# Chapter 3: Supply Analysis

3.1 Definition of Supply

Individual supply refers to the quantity of a given commodity that a producer is willing and able to sell at a given price over a specific time period. Market supply refers to horizontal summation of individuals producers/firms supply in the market. The supply schedule and the supply curve demonstrate the relationship between market prices and quantities that suppliers are willing to offer for sale. Supply differs from “existing stock” or the amount available because it is concerned with amounts actually brought to the market.

The basic law of supply states that, “a greater quantity will be supplied at a higher price than at a lower price”, holding other factors An individual producer’s supply schedule shows alternative quantities of a given commodity that a producer is willing and able to sell various alternative prices for that commodity ceteris paribus (other things remaining constant).

3.2 Factors Affecting Supply

The factors affecting supply also refers to the determinants of supply. They are factors that affect the supply of a product in the market. Generally, the supply of a product is influenced by the following factors:

1) Price of the good

As the price of a given commodity say X rises, with the costs and the prices of all other goods remaining unchanged, the production of commodity X becomes more profitable. The existing firms are therefore likely to expand their profit and new firms are to be attracted into the industry. It should be noted however, that not just the current rise but also expectations concerning the future increases prices may motivate producers. The total supply of goods is expected to increase as the prices rise.

Prices of other related goods

Changes in the prices of other commodities may affect the supply of a commodity whose price does not change.

• Substitutes: two goods X and Y are said to be substitutes in production if the supply of good X is inversely/negatively related to the price of Y. For instance barley and wheat or tea and coffee. If a firm producing both tea and coffee notices that the price of tea is rising may decide to allocate more resources to tea at the expense of coffee. The supply of coffee will therefore fall as the price of tea increases. However, the movement of resource from one use to the other is dependent on the mobility of factors of production.
• Complementary goods: two goods X and Y are said to be complements if an increase in the price of X causes an increase in the supply of Y such as a vehicle and petrol.
• Jointly supplied goods: two goods X and Y are said to be jointly supplied if an increase in the price of X causes an increase in the price of Y such as petrol and paraffin. If the demand for petrol increases the supply of petrol will rise and at the same time the supply of paraffin will increase. N/B: The extent to which firms can move from one industry to another in search of higher profits depends on occupational and geographical mobility of the factors of production.

3) Prices of factors of production

As the prices of factors of production used intensively by producers of a certain commodity rise, so do the firm costs. This will cause the supply to fall since some firms will eventually leave the industry. Similarly, if the price of one factor of production, say land, increases, some firms may move out of the production of land intensive products into the production of goods that are intensive in other factors of production which are relatively cheaper. Finally other less efficient firms will make losses and eventually leave the market.

4) The state of technology

This refers to a society’s pool of knowledge concerning industrial activities and its improvements. Technological improvements or progress such as improvements in machine performance, management and organization or an improvement in quality of raw materials leads to lower costs through increased productivity and increases the profit margin in every unit sold. This leads to increase in supply.

5) Future expectations of price change

Supply of a good is not only influenced by the current prices but future expected price as well. For example, if the price of a good is expected to rise the firm may decide to reduce the amount of supply in the current period. This is to enable them pile stock which they can offer for sale when prices increase in the future. This is known as hoarding.

6) Government policies

There are various ways through which government policy can affect the supply of goods and salaries. They include:

• Through tax imposition on goods increases the cost of production hence decline in production and supply
• Through subsidies – a grant to citizens of a country which lowers the cost of production hence encourages production and increases in supply.
• Through price control, which can either be price minimization where prices are fixed above equilibrium, hence encouraging producers to produce more and increase in supply. It may be undertaken through price maximization where prices are fixed below equilibrium discouraging production hence decline in supply.
• Though quotas where the government puts restriction or limit production of various goods which leads to decline in supply.

7) Weather/climate

The supply of agricultural products is considerably affected by changes in weather conditions. Output in agriculture is subject to variations in weather from year to the next. An excellent growing season associated with favorable weather conditions will result in a bumper harvest leading to an increase in supply. An unfavorable season that results in a poor harvest may be viewed as an increase in the average costs of production because a given expenditure on inputs yields a lower input than it would in a good/ favorable season. A bad harvest is represented by a leftward shift of the supply curve.

8) Objectives of the firm

A business may pursue several objectives such as sales maximization, market leadership, quality leadership, survival, profit maximization, social responsibility. Firms with sales maximization as an objective aim at supplying greater quantities of its product than a firm aiming at profit maximization where the later supplies less quantities but at a higher price in order to maximize the profit.

9) Strikes/demonstrations

Incidence of strikes lead to a reduction in supply of a product. The supply of manufactured goods is particularly likely to be affected by industrial disputes because of generally stronger unions in the industrial sector.

3.3 Supply Curve Derivations

The market supply curve represents the alternative amount of a good supplied per period of time at various alternative prices by all the producers of goods in the market. The market supply of goods therefore will be influenced by all the factors that determine individual producer supply and all the number of producers of goods in the market. This concept is illustrated in Figure 2.10 It therefore follows that the market supply curve will have a gently slope than individual supply curves.

To derive the supply curve, we will consider the supply of tea for various prices. If the price of tea increases or decreases for some reason, the quantity supplied will change in line with the law of supply which states that an increase in the price of product leads to an increase of the quantities supplied, leading to a positively sloping supply curve from left to right. This law can be illustrated using the supply schedule and supply curve below:

 Quantity 5 8 9 11 12 15 Price 12 16 20 25 30 35

Quantity

As shown in the figure above, the supply curve is derived by joining points that show a combination of quantities supplied and prices of commodities. For example, at the price of \$12, the quantity supplied is 5 units. When the price rises to \$16, the quantity supplied increases to 8 units. This generates a positively sloping supply curve as indicated in the figure.

3.4 Shift and movement along the supply curve

a) Movement along the supply curve

The relationship between price of a commodity and quantity supplied give rise to a supply curve. Any changes in the price of a good causes change in the quantity supplied. This can be traced by the movement along supply curve as shown in the figure below. The movement from point A to B is caused by changes in price from P1 to P2 which bring fourth the movement along the supply curve. Therefore, a movement along the supply curve is brought about by a change in own price of a product.

An increase in price from P1 to P2 leads to a movement along the supply curve from point A to point B, which causes an increase in quantities supplied from Q1 to Q2.

b) Shift in the Supply Curve

A shift of supply curve is caused by a change in any other factors affecting supply other than the price of the goods. This shift indicates changes in supply as a result of e.g. advances in technology which makes it cheaper to produce goods and services and therefore their supply will increase. Similarly in case of an increase in cost of production will lead to a fall in quantity supplies as shown in Figure 2.12. A shift to the right from S1S1 to S3S3 shows a fall in supply.

3.5 Elasticity of Supply

Elasticity of supply refers to the measure of responsiveness of quantity supplied of a commodity to change in the factors affecting supply. Price elasticity of supply is the measure of responsiveness of quantity supplied of a commodity to change in its own price. It is abbreviated as ES and calculated as:

Elasticity of Supply will have a positive value because of the direct relationship between the price of the product and quality supplied.

• If ES is greater than 1, then the supply is said to be price elastic
• If ES < 1, then supply is price inelastic
• If ES = 1, then supply is unit elastic

Types of Price Elasticity of Supply

• Perfectly elastic supply
• Elastic supply
• Unit elastic supply
• Inelastic supply
• Perfectly inelastic supply

Factors Affecting Price Elasticity of Supply

1) Mobility of factors of production

If they are highly mobile then supply will be price elastic since more factors can be employed quickly when the prices increase thus increase in supply

2) The level of employment of resources

This refers to the utilization and allocation of resources. If the factors are fully utilized supply will be price inelastic due to the fact that all the facts are occupied and thus cannot be mobilized in order to increase supply. However if they are under employed, supply will be price elastic.

3) Production period

For products that take short period of time to produce their supply tend to be price elastic. While those that take a longer period will be price inelastic because it will take a while before the products can reach the market.

4) Nature of the commodity

Price elasticity of supply for perishable goods tend to be inelastic due to the fact that the goods do not respond to price fall as they cannot be easily stored. On the other hand supply for durable goods tend to be price elastic since they can be store when the price falls thus contracting supply.

5) Risk taking

If the entrepreneurs are willing to take risk then supply of the products will be price elastic. Risk taking will in return be determined by the prevailing conditions in the economy, e.g. political stability, security, government incentives, infrastructure, etc.

6) Level of stock

If the level of stock is high, the price elasticity will be price elastic because if the price of a good increases, more of the good will be supplied from the stock

7) Time period

Supply for most goods and services will tend to be more elastic in the long run than in the short run because producers need more time to reorganize factors of production so that they can increase supply of the products.

Importance of Price Elasticity of Supply

• If supply of a good is price elastic thus an increase in demand will benefit both the producer and consumer of products because the producer will be in apposition to supply relatively more of their products and consumer will eventually pay a relatively lower price.
• If the supply of a commodity is price inelastic, business may risk losing revenue when there is a fall in the price of their products. This is because they will be forced to sell their products at a loss or a reduced price margin, e.g. In the case of perishable goods, however in the supply of the goods is price elastic the business people may store their products when price fall thus contracting supply e.g. the case of durable goods.

Relationship between Total Revenue and Elasticity

• Elastic demand: Increase in price will reduce the total revenue while a fall in price increase the total revenue
• Inelasticity demand Increase in price will reduce the total revenue while a fall in price causes reduction in total revenue.
• Unit demand change in price will leave the price unchanged.

Application of Elasticity in Economic Policy Decisions

• Products/services pricing decisions
• Customer spending programs
• Production decisions
• Government policy orientation, e.g. Taxation policy evaluation programs, price control
• Price discrimination
• Shift of the tax burden