Supply Theory (NCUK) PDF

International Supply Theory Foundation Year (NCUK) Microeconomics NCUK Guide  Learning Objectives Students should be able to: – Define supply – Explain why the supply curve slopes upwards – Construct a...

International Supply Theory Foundation Year (NCUK) Microeconomics NCUK Guide  Learning Objectives Students should be able to: – Define supply – Explain why the supply curve slopes upwards – Construct a supply curve from raw data – Identify the factors that cause shifts in the supply curve – Distinguish between movements along the supply curve Extensions / contractions – … and movements of the whole supply curve Supply Supply is the amount of goods or services producers plan to offer for sale at each given price level. When you think of supply think of firms, businesses, producers – the economic agents that are producing the goods or services to sell. Note in the definition that is says plan – just as we said with demand it is planned not actual supply. Consumers might not actually buy all of that the producers supply. Imagine your mum had a fantastic recipe for cakes and you thought that you could make some money by selling them at school. How would you decide the amount to sell and what would make you sell more? Supply We made some assumptions about consumers before when we were talking about demand. We now make some assumptions again about firm’s supply Firms’ main objective is to maximise profit – when thinking about how much to produce they will think about their production costs and the price they will receive for each unit – they will want to supply the amount that makes them most profit Firms will be incentivised to produce more if the selling price increases – potentially more profit will be available We will learn later that as companies produce more their costs will reduce due to economies of scale but there will come a point where the costs increase the more that is produced. If costs increase and the selling price remains the same then there will be less profit. Firms will need a higher price to make it worthwhile them supplying more For there to be an increase in supply the market may need more firms (maybe the existing firms are all working at capacity). For new firms to be attracted to the market there will need to be higher prices This is why we get an upward sloping curve  The Supply Curve  Remember with demand there was an inverse or negative relationship between demand and price and the curve went down?  With supply there is a positive relationship between price and the amount supplied – the higher the price the higher the supply so the curve goes upwards (to the sky!) Price Supply P2 P1 Supply to the Sky! P3 Q3 Q1 Q2 Quantity  Individual and Market Supply Each individual firm will decide how much to supply at a given price The example below shows two individual firms; one that produces 20 at £3 and another that produces 10 at £3 All the individual supply plans of firms at each price level can be added together to form the market supply curve Individual firm Individual firm supplies 20 cakes supplies 10 cakes Market supply P S P S P S £3 £3 £3 0 20 0 10 0 Q Q 30 Q  Individual and Market Supply The last curve shows the total of both individual firms (assuming there are only 2 in the market) – that is the market supply. The market supply therefore is the combined total of all the individual supply plans in that market. The total supply of tomato soup, for example, is the sum of all the different producers of tomato soup in the market - Heinz, Campbell's, Cross and Blackwell as well as all the other own brand labels. Individual firm Individual firm supplies 20 cakes supplies 10 cakes Market supply P S P S P S £3 £3 £3 0 20 0 10 0 Q Q 30 Q Movements along the supply curve Just as we saw in the demand curve movements along the curve are only caused by changes in price Because there is a positive relationship the price and quantity move the same way so If the price falls there will a fall in quantity supplied – there will be a contraction in supply Firms will supply less because there is less potential to make profit Price If the price increases Supply there will be an increase in quantity supplied – there will be P2 extension an extension of supply P1 Firms will supply contraction P3 more because there is more potential to make profit Q3 Q1 Q2 Quantity Movements along the supply curve. See if you can write a description of an extension Describing what is Price happening in the diagram Supply Extension – the price has increased from P1 to P2. This P2 has incentivised existing firms extension to supply more because they P1 contraction will make more profit or may P3 have encouraged new entrants. The quantity supplied has increased from Q1 to Q2 Q3 Q1 Q2 Quantity Movements along the supply curve. Now write a description of a contraction Describing what is Price happening in the diagram Supply Contraction – the price has fallen from P1 to P3. This has P2 made existing firms supply extension less because there is less P1 contraction profit to be made. Some firms P3 may have left the market. The quantity supplied has decreased from Q1 to Q3 Q3 Q1 Q2 Quantity Factors causing shifts in supply (the conditions of supply) So what causes the supply curve to shift? What makes a firm want to supply more (or less) at the same price? Well, its many things but just like shifts in the demand curve it is NEVER THE PRICE!! Think about the main assumption we make about a firm – it is a profit maximiser. So…what do you think would make it want to supply more or less if it is still getting the same price? Factors causing shifts in supply (the conditions of supply) There are so many but what you need to remember is that the majority of them affect the production costs of a firm Changes to raw material prices Technology improvements Labour productivity Regulation and bureaucracy Wage rates Government subsidies Indirect taxes Expectations about future prices Objectives of sellers in the market Other things could be a bumper harvest, new discoveries of oil or precious metals etc  An outward shift in the Supply Curve An outward shift or a shift to the right means that there is an increase in supply at every given price level Sometimes when we draw this Price S1 diagram it visually looks like the S2 supply curve is lower but don’t be fooled into thinking the supply is less. Always look at the affect on the quantity and remember if P1 the curve moves to the Right the supply is moRe Again, be careful with your wording – there is an increase in supply (not quantity supplied because 0 Q1 Q2 Quantity that is a movement along the curve  An outward shift in the Supply Curve Describing what is happening in the diagram Lets say that this increase in supply has been caused by improvements in Price technology. S1 S2 An improvement in technology has meant that firms can produce more efficiently and at less cost. This means that they can produce more at every P1 given price level and will do so because they will make more profit. Originally at P1 the market produced Q1. Since the technology improvement the market is producing Q2 at the same price of P1 0 Q1 Q2 Quantity  An inward shift in the Supply Curve An inward shift or a shift to the left means that there is less supply at every given price level Price S2 S1 The curve moves to the Left so the supply is Less P1 Q2 Q1 Quantity  An inward shift in the Supply Curve Describing what is happening in the diagram Lets say that this fall in supply has been caused by an increase in the Price S2 costs of raw materials. S1 An increase in the costs of raw materials has meant that the production costs of firms has increased and less profit will be P1 made if the price remains the same. Because the firms are profit maximisers they will produce less at every given price level. Originally at P1 the market produced Q1. Since the increase in raw material costs the market is producing Q2 at Q2 Q1 Quantity the same price of P1  Factors affecting the market supply of milk What things do you think affect the market supply of milk The price of raw milk from farmers Productivity in milk industry The number of suppliers in the industry Costs of packaging and transportation Government subsidies to milk producers Diagram Practice