Supply Analysis
4.1 Supply
The supply of goods refer to the quantity offered for sale
in a given market, at a given time, at various prices.
Determinants of Supply
Supply of a product is influenced by various
factors like:
i)
Price of the commodity: Supply of a good
increases with a rise in its price, as the producer earn more profits at a
higher price, other things remaining the same.
ii)
Price of factors of production: An increase in the price
of one or more factors of production leads to a rise in the cost of production.
This reduces profitability. When cost of production increase, supply falls.
iii)
Price of related goods: If the
price of substitute goods increases, its quantity supplied shall be more than
the goods in question. Therefore, producers will tend to shift their resources
to the production of the substitute goods, provided other things remain the
same.
iv)
Government Policy: Different taxes
such as excise duty; sales tax, import duties etc. levied by the Government,
increases the cost of production, causing adverse impact on supply.
4.2 Law of Supply
There is a direct relationship between the price
and quantity supplied. When the price of a commodity increases, more profit can
be earned by producing and selling more. Similarly when the price, decreases,
profitability will be less and producer will be interested to sell less. So,
according to the law of supply, increase in price brings increase in supply or
vice versa.
Example
The law can be explained with the help of the
following example:
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Supply Schedule
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Price
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Quantity Supplied
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Rs.10/Kg.
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15 kg.
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Rs.12/Kg
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20 kg.
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Rs.15/kg.
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25 kg.
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Rs.17/kg.
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30 kg.
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Rs.19/kg.
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35 kg.
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Limitation of Law of Supply
i)
Climate
Condition: Supply of a commodity depends upon its production
which again depend on other factors mainly climate condition. It cannot be
enhanced, beyond a certain limit, therefore, the supply of such products will
always be restricted. Howsoever, their prices may increase.
ii)
Static situation: Law of
supply assumes only a static situation. It does not consider changes in the
factors affecting supply of a commodity, like income level, tastes and
preferences of buyers and sellers, change in the cost of factors of production,
change in the level of technology etc.
iii)
Anticipation of future price change: Law of supply is
not applicable if there is an expectation of price change of a commodity in
near future. If the price of a commodity declines, but there is a expectation
that the price will fall further, the supply of that commodity will not reduce;
rather it will increase because the producers would not like to store it for
future.
iv)
Artistic goods: Law of supply does
not apply on artistic goods, as the supply of these products cannot be changed
easily. So, price increase does not bring increase in supply.
Supply Curve Slope
Law of supply explains direct relationship between
price of a commodity and its supply. Supply of a commodity rises due to
increase in its price and declines on a decrease in its price. Due to a direct
relationship between price and supply of a commodity, supply curve slopes
upward.
(i)
When the price of a commodity rises, it
motivates the producers to produce and also sellers to sell more to earn more
profit.
(ii)
If the price of a commodity falls, producers
and sellers would like to reduce the supply as it will reduce their profit
margin.
4.5
Elasticity of Supply
Elasticity of Supply is the responsiveness of the quantity supplied of a commodity, due
to change in its price.
Elasticity
of Supply is defined as the percentage change in quantity supplied divided by
percentage change in price.
Formula
EP = (% Change in Quantity Supplied) /
(% Change in Price)
Symbolically,
EP = ∆q / ∆p x p /q
Here, q = quantity, p = price, ∆q = change in
supply quantity, ∆p = change in price
EP = Elasticity of Supply
Positive Sign: As per law of
supply, Price & Quantity are directly related. So, Elasticity will be positive.
Example
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Quantity
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Price
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% Change in qty Supplied = (800 – 500) /
500 = 60%
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500 units
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Rs.10
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% Change in Price = (15-10) / 10 = 50%
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800 units
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Rs.15
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So, EP = 60% / 50% = 1.2
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4.5.1
Types / Degrees of Elasticity of Supply
We
have five types of price elasticity of supply
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Coeff. of ES
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Types of ES
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Situation
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Shape of Supply Curve
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1. ES = 0
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Perfectly inelastic supply
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Occurs when to a percentage change in price,
there is no change in quantity supplied
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Parallel to price axis
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2. 0<ES<1
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Inelastic (or less than unitary elastic)
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Occurs when to a percentage change in price,
there is lesser change in quantity supplied
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Upward sloping originating from x-axis (intercept
on X axis)
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3. ES = 1
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Unitary elastic supply
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Occurs when to a percentage change in price,
there is equal change in quantity supplied.
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Upward sloping originating from origin
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4. 1<ES<µ
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Elastic (or more than unitary elastic) supply
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Occurs when to a percentage change in price,
there is more than proportionate change in quantify supplied.
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Upward sloping originating from negative of X
axis.
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5. ES = µ
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Perfectly elastic supply
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This occurs when there is infinite change in
quantity supplied at a price
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Parallel to quantity axis.
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4.5.2 Measurement of Elasticity of Supply
The elasticity of supply can be measured with reference
to a given point on the supply curve (point elasticity) or between two points
on the supply curve (Arc elasticity).
(i)
Point elasticity: Point elasticity can be measured with the help of the following
formula:
Es = (dq / dp) x (p/q)
Where, dq / dp = differentiation of quantity with respect to price, p =
price, q =quantity.
(ii)
Arc elasticity: In this method the average of the two prices and two quantities is
used;
Es = {(q2 –q1) /(q2 + q1)}
x {(p2 – p1) / (p2 + p1)}
Where, p2 = new
price, p1= original price, q1 = new quantity supplied, q2
= original quantity supplied
Example
Original price Rs.800/-,
New Price Rs.1,000/-, Original Quantity 4,000 kg, New Quantity 5,000 kg.
Elasticity of supply
under Arc elasticity method is computed as
Es = {(5,000 – 4,000) / (5,000 + 4,000)}
x {(1,000 – 800) / (1,000 + 800)}
=
{(1,000/9,000) x (200/1,800)} = 1/81 = .0123 = 1.23%
4.5.3 Determinants of Elasticity of Supply
Different types of factors influence the elasticity
of supply, such as,
(i)
Future price expection:
If firms expect the prices to rise in future, they may hold the stocks of the
commodity and not make available for sale in the market. In this situation,
supply would be inelastic. Similarly when prices are expected to fall in
future, supply would be elastic.
(ii)
Techniques of production:
If production and supply of goods require, simple technique, then supply can
easily be increased in response to a change in its price. So it will have
elastic supply. If the production technique of a commodity is complicated and
time consuming, it would not be possible to change the supply in response to
varying price-demand condition. Therefore, in this situation supply will be
elastic.
(iii) Nature of the commodity:
Perishable commodities have inelastic supply as their supply cannot be
increased substantially as a result of a change in their prices. Durable goods
on the other hand, generally have elastic supply.
(iv) Time-factor:
Longer the time period involved in the production of a commodity, more is the
time available for changing the size of plant and making other cost adjustments.
Consequently, more elasticity of supply of the commodity would be more. On the
other hand, shorter the time period involved in production, more inelastic the
supply of a commodity would be.
4.6
Change in Supply
Change in supply means the change in supply of a
commodity due to
a.
Change in price alone (causes expansion &
contraction of supply, known as Movement of Supply Curve)
b.
Change in factors other than price (causes Increase
& decrease of supply, known as Shifting of Supply Curve)
4.6.1
Movement in Supply Curve
This is caused by change in Supply due to price
alone
Expansion
of supply: When supply of a commodity increase on increase in
its price, it is called expansion of supply. It is shown by upward
movement of supply curve.
Contraction
of supply: When supply of a commodity decrease on fall in its
price, it is called contraction of supply. It is shown by downward
movement of supply curve.
4.6.2
Shifting of Supply Curve
When the supply changes due to change in factors
other than price, (like change in income, change in taste etc.), it makes the
supply curve shift either leftward or rightward of the original supply curve.
This is called shifting of the supply curve.
Due to upgradation of
technology, the supply curve will shift
to right.
a.Increase
in Supply: When supply of a commodity increase due to change
in any factor other than price, it is called increase in supply. It is shown by
rightward shift of supply curve.
Important causes for
increase in supply
(i)
Improvement in technique of production.
(ii)
Fall in price of substitute goods
(iii)
Fall in cost of production
(iv)
Favourable changes in govt policy.
(v)
Fall in the expected price of the good.
b.Decrease
in Supply: When the supply of a commodity decrease due to a
change in any factor other than price, it is shown called decrease in supply.
It is shown by leftward shift of the supply curve.
Important causes for
decrease in supply
(i)
Obsolete technique of production
(ii)
Increase in price of substitute goods.
(iii)
Increase in the cost of production.
(iv)
Increase in the expected price of the good.
(v)
Unfavourable changes in govt. policy.
c.Distinction between
movement & shifts in the supply curve
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Movement along a supply curve
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Shifts in the Supply Curve
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A rise or fall in supply due to change in price
is called extension or contraction of supply respectively. When we show them
graphically, it means movement along a supply curve.
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The shifts in supply curve reflects increase or
decrease in supply.
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There are two types of movements:
(i)
Upward movement (expansion of supply).
(ii)
Downward movement (constraction of supply).
Thus, under movements along the same supply
curve, extension and contraction of supply are shown
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There are also two types of shifts in supply
curve
(i)
Rightwards shift (increase in supply curve)
(ii)
Upward shift that indicates decrease in supply.
Thus, under shifts in the
supply curve, increase and decrease of supply are shown.
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The producer / seller is under the influence of
change in price of the commodity only.
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The producer is under the influence of factors
other than price.
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