm increases if the price of its product increases.

 Price of the Related Commodities :

 The supply of a commodity also depends on the prices of related commodities i.e. substitute goods
and complementary goods.
 Other things being equal, if the price of a substitute goes up, the firms will be tempted to produce
that substitute to get higher profits. Example – If the price of coffee rises, the firm would reduce the
quantity supplied of tea.
 On the other hand, other things being equal/if price of a complementary good goes up, the supply of
the product in question also rises. Example – If the prices of fountain pens rise, it may cause an
increase in the supply of ink.

 Prices of factors of Production :

 Supply of a commodity depends on the cost of production. The cost of production itself depends
upon the prices of various factors of production.

2 Business Economics
  So, if the price of any factor of production rises, the production costs would be higher for the same
level of output (and vice versa), Hence the supply will tend to decrease.
 Conversely, a fall in the cost of production tends to increase the supply.

 State of technology :
 A change in technology affects the supply of commodity.
 A technological progress and improvement in the methods of production increases productivity,
reduce the cost of production and increases the profits. As a result more is produced and supplied.
 Also discoveries and innovations bring new variety of goods.

 Objectives of the firm :

 The objectives of the firm and business policy pursued by it also affect the supply of the product
produced by it.
 Some firms believes in higher margin of profits and lower turnover while others believe in lower
margin of profit and higher turnover (Le. sales) to capture the market or to improve status, goodwill
and prestige in the market.

 Government Policy:
 The supply of a commodity is also affected by the economic policies followed by the Government.
 The Government may impose taxes on commodities in the form of excise duty, sales tax and import
duties or may give subsidies.
 Any increase in such taxes will raise the cost of production and so the quantity supplied will fall.
Under such conditions supply will increase only when its price in the market rises.
 Subsidies reduce the cost of production and thus encourages firms to produce and sell more.

 Expectations:
Choices of firms in respect of selling the product now or later depends on expectations of future prices.
Sellers compare current prices with future prices. An increase in the anticipated future price of a good or
service reduces its supply today; and if sellers expect a fall in prices in future, more will be supplied now.

 Number of Sellers:
If there are large number of firms in the market, supply will be more. Besides, entry of new firms, either
domestic or foreign, causes the industry supply curve to shift rightwards.

3 Supply
 Time:
 Supply is a function of time also.
 In a short period, it is not possible to adjust supply to the conditions of demand.
 If the time period is sufficiently long, all possible adjustments can be made in the production
apparatus and the supply can be fully adjusted to demand.

 Other Factors
Supply of a commodity also depends upon Natural conditions like rainfall, temperature, etc.; industrial
and foreign policies, infrastructural facilities; War; market structure; etc.
Questions for Practice

Question An increase in the number of sellers of bikes will increase the.

(a) The price of a bike (b) Demand for bikes
(c) The supply of bikes (d) Demand for helmets

Question Which of the following statements is correct?

(a) When the price falls the quantity demanded falls
(b) Seasonal changes do not affect the supply of a commodity
(c) Taxes and subsidies do not influence the supply of the commodity
(d) With lower cost, it is profitable to supply more of the commodity

Relation between supply and factors affecting supply (Summary)

Factors affecting individual supply Relation between supply & factor
Price Positive
Stock Positive
Time Positive Relation
Cost of Production Inverse Relation
Improved Techniques of Production Positive Relation
Infrastructure Positive/Inverse Relation
Weather conditions Positive/Inverse Relation
Taxation policy Positive/Inverse Relation
Monetary Policy Positive/Inverse Relation
Trade policy Positive/Inverse Relation
Natural Resources Positive/Inverse Relation

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 The Law of Supply:
 The law of supply is explained by Dr. Alfred Marshall.
Law of Supply express the nature of functional relationship between the price of a commodity and its
quantity supplied
 “The Law of Supply states that at a higher price seller will supply more and at a lower price seller
will supply less.
 Thus, there is DIRECT RELATIONSHIP between supply and price.
 It is assumed that other determinants of supply are constant and Only price is the variable and
influencing factor. Thus, the law of supply is based on the following main assumptions:-
 Cost of production remains unchanged even though the price of the commodity changes.
 The technique of production remains unchanged.
 Government policies like taxation policy, trade policy, etc. remains unchanged.
 The prices of related goods remains unchanged.
 The scale of production remains unchanged etc.
The law can be explained with the help of supply schedule and a corresponding supply curve.

 A supply schedule
Is the tabular presentation of the law of supply. It shows the different prices of a commodity and the
corresponding quantities that suppliers are willing to offer for sale, with all other variables held constant.

 The supply curve

Is a graphical presentation of the supply schedule.
The supply curve is thus a relationship between the quantity supplied and the price.

Price (Rs) (per kg) Quantity supplied (kg)

1 5

2 35

3 45

4 55

5 65

5 Supply
 Fig. 1 : Supply Curve
 Important note
 Features of Supply curve
(1) Supply Curve slopes upwards from left to the right.
(2) Supply Curve is positively sloped.
(3) Supply Curve may be sometimes a straight-line or sometimes a free hand curve.
(4) The sloping of the Supply Curve explains the Law of Supply, which describes a direct Price-Demand
relationship.
(5) The Market Supply Curve is a lateral summation (totalling) of Individual Supply Curves of all Producing
Firms, and also slopes upwards from left to the right.

Fig. 2
The market supply,
It is derived by adding the quantity supplied by each seller at different prices.
The market supply curve for ‘X’ can be obtained by adding horizontally the supply curves of various firms.

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 The market supply is governed by the law of supply and depends on all the factors that determine the
individual producer’s supply and, in addition, on the number of producers of the commodity in the
market.

 Movements on the Supply Curve – Increase or Decrease in the Quantity Supplied

Changes in Quantity Supplied OR Expansion & Contraction of supply OR Movement along a
supply curve
(a) When supply of a commodity changes only due to change in the price of commodity other
determinants remaining unchanged, it is called changes in quantity supplied.
 Changes in quantity supplied thus means -expansion of supply & contraction of supply
 When price of a commodity rises, quantity supplied also rises. This is called expansion of
supply.
 When price of a commodity falls, quantity supplied also falls. This is called contraction of
supply.
(b) As other determinants of supply like price of related commodities, prices of factors of production,
state of technology, etc. are assumed to be constant, the position of the supply curve remains the
same.
 The seller will move upwards or downwards on the same supply curve.

Fig. 3 : Figure Showing Change in Quantity Supplied as a Result of Price Change

Shifts in Supply Curve – Increase or Decrease in Supply

 Changes in supply OR Increase and decrease in Supply OR Shift in Supply curve

(a) When there is change in supply due to change in factors other than price of the commodity, it is
called changes in supply.

7 Supply
  It is the result of change in technology, govt. policies, prices of related goods etc.
 Change in supply means- increase in supply & decrease in supply.
 Price remaining the same when supply rises due to change in factors other than price, it is
called increase in supply.
 Likewise, price remaining the same when supply falls due to change in factors other than
price, it is called decrease in supply.
(b) In this case the supply curve shifts from its original position to rightward when supply increases
and to leftward when supply decreases.
 Thus, change in supply curve as a result of increase and decrease in supply, is technically
called shift in supply curve.

Fig. 4: Shifts in Supply Curves

Questions for Practice

Question When supply curve moves to the left, it means

(a) lesser quantity is supplied at a given price
(b) larger quantity is supplied at a given price
(c) prices have fallen and quantity is supplied at a lower price
(d) none of the above

Question When supply curve moves to right, it means

(a) supply increases and more quantity is supplied at a given price
(b) supply decreases and less quantity is supplied at a given price
(c) supply remains constant at a given price
(d) none of the above

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Question The supply curve shifts to the right because of
(a) improved technology
(b) increased price of factors of production
(c) increased excise duty
(d) all of the above

 Elasticity of Supply :
 Meaning :
Price elasticity of supply measures the degree of responsiveness of quantity supplied of a
commodity to a change in its own price.
 In other words, the elasticity of supply shows the degree of change in the quantity supplied in
response to change in the price of the commodity.
 Elasticity of supply can be defined “as a ratio of the percentage change in the quantity
supplied of a commodity to the percentage change in its own price”.
 Formula:
Percentage change in quantity supplied
ES 
Percentage change in Price

Change in quantity supplied

quantity supplied
Change in price
Price
Where q denotes original quantity supplied.
Δq denotes change in quantity
supplied. P denotes original price.
Δp denotes change in price.

Example
(a) Suppose the price of commodity X increases from Rs 2,000 per unit to Rs 2,100 per unit
and consequently the quantity supplied rises from 2,500 units to 3,000 units. Calculate the
elasticity of supply.
Here ∆q = 500 units ∆p = Rs.100
p = Rs. 2000 q = 2500 units
500 2000
 Es =  4
100 2500
Elasticity of Supply = 4

9 Supply
 Types of Supply Elasticity
The elasticity of supply can be classified as under:
(i) Perfectly inelastic supply: (Es = 0.)
If as a result of a change in price, the quantity supplied of a good remains unchanged,
Example – If price rises by 20% and the quantity supplied remains unchanged then Es = 020 = 0.
In this case, the supply curve is a vertical straight line curve parallel to Y-axis as shown in the figure.

Fig. 5: Supply Curve of Zero Elasticity

(ii) Relatively less-elastic supply: 0 < Es < 1
When a big change in price leads to small change in quantity supplied, then supply is said to
relatively inelastic or less elastic.
Example – If price rises by 30% and supply rises by 10% then, Es = 10/30 = 1/3.
The coefficient of elasticity would be somewhere between ZERO and ONE. The supply curve in
this case has steep slope as shown below –

Fig. 6 : Showing Relatively Less Elastic Supply

(iii) Relatively greater-elastic supply :(Es > 1):
When a small change in price leads to big change in quantity supplied, then the supply is said to be
relatively or more elastic.

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 Example – If price rises by 10% and supply rises by 30% then, 30 Es = 30/10 = 3 > 1.
The elastic supply curve is flatter as shown below-

Fig. 7 : Showing Relatively Greater Elastic Supply

(iv) Unit-Elastic(Es = 1).
The percentage change in quantity is equal to the percentage change in price.
Unit elasticity is essentially a dividing line or boundary between the elastic and inelastic ranges.

Fig. 8: Showing Unitary Elasticity

(v) Perfectly elastic supply:
(Es = ∞):
When with no change in price or with very little change in price, the supply of a commodity expands or
contracts to any extent, the supply is said to be perfectly elastic. In this case, the supply is a horizontal
straight line and parallel to X-axis

11 Supply
 Fig. 9: Supply Curve of Infinite Elasticity

Questions for Practice

Question A vertical supply curve parallel to Y axis implies that the elasticity of supply is :

(a) Zero (b) Infinity

(c) Equal to one (d) Greater than zero but less than infinity

Question A horizontal supply curve parallel to the quantity axis implies that the elasticity of supply is :

(a) Zero (b) Infinity

(c) Equal to one (d) Greater than zero but less than infinity

Question Elasticity of supply is greater than one when

(a) Proportionate change in quantity supplied is more than the proportionate change in price.

(b) Proportionate change in price is greater than the proportionate change in quantity supplied

(c) change in price and quantity supplied are equal

(d) None of the above

 Measurement of supply-elasticity:

The different methods of measuring price elasticity of supply are:

 The Percentage or Ratio or Proportional Method,

 The Point or Geometric Method, and
 The Arc Method

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(1) The Percentage Method:
Thus method is based on the definition of elasticity of supply. The coefficient of price elasticity of supply
is measured by taking ratio of percentage change in supply to the percentage change in price. Thus, we
measure the elasticity by using the following formula
 If the coefficient of above ratio is equal to One, the supply will be unitary
 If the coefficient of above ratio is More than one, the supply is relatively elastic
 If the coefficient of above ratio is Less than one, the supply is relatively inelastic.

Question If price of computers increases by 10% and supply increases by 25%. The elasticity of supply is :
(a) 2.5 (b) 0.4
(c) (–)2.5 (d) (–) 0.4

 Point elasticity Method of derivative

The elasticity of supply can be considered with reference to a given point on the supply curve or between
two points on the supply curve.
Point-elasticity of supply can be measured with the help of the following formula:
dp p
ES  
dp q

Example :
The Supply function is given as q = -100 + 10p. Find the elasticity of supply using point method,
when price is Rs 15.
Solution :
dp p
ES  
dp q

dp
Since = 10, p = Rs. 15, q = – 100 + 10 (15)
dp

q = 50
15
 Es = 10 ×
50
Or Es = 3

13 Supply
 dp
Where is differentiation of the supply function with respect to price and p and q refer to price
dp
and quantity respectively.
Arc-Elasticity: Arc-elasticity i.e. elasticity of supply between two prices can be found out with the
help of the following formula:
Q2 - Q1 P2 + P1
Es = ×
Q2 + Q1 P2 - P1

Where P1 Q1 are original price and quantity and P2 Q2 are new price and quantity supplied.
Thus, if we have to find elasticity of supply when P1 = Rs. 12, P2 = Rs. 15, Q1 = 20 units and
Q2 = 50 units. Then using the above formula, we will get supply elasticity as :
50 - 20 15 +12
Es = ×
50 + 20 15 -12
30 27
=   3.85
70 3
 Determinants of Elasticity of Supply
 Following are the general determinants of elasticity of supply:
(1) If increase in production causes substantial increase in costs, producers will have less
incentive to increase quantity supplied in response to increase in price and therefore, price
elasticity of supply would be less. If there are constant costs or negligible rise in costs as
output increases, supply will be elastic. Products that involve more complex production
processes or require relatively longer time to produce exhibit lower elasticity of supply. For
example the supply of aircrafts and cruise ships is less elastic compared to supply of motor
bikes.
(2) The longer the period of time, the more responsive the quantity supplied to changes in price
and the greater the supply elasticity. A shorter time period does not allow sellers sufficient
time to find resources and alternatives and to adjust their production decisions to changes in
price. In the long run, firms can build new plants or new firms may be able to enter the
market and increase the supply.
(3) Supply is more elastic when there is large number of producers and there is high degree of
competition among them. Supply elasticity is also higher when there are fewer barriers of
entry into the market.
(4) Supply will be elastic if firms are not working to full capacity. If spare production capacity
is available with the firms, they can increase output without a rise in costs. The greater the
spare capacity available, the greater will be the elasticity of supply.

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 (5) If key raw materials and inputs are easily and cheaply available, then supply will be elastic.
If drawing productive resources into the industry is easier, the supply curve is more elastic.
In case it is difficult to procure resources economically, the cost of production increases and
supply will become less elastic.
(6) If firms have adequate stocks of raw materials, components and finished products, they will
be able to respond with higher supply as price rises. Generally, those commodities which
can be easily and inexpensively stored without losing value may have elastic supply.
(7) The ease with which factor substitution can be made and the costs of such factor
substitution also determine price elasticity of supply. If the factors of production used in the
production of the commodity are commonly available and can be easily substituted or
increased, then the firms will be able to produce quickly and respond to an increase in
price. If a production process involves use of materials which are in short supply, or those
that take longer delivery period or which are highly specialized, then supply elasticity will
be low. If the labour employed is scarce or are required to be highly skilled and specific and
if they require longer training period, then elasticity of supply will be low. For example,
physicians in healthcare industry and chartered accountants in accounting service.
(8) If both capital and labour are occupationally mobile, then the elasticity of supply for a
product is higher than if capital and labour cannot be easily switched. For example, a
printing press can easily switch between printing magazines and greeting cards. Similarly
falling prices of a particular vegetable encourage farmers to switch to the production of
another. Products which are more continuously produced have greater supply elasticity than
those which are produced infrequently.
(9) Expectations about future prices also affect elasticity of supply. Expectation of substantial
rise in prices in future will make the sellers respond less to a current rise in price.
 Equilibrium Price
(1) Equilibrium means a market situation where the quantity demanded is equal to quantity
supplied. Thus, the two factors determining equilibrium price are market demand and
market supply.
(2) Equilibrium price is the price at which the sellers of a good are willing to sell the quantity
which buyers want to buy. Thus, equilibrium price (also called market clearing price) is the
price at which demand and supply are equal.
(3) At equilibrium price both sellers and buyers are satisfied.
(4) At equilibrium price, there is neither SHORTAGE nor SURPLUS. So at equilibrium price,
market is said to be CLEARED.

15 Supply
 The determination of market price is the central theme of micro economic analysis. Hence, micro-
economic theory is also called price theory.
The following table presents the concept of the equilibrium price.
Table 11: Supply and Demand Schedule

Price (Rs) Quantity Demanded Quantity Supplied Impact on price

5 6 31 Downward

4 12 25 Downward

3 19 19 Equilibrium

2 25 12 Upward

1 31 6 Upward

The equilibrium between demand and supply is depicted in the diagram below.
Demand and supply are in equilibrium at point E where the two curves intersect each other.
It means that only at price Rs. 3 the quantity demanded is equal to the quantity supplied.
The equilibrium quantity is 19 units and these are exchanged at price Rs 3.
If the price is more than the equilibrium level, excess supply will push the price downwards as there
are few takers in the market at this price and vice versa.

Fig. 10: Equilibrium Price

 Market Equilibrium and Social Efficiency
Social efficiency represents the net gains to society from all exchanges that are made in a particular
market.
It consists of two components: consumer surplus and producer surplus.

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 Producer surplus is the benefit derived by producers from the sale of a unit above and beyond their
cost of producing that unit. This occurs when the price they receive in the market is more than the
minimum price at which they would be prepared to supply.
It is represented by the area above the supply curve and below the price line
Consumer surplus is a measure of consumer welfare It is represented by the area above the demand
curve and below the price line.

Fig. 11: Equilibrium Price and Social Efficiency

For all quantities below OQ, we find that there is a difference between the price that producers are
willing to accept for supplying the good and the price that prevails in the market (P).Producer
surplus disappears when market price is at equilibrium i.e the price at which sellers are willing to
offer for sale is equal to the price that they receive.
From figure 35, we find that at price P, when the market is in equilibrium, social efficiency is
achieved with both producers and consumers enjoying maximum possible surplus.

17 Supply