Supply Analysis PDF

4 Supply Analysis Introduction : Supply is a flow concept. It refers to the amount The study of supply is as important as of a commodity that the firms produce and offer the study of demand. Supply is a fundamental...

4 Supply Analysis Introduction : Supply is a flow concept. It refers to the amount The study of supply is as important as of a commodity that the firms produce and offer the study of demand. Supply is a fundamental for sale in the market over a period of time, say economic concept that describes the total amount a day, a week, a month or a year. of a specific good or service that is available to Stock Supply a seller. The total amount of goods or services available for sale at any specified price is known as supply. Concept of Total Output, Stock and Supply : Total Output : Output is produced in the process of production. “Total output can be defined as the sum total of the quantity of the commodity produced at a given period of time in the Fig. 4.1 economy.’’ Production leads to consumption. In Try this : the process of production inputs are converted Distinguish between stock and supply. into output or final goods. Stock : Definition of Supply : Stock is the total quantity of commodity According to Paul Samuelson, “Supply available for sale with a seller at a particular refers to the relation between market prices and point of time. It is the source of supply. It is the amount of goods that producers are willing potential supply. By increasing production, to supply.’’ stock can be increased. Without stock, supply Supply refers to the quantity of a commodity is not possible. Normally, stock exceeds supply that a seller is willing and able to offer for sale and it is fixed and inelastic. In case of perishable at a given price, during a certain period of time. goods such as milk, fish etc. stock may be equal For example, a farmer's total output of rice is to supply. On the other hand, for durable goods 4000 kgs. This is the total stock. If the price is ` such as furniture, garments etc. stock can exceed 40 per kg, he offers 1000 kgs for sale. This is the the supply. actual supply. Supply : Supply schedule : Supply is a relative term. It is always A supply schedule is a tabular representation expressed in relation to price, time and quantity. of the functional relationship between price and quantity supplied of a particular commodity. Meaning of Supply : The word ‘supply’ implies the various 1) Individual Supply Schedule : Individual quantities of a commodity offered for sale supply schedule refers to a tabular by producers during a given period of time at representation showing various quantities a given price. It is related to time and price. of a commodity that a producer is willing to 37  sell at various prices, during a given period schedule refers to a tabular representation of time. showing different quantities of commodity Table 4.1 which all producers are prepared to sell at Individual Supply Schedule different prices at a given period of time. Price of a commodity Supply of a commodity Table 4.2 x (in ` per kgs.) x (in kgs.) Market Supply Schedule 10 100 Price of Quantity supplied Market 20 200 commodity (in kgs.) supply (in `) (in kgs.) 30 300 Seller Seller Seller (A+B+C) A B C 40 400 10 100 200 300 600 50 500 20 200 300 400 900 Table 4.1 explains the functional 30 300 400 500 1200 relationship between price and quantity supplied 40 400 500 600 1500 of a commodity. Lower the price, lower the 50 500 600 700 1800 quantity of a commodity supplied and vice versa. At the lowest price of ` 10, supply is also In Table 4.2, market supply is obtained by lowest at 100 kgs. At the highest price of ` 50, adding the supply of sellers A, B and C at different quantity supplied is highest at 500 kgs. prices. At a highest price of ` 50, market supply Individual Supply Curve : It is a graphical is the highest at 1800 kgs. At a lowest price of presentation of individual supply schedule. ` 10 market supply is lowest at 600 kgs. Individual Supply Curve Market Supply Curve : It is a graphical SS = Individual Supply Curve presentation of market supply schedule. Y Market Supply Curve S SS = Market Supply Curve 50 Y S 40 50 Price in ` 30 40 Price in ` 20 30 10 20 S 0 100 200 300 400 500 X 10 S Quantity Supplied in kgs 0 300 600 900 1200 1500 1800 X Fig. 4.2 Quantity Supplied in kgs In figure 4.2, quantity supplied is shown on Fig. 4.3 the X axis and price on the Y axis. Supply curve In figure 4.3, quantity supplied is shown on SS slopes upwards from left to right, indicating the X axis and price on the Y axis. Supply curve a direct relationship between price and quantity SS slopes upwards from left to right, indicating supplied. a direct relationship between price and market 2) Market Supply Schedule : Market supply supply. 38  Try this : will reduce the supply and vice versa Draw a supply curve with the help of a 8) Other factors : It includes, hypothetical supply schedule. nature of the market, relative prices of other goods, Determinants of Supply : export and imports, 1) Price of commodity : Price is an important industrial relations, factor influencing the supply of a availability of factors of production etc. commodity. More quantities are supplied If all factors are favourable, supply of a at a higher price and less quantities are commodity will be more and vice versa. supplied at a lower price. Thus, there is Law of Supply a direct relationship between price and Introduction : quantity supplied. The law of supply is also a fundamental 2) State of technology : Technological principle of economic theory like law of improvements reduce the cost of production demand. It was introduced by Prof. Alfred which lead to an increase in production and Marshall in his book, ‘Principles of Economics’ supply. which was published in 1890. The law explains 3) Cost of Production : If the factor price the functional relationship between price and increases, the cost of production also quantity supplied. increases, as a result, supply decreases. Statement of the Law : 4) Infrastructural facility : Infrastructure “Other things being constant, higher the in the form of transport, communication, price of a commodity, more is the quantity power, etc. influences the production process supplied and lower the price of a commodity less as well as supply. Shortage of these facilities is the quantity supplied” decreases the supply and vice versa. In simple words, “other factors remaining 5) Government policy : Favourable constant, a rise in price results in a rise in the Government policies may encourage supply quantity supplied and vice-versa. Thus, there is and unfavourable government policies a direct relationship between price and quantity may discourage the supply. Government supplied. policies like taxation, subsidies, industrial Symbolically, policies, etc. may encourage or discourage Sx = f (Px) production and supply, depending upon S = Supply government policy measures. x = Commodity 6) Natural conditions : The supply of f = Function agricultural products depends on the natural P = Price of commodity conditions. For example, a good monsoon Assumptions of the law : and favourable climatic condition will The law of supply is based on the following produce a good harvest, so the supply of assumptions : agricultural products will increase and 1) Constant cost of production : It is assumed unfavourable climatic conditions will lead that there is no change in the cost of to a decrease in supply. production.A change in cost of production 7) Future expectations about price : If the will affect the profits of the seller. Therefore prices are expected to rise in the near future, less quantity will be supplied at the same the producer may withhold the stock. This price. 39 2) Constant technique of production : It is when price rises supply also rises and when also assumed that technique of production price falls supply also falls. Thus, there is direct does not change. Improved technique of relationship between price and quantity supplied production may lead to an increase in which is shown in following figure 4.4 : production. This in turn may lead to an Supply Curve increase in the supply at the same price. Y 3) No change in weather conditions : It is 50 S assumed that there is no change in the weather conditions. Natural calamities 40 Price in ` like floods, earthquakes etc. may decrease 30 supply. 20 4) No change in Government policy : It is also assumed that government policies like 10 S taxation policy, trade policy etc. remain unchanged. 0 100 200 300 400 500 X 5) No change in transport cost : It is assumed Quantity Supplied in kgs that there is no change in the condition of Fig. 4.4 transport facilities and transport cost. For In the figure 4.4, X axis represents quantity example, better transport facility increases supplied and Y axis represents the price of the supply at the same price. commodity. Supply curve 'SS' slopes upwards 6) Prices of other goods remain constant : from left to right which has a positive slope. It Prices of other goods are assumed to remain indicates a direct relationship between price and constant. If they change, the law of supply quantity supplied. may not hold true because producer may Exceptions to the Law of Supply : transfer resources to other products. Following are the exceptions to the law of supply: 7) No future expectations : The law also 1) Supply of labour : Labour supply is the assumes that the sellers do not expect future changes in the price of the product. total number of hours that workers to work Law of supply is explained with the help of at a given wage rate. It is represented the following schedule and diagram : graphically by a supply curve. In case of Table 4.3 labour, as the wage rate rises the supply Supply Schedule of labour (hours of work) would increase. So supply curve slopes upward. Supply of Price of commodity x Supply of commodity x (in `) (in kgs.) labour (hours of work) falls with a further 10 100 rise in wage rate and supply curve of 20 200 labour bends backward. This is because the 30 300 worker would prefer leisure to work after 40 400 receiving higher amount of wages. Thus, 50 500 after a certain point when wage rate rises Table 4.3 explains the direct relationship the supply of labour tends to fall. between price and quantity of commodity  It can be explained with the help of a supplied. When price rises from ` 10 to 20, 30, backward bending supply curve. Table no. 40 and 50, the supply also rises from 100 to 200, 4.4 and fig. no 4.5 explains the backward 300, 400 and 500 units respectively. It means, bending supply curve of labour. 40  Table. 4.4 Due to unfavourable changes in weather, Labour Supply Schedule if the agricultural production is low, their Wage rate (`) Hours of work Total amount supply cannot be increased even at a higher per hour per day of wages (`) price. 100 5 500 3) Urgent need for cash : If the seller is in 200 7 1400 urgent need for hard cash, he may sell his 300 6 1800 product at which may even be below the SAS1 = Backward bending market price. labour supply curve SA = Increasing supply curve 4) Perishable goods : In case of perishable AS1 = Leisure time goods, the supplier would offer to sell more Wage rate (`) per hour quantities at lower prices to avoid losses. For example, vegetables, eggs etc. 5) Rare goods : The supply of rare goods cannot be increased or decreased according to its demand. Even if the price rises, supply remains unchanged. For example, rare paintings, old coins, antique goods etc. Variations in Supply : Supply of Labour (hours of work) When quantity supplied of a commodity Fig. 4.5 varies due to change in its price, other factors In fig. 4.5, supply of labour (hours of remaining constant, it is known as variations work) is shown on X axis and wage rate in supply. There are two types of variations in per hour is shown on the Y axis. The curve supply : SAS represents backward bending supply 1) Expansion of supply : Expansion of supply curve of labour. Initially, when the wage refers to a rise in the quantity supplied due rate is ` 100 per hour, the hours of work is to a rise in the price of a commodity, other 5. The total amount of wages received is ` factors remaining constant. Expansion in 500. When wage rate rises from ` 100 to supply leads to an upward movement on the ` 200, hours of work will also rise from 5 same supply curve due to a rise in price. It is hours to 7 hours and total amount of wages shown in figure 4.6 would also rise from ` 500 to ` 1400. At this point, labourer enjoys the highest amount Expansion of supply i.e. ` 1400, and works for 7 hours. If wage Y SS = Supply Curve rate rises further from ` 200 to ` 300, total MN = Extension of supply amount of wages may rise, but the labourer will prefer leisure time and denies to work for extra hours. Thus, he is ready to work S Price only for 6 hours. At the point A, the supply P1 N curve bends backward, which becomes an M exception to the law of supply. P S 2) Agricultural goods : The law of supply does not apply to agricultural goods as they 0 Q Q1 X are produced in a specific season and their Quantity Supplied production depends on weather conditions. Fig. 4.6 41  In figure 4.6, quantity supplied is shown shifts to the right of the original supply on the X axis and price on the Y axis. Quantity curve. It is shown in figure 4.8 supplied rises from OQ to OQ1, with a rise in Increase in supply price from OP to OP1, resulting in an upward SS = Original supply curve Y movement from M to N along the same supply S1S1 = Shift in supply curve curve SS. It is known as Expansion of supply. 2) Contraction of supply : Contraction of S supply refers to a fall in the quantity supplied, Price S1 M N due to fall in the price of a commodity, P other factors remaining constant. In case of S contraction of supply, there is a downward S1 movement on the same supply curve. It is shown in figure 4.7 0 Q Q1 X Contraction of supply Quantity Supplied SS = Supply Curve Fig. 4.8 Y In figure 4.8, quantity supplied is shown on NM = Contraction of Supply the X axis and price on the Y axis. Supply rises from OQ to OQ1 at the same price OP, resulting S in an outward shift of the original supply curve to Price P N the right from SS to S1S1. It is known as Increase in supply. P2 M 2) Decrease in supply : Decrease in supply S refers to a fall in the supply of a given 0 Q2 Q X commodity due to unfavourable changes in Quantity Supplied other factors such as increase in the prices Fig. 4.7 of inputs, increase in tax rate, outdated In figure 4.7, quantity supplied is shown technology, strikes by worker, while price on the X axis and price on the Y axis. Quantity remains constant. The supply curve shifts supplied falls from OQ to OQ2 with a fall in to the left of the original supply curve. It is price from OP to OP2, resulting in a downward shown in figure 4.9 movement from N to M on the same supply curve Decrease in supply SS = Original supply curve SS. It is known as Contraction of supply. S2S2 = Shift in supply curve Changes in Supply : When other factors change and price remains constant, it is known as changes in supply. There Price are two types of changes in supply : 1) Increase in supply : Increase in supply refers to rise in the supply of a given commodity due to favourable changes in other factors such as fall in the price of inputs, fall in tax rates, technological upgradation etc., while Quantity Supplied price remains constant. The supply curve Fig. 4.9 42  In figure 4.9, quantity supplied is shown on machinery etc. the X axis and price on the Y axis. Supply falls Total Variable Cost (TVC) : Total variable from OQ to OQ2 at the same price OP, resulting costs are those expenses of production in an inward shift of the original supply curve to which are incurred on variable factors such the left from SS to S2S2. It is known as Decrease as labour, raw material, power, fuel etc. in supply. 2) Average Cost (AC) : Average cost refers to cost of production per unit. It is calculated You should know : by dividing total cost by total quantity of 1) Supply : Supply is a micro-economic production. concept. Supply refers to quantity of a TC AC = commodity that a seller is willing and able TQ to offer for sale at a particular price, during AC = Average cost a certain period of time. TC = Total cost 2) Aggregate supply : It is a macro-economic TQ = Total quantity concept. It refers to the minimum amount of For example, If the total cost of production sales proceeds which entrepreneurs expect of 40 units of commodity is ` 800 then the to receive from the sale of output at a given average cost is : level of employment. TC AC = TQ Concepts of Cost and Revenue : 800    = A) Cost Concepts : 40 When an entrepreneur undertakes an act    = ` 20 per unit of production, he has to use various inputs like 3) Marginal cost (MC) : Marginal cost is the raw material, labour, capital etc. He has to net addition made to total cost by producing make payments for such inputs. The expenditure one more unit of output. incurred on these inputs is known as the cost of MCn = TCn – TCn-1 production. Cost of production increases with an   n = Number of units produced increase in need of output. There are three types MCn = Marginal cost of the nth unit of costs which are as follows : TCn = Total cost of nth unit 1) Total Cost (TC) : Total cost is the total expenditure incurred by a firm on the factors TCn-1 = Total cost of previous units of production required for the production of If previous total cost of producing 4 units goods and services. Total cost is the sum is ` 200 and total cost of producing 5 units of total fixed cost and total variable cost at is ` 250, then : various levels of output. MCn = TCn – TCn-1 TC = TFC + TVC   = ` 250 – ` 200 TC = Total cost   = ` 50 TFC = Total Fixed Cost TVC = Total Variable Cost Find out : Total Fixed Cost (TFC) : Total fixed costs If a firm produces 600 units of a are those expenses of production which commodity in a day and incurs a total cost are incurred on fixed factors such as land, of ` 30,000. Calculate the Average Cost. 43 B) Revenue Concepts : For example, if the total revenue of 15 units, The term ‘revenue’ refers to the receipts is ` 3000, then average revenue is calculated as : obtained by a firm from the sale of certain TR AR = quantities of a commodity at given price in the TQ market. The concept of revenue relates to total 3000   = revenue, average revenue and marginal revenue. 15 1) Total Revenue (TR) : Total revenue is the   = ` 200 total sales proceeds of a firm by selling a 3) Marginal Revenue : Marginal revenue is commodity at a given price. It is the total the net addition made to total revenue by income of a firm. Total revenue is calculated selling an extra unit of the commodity. as follows : MRn = TRn – TRn-1 Total revenue = Price × Quantity MRn = Marginal revenue of nth unit For example, if a firm sells 15 units of a commodity at ` 200 per unit TR is calculated TRn = Total revenue of nth unit as : TRn-1 = Total Revenue of previous units TR = P × Q n = Number of units sold = ` 200 × 15 For example, if the previous total revenue = ` 3000 from the sale of 20 tables is ` 4000 and 2) Average Revenue (AR) : Average revenue that from the sale of 21 tables is ` 4200, is the revenue per unit of output sold. It is marginal revenue is calculated as : obtained by dividing the total revenue by MRn = TRn – TRn-1 the number of units sold.   = 4200 – 4000 TR   = ` 200 per table AR = TQ Find out : AR = Average Revenue TR= Total Revenue If a firm sells 400 units of a commodity TQ =Total Quantity at ` 10 unit. Calculate the TR and AR. EXERCISE Q. 1. Complete the following statements : b) decrease in supply 1) When supply curve is upward sloping, it’s slope c) expansion of supply is.............. d) increase in supply a) positive   3) A rightward shift in supply curve shows b) negative................ c) first positive then negative a) contraction of supply d) zero b) decrease in supply 2) An upward movement along the same supply c) expansion of supply curve shows................ d) increase in supply a) contraction of supply 4) Other factors remaining constant, when less 44  quantity is supplied only due to a fall in price, it Q. 5. Observe the following table and answer the shows................ questions : a) contraction of supply A) Supply schedule of chocolates b) decrease in supply Price in ` Quantity supplied in units c) expansion of supply 10 200 d) increase in supply 15 20 300 5) Net addition made to the total revenue by selling 25 350 an extra unit of a commodity is.................. 30 a) total Revenue 35 b) marginal Revenue 40 c) average Revenue 1) Complete the above supply schedule. d) marginal Cost 2) Draw a diagram for the above supply schedule. Q. 2. Complete the Correlation : 3) State the relationship between price and 1) Expansion of supply : Price rises :: Contraction quantity supplied. of supply : B) Observe the market supply schedule of potatoes 2) Total revenue : :: Average revenue : and answer the following questions. TR/TQ Price Firms Market 3) Total cost : TFC + TVC :: Average cost : in ` “A” “B” “C” supply (kg) 4) Demand curve : :: Supply curve : 1 20 45 100 2 37 30 45 Upward 3 40 55 135 5) : Change in supply :: Other factors 4 44 50 154 constant : Variation of supply 1) Complete the quantity of potato supplied by the Q. 3. Give economic terms : firms to the market in the above table. 1) Cost incurred on fixed factor. 2) Draw the market supply curve from the schedule 2) Cost incurred per unit of output. and explain it. 3) Net addition made to total cost of production. Q. 6. Answer the following questions : 4) Revenue per unit of output sold. 1) Explain the concept of total cost and total Q. 4. Distinguish between : revenue. 1) Stock and Supply. 2) Explain determinants of supply. 2) Expansion of Supply and Increase in Supply. Q. 7. Answer in detail : 3) Contraction of Supply and Decrease in Supply. 4) Average Revenue and Average Cost. 1) State and explain law of supply with exceptions.  45