Supply - The Economic Lowdown Video Series

Hi, I’m Scott Wolla and this is the Economic Lowdown Video Companion. If you listened to Episode 7 in our podcast series, you’ll know it’s all 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.

For example, let’s say I own a firm that produces and sells widgets—a piece of hardware people used 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.

The law of supply says that as the price of a good or service rises, the quantity of the good or service also rises. Likewise, as the price of a good or service falls, the quantity of the good or service also falls.

Notice that I 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.

Picture This…

If we put the quantity of widgets on the X, or horizontal axis of a graph, and the price of widgets on the Y, or vertical axis, we can start to plot the relationship between the two variables.

I will only produce a larger quantity of widgets if the market price of widgets increases.

The same principle can be applied at each possible price, and by connecting the points on the graph, we’ll begin to see an upward-sloping line. 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 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. Or, consider a change of the cost 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. Other things that might cause a supply-curve shift to the right or to the left include a change in the number of producers in the market; government policies, such as taxes, subsidies and regulations; and expectation of future prices. We call these factors a change in market conditions.

Notice we have describe two types of movements: a shift along the curve that we call a change in the quantity supplied that reflects the change in price, and the shift of the curve that we call the change in supply that reflects in change in market conditions.

That’s all the time we have for today. Thanks for watching.This video is brought to you by the Federal Reserve Bank of St. Louis. For more information, visit us online at stlouisfed.org.