Volume 1, Episode 7
The seventh episode of our podcast series discusses the supply side of the market - the law of supply, slope of the curve and the difference between a change in supply and a change in quantity supplied.
Watch the video version of this podcast.
The Economic Lowdown Podcast Series
Today I'm talking about supply.
Economists define supply as the quantity of a good or service that producers are willing and able to offer for sale at each possible price during a given time period.
Understanding the concept of supply provides some insight into the behavior of sellers. For example, imagine I own a firm that produces and sells widgets-a piece of hardware people buy to improve the performance of their computers. My objective as a business owner is to make a profit, which is the difference between my cost of producing the widgets and the price that I receive for selling the widgets to buyers.
I will only produce a larger quantity of widgets if the market price of widgets increases.
This relationship is called the law of supply by economists. Simply stated, the law of supply says that as the price of a good or service rises, the quantity of the good or service supplied also rises. Likewise, as the price of a good or service falls, the quantity of the good or service supplied falls. Notice that we included only two variables, price and quantity. That's all the law of supply does; it states how a change in the price of a good or service will affect the quantity supplied
In fact, if we put the quantity of widgets on the x- (horizontal) axis of a graph and the price of widgets on the y- (vertical) axis and plot the information we just discussed, we would start to see a visual relationship between the two variables: The line that is created when we connect the points on the graph slopes upward. The upward slope means that there is a direct relationship
between price and quantity supplied: When price rises, the quantity supplied rises, and when price falls, the quantity supplied falls. In fact, we could recreate this same scenario with almost any good or service and get the same result-an upward-sloping line. This upward-sloping line is called a supply curve
The supply curve is a helpful tool, but it is not static (or unchanging). It shifts back and forth as conditions in the market change. For example, if a new technology allowed me to produce widgets at a substantially lower cost than my current production cost, the increased profit would cause me to increase my production of widgets. In this case, the original supply curve no longer tells the whole story: It must be shifted to the right to accurately reflect the new widget supply. Or put another way, the widget supply curve shifted to the right because the quantity of widgets supplied by me-and other widget sellers-would be greater at each of the given prices.
What Things Change the Supply Curve?
There are several reasons a supply curve might shift to the left or the right. In each of the following examples, imagine that the price of widgets remains constant but something else in the market changes.
- A change in the costs of inputs to the production process. Let's assume that widgets are made of copper. If copper prices rise, my cost of producing widgets would rise as well. This higher cost of production would mean that my profits—the difference between my costs and the price—would be lower than before, so I would produce and sell fewer widgets. Other widget producers would likely do the same. This would shift the widget supply curve to the left.
- A change in technology. Generally speaking, improvements in technology will lower my production costs. Lower production costs mean my profit—my incentive—will increase. As a seller, I would respond by offering more widgets to the market. As other firms adopt the new technology, they would behave in a similar fashion, causing the supply curve to shift to the right.
- A change in the number of producers in the market. If more firms start producing widgets, the market supply of widgets will rise - shifting the supply curve to the right.
- Government policies. Government policies, such as taxes, subsidies, and regulations, all affect the cost of producing goods and services, which affects profits and-as a result-my production decisions. For example, imagine the government taxed every new widget that producers made; the result would be smaller profits. Smaller profits would cause me to decide to reduce the quantity of widgets I produce. Other widget producers would likely do the same. This would shift the widget supply curve to the left.
- Expectations of future prices. If widget prices are expected to increase in the near future, I might store much of my current production of widgets to take advantage of the higher future price - cutting back the supply for the short term. Other producers would react in a similar way. So, an expectation that prices will rise in the future causes supply to decrease today - causing the supply curve to shift left.
Notice two types of changes are occurring. The first is called a change in the quantity supplied, which is the result of a change in price. A change in quantity supplied is illustrated by shifting along the different points of the supply curve.
The second type is called a change in supply. The supply of a good or service changes not when the price of the good changes, but when something else in the market changes - for example, changes in production costs, technology, number of suppliers, or government policies. These market changes make the original supply curve irrelevant. A change in supply is illustrated by shifting the supply curve left or right.
To summarize, the law of supply describes the behavior of sellers. Generally speaking, suppliers offer more of a good at higher prices than they do at lower prices. When this relationship is graphed, the result is a supply curve. A change in price results in shifting along different points of the supply curve and is called a change in the quantity supplied. When factors in the market change, the supply curve shifts to the left or the right. We call this a change in supply.
Of course, supply is only one side of the market. The other side is demand and was the topic of our previous podcast. When we put supply and demand together, we get market equilibrium, which is the topic of our next podcast.