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Supply
Supply is the amount of a good or service that producers are willing and able to provide at a given price.
Supply has various determinants:
- Price. As price increases, the profit margin on an extra unit of production increases. This incentivises the firm to increase production to increase profits. So supply increases.
- Labour costs. Labour includes workers’ physical and mental abilities. If workers’ wages rise, this reduces firms’ profit margins. This lowers the incentive to supply, so supply falls. A similar thing happens if labour productivity falls – workers produce less output per unit of labour input.
- Other costs – this can include capital costs (machinery, factory building) or land / materials like steel and energy. Increasing costs reduces profit margins for additional units, reducing incentive to supply. So supply falls.
- Subsidies – a subsidy is a government payment to a firm. Subsidies reduce business costs, increasing profit margins. This incentivises firms to increase supply.
- Taxes – a tax is a payment to the government. For example a provider may have to pay the government £1 per unit of a good sold. Taxes raise the cost of supplying a good. Higher taxes increase business costs, reducing the incentive to supply, so supply falls.
- Weather – a bad weather event, such as drought, may reduce the supply of food.
While there are many other factors that can affect supply, these are some of the key determinants.
Supply curve
We established above that as price increases, supply increases.
The supply curve shows this relationship, as it is upward sloping.
Supply curve – movement along versus shift
If the price changes, there is a movement along the supply curve.
A price increase leads to a movement up and right along supply (we call this an “extension” in supply).
The opposite is called a “contraction” in supply.
If any determinant other than price changes, the supply curve shifts. For example a fall in wages shifts supply to the right. While an increase in costs, for example higher machinery costs, shift supply to the left.
Price elasticity of supply
Price elasticity of supply (PES) is the responsiveness of supply to a change in price.
The formula for PES is
$$\frac{% change in supply}{% change in price}$$
Different values of PES | Table
| PES type | Value of PES | Meaning |
| Perfectly inelastic | 0 | Supply is completely unresponsive to price changes. |
| Inelastic | Between 0 and 1 | Supply responds proportionally little to price changes. |
| Unitary | 1 | Supply responds to price in equal proportions. |
| Elastic | Above 1 | Supply is very responsive (proportionally) to price changes. |
| Perfectly elastic | Infinite | Supply is extremely* responsive to price changes |
A way to remember this:
- Elastic means responsive. Supply responds significantly to price changes.
- Inelastic means unresponsive. Supply responds only a little to price changes.
Price elasticity of supply diagrams
What determines the price elasticity of supply?
The MUST acronym helps remember the key four determinants of the PES:
- Mobility (and availability) of factors of production. The factors of production include labour, capital, land and enterprise. If factors can transition easily from producing one good to producing another, then the level of. production can change more easily. So the PES is more elastic.
- Unused capacity. If the firm has lots of unused capacity for production, the firm can more easily increase its production following a price rise. So the PES is more elastic.
- Stocks. If the firm has built up lots of the good or service in stock, then it can release these stocks to increase supply if needed. This makes supply more responsive to price changes. So the PES is more elastic.
- Time frame – short run versus long run.
- In economics, the short run means at least one factor of production is fixed – the amount of that factor cannot be changed.
- For example, imagine a firm can easily change the number of workers in the short run, but it takes time to build more factories – so the number of factories is fixed in the short run.
- As factors of production are less flexible in the short run, it is more difficult to increase production. So supply is less sensitive to price, so the PES is more inelastic in the short run.
- In the long run, all factors are variable – we can change the amounts of each factor of production.
- So production is more flexible – it is easier to achieve an increase in production if desired. So the PES is more elastic in the long run.
For labour supply elasticity, see this link.
Evaluation points for supply and PES
- Supply shifts depend on the proportion of that cost relative to firms’ total costs.
- For example, we know an increase in wages shifts supply left.
- But suppose firms in an industry do not rely on labour too much. Then the supply shift left is likely to be smaller.
- PES will vary by industry. For example due to time lags in agriculture (it takes time to plant a crop and let it grow), supply can be very price-in elastic in the short run.
- The cost of capacity or storage will be key in determining the PES. Cheap capacity allows firms to be more flexible in responding to a change in price.
- High capacity is typically more likely in a negative output gap (when low aggregate demand relative to long run aggregate supply, implying high spare capacity).
- Government policy can influence the PES.
- Consider migration policy. The easier it is to migrate into a country to work, the easier firms can hire workers. So firms can increase production more easily. Hence, supply is more price-elastic.
Related questions
Why is the price elasticity of supply important?
The price elasticity of supply determines the effects of subsidies and taxes for the government.
Suppose the PES is inelastic while the PED is elastic.
All else equal, the incidence (burden) of the tax will fall mostly on producers in this case.
Consumers can easily switch to other goods without facing the increased price, while producers do not have the flexibility to reduce production to escape paying the tax.
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