Theory of Demand and Supply

UNIT – 3 : SUPPLY

At the end of this Unit, you should be able to:

1. Explain the meaning of supply.

2. List and provide specific examples of determinants of supply and elasticity of supply.

3. Describe the law of supply.

4. Describe the difference between movements on the supply curve and shift of the supply curve.

5. Explain the concept of elasticity of supply with examples.

6. Illustrate how the concepts of demand and supply can be used to determine price.

SUMMARY

• Supply means the quantity of goods (or commodities) offered for sale at a particular price at a certain point of time. Supply always relates to price.

• The determinants of supply other than its own price are: prices of the related goods, prices of factors of production, state of technology, government policy and other factors.

• The law of supply states that when the price of the good rises, the corresponding quantity supplied increases and when the price reduces, the quantity supplied also reduces. There is a direct relationship between price and quantity supplied.

• The supply curve establishes the relationship between the amount of supply and the price. It is an upward sloping curve showing a positive relationship between price and quantity supplied.

• When the supply of a good increases as a result of an increase in its price we say that there is an increase in the quantity supplied and there is an upward movement on the supply curve. The reverse is the case when there is a fall in the price of the good.

• Elasticity of supply means the responsiveness of supply to change in the price of the commodity.

• The elasticity of supply can be classified in to perfectly inelastic supply, relatively less-elastic supply, relatively greater-elastic supply, unit-elastic and perfectly elastic supply.

• The measurement of supply-elasticity is of two types- point elasticity and arc-elasticity.

• Elasticity of supply can be considered with reference to a given point on the supply curve (point elasticity) or between two points on the supply curve (arc elasticity).

• The general determinants of elasticity of supply are change in costs as output changes, complexity of production processes, the time period, number of producers and degree of competition, barriers of entry into the market, availability of spare production capacity, availability and stocks of key raw materials and inputs, the ease of factor substitution and mobility and expectations about future prices

• Equilibrium price is one at which the wishes of both the buyers and the sellers are satisfied. At this price, the amount that buyers want to buy and sellers want to sell will be equal.

• The welfare gain to producers is producer surplus, which 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 they would be prepared to supply for.

• At equilibrium price, when the market is in equilibrium, social efficiency is achieved with maximum social surplus to both producers and consumers enjoying maximum possible surplus..