Price of other related goods

Meaning of Supply

In a market sellers for products and services constitute

the supply side. Supply refers the amount of a good or service
that the producers are willing and able to offer at various prices
during a given period of time

Three points :
1. Supply refers to what a firm offer for sale in the market not
necessarily to what they succeed in selling
2. Supply requires both willingness and ability to supply.
Production cost is often the primary influence on ability
3. Flow concept – measured for a specified period of time.
may be a day, a week, a month, per year
Determinants of Supply
The following are the determinants of supply.
1. Price of the good
2. Prices of related goods
3. Prices of factors of production
4. State of Technology
5. Government policy
6. Nature of competition or size of industry
7. Expectations
8. Number of sellers.

Price of the commodity

1. Price of the commodity : Direct positive relationship. When Price increases
supply also increases and price falls supply also falls. There is a positive
relationship When price increases the expected profit is also high. Therefore
the sellers are willing to sell more. When price falls, the expected profits fall or
there may even loss. The sellers are willing to sell less.
Price of other related goods
The price of other related goods will also influence the supply
of a commodity. If the price of other related goods (y) increases, the
supply of X declines as the production and supply of Y is more
profitable. Likewise, if price of other related goods is less, the supply of
X increases, as the production of X is more profitable than production
of Y. Therefore the supply of X increases. Therefore, price of other
related goods and supply a commodity are inversely related.

Price of factors of production

Cost of production is a significant factor that affects supply of a
commodity. Any increase in the price of factors will cause increase in
the cost of producing a commodity. It will affect the profitability of
producing that good. Hence the producer will produce the products
whose factors price is less and therefore profitability is high. Price of
factors and supply of a commodity are inversely related.
Price of factors of production

Cost of production is a significant factor that affects supply of a

commodity. Any increase in the price of factors such as wages, price of
raw material, rent and interest, will cause increase in the cost of
producing a commodity and the producers are willing to supply less of
that commodity. It will affect the profitability of producing that good.
Hence the producer will produce the products whose factors price is
less and therefore profitability is high. Price of factors and supply of
a commodity are inversely related.
State of technology
Supply of a product depends upon the state of
technology. The use of new technology in an industry increases
production efficiency and reduce costs

Inventions and innovations(technology) tend to produce

more of a goods. Handloom, power looms and weaving mills. New
technology will increase the production. New machines introduced in
agriculture have increase in production
 Govt policy

Tax policy – Any increase in indirect tax will raise the cost of
production. Therefore, the is a decrease in supply.
Subsidy given by the government will reduce cost of production.
Therefore, the supply will increase.
Likewise the provision of tax holiday and tax rebate will also reduce
the cost of production which will increase the supply.
Import quota and inputs rationing will reduce supply.

Nature of competition and size of industry

Under competitive conditions supply is high. In
competitive market, there are large no of firms. As a result the
supply is high. In a monopoly market there is only one seller.
Hence the supply is less. Likewise, in case of oligopoly market,
there are few sellers, the supply will be less.
Expectations
Choice of firms in respect of selling the product now or
later depends on expectations of future price. Sellers current
prices and with future price. An increases in the anticipated
future price of a good or service reduces its supply today. If
sellers expect a fall in prices in future, now the supply will
increase now
Other factors :
Government’s industrial and foreign policies will
also influence the supply. It also depends upon the goals of the
firm. If the firms aim is sale maximization, then supply will
increase. Supply also depends upon infrastructural facilities
etc
Number of sellers

If there are large number of firms in the market, supply

will be more. Besides entry of new firms either domestic or
foreign causes the supply will increase

Other factors :
Government’s industrial and foreign policies will
also influence the supply. It also depends upon the goals of the
firm. If the firms aim is sale maximization, then supply will
increase. Supply also depends upon infrastructural facilities
etc
Law of supply

Law of supply: Law of supply explains the relationship

between Price and quantity supplied. When other things
remain constant, if the price of a commodity increases
the quantity supplied of a commodity also increases
and when price falls supply also falls. When price
increases the seller sells more in order to take the
advantage of higher profits. Hence he sells more. Thus there
is a positive relationship between price of a
commodity and its quantitative supplied.
Illustration of Law of supply

Supply schedule Supply schedule is a

table giving various prices
Quantity supplied and corresponding quantity
Price supplied. The table shows
10 100 that when price is Rs.10 the
supply is 100 units. When
8 80 price falls the supply also
falls. When Price is Rs.2, the
6 60 supply falls to 20. so
therefore there is a positive
4 40 relationship between price
and quantity supplied.
2 20
Diagrammatic illustration of Law of supply

The law of supply can also

be illustrated with the help of the
diagram. In this diagram x
represents number of units and
Y-axis represents price of the
commodity. Initially price is OP
and the quantity supplied is OQ.
When price increases to OP1 the
quantity supplied increases to
OQ1. Hence the supply curve
is upward sloping or it has
positive slope
Exceptions :

1. Expected change in the prices of the good

2. Perishable goods
3. Auction sale
4. Supply of labour

Expansion or contraction and increase and decrease in supply

Changes in Supply:
Changes in supply due to the change in the price of the
commodity is called as extension (expansion) and
contraction of supply. Changes in supply due to other
factors such as price of other goods, price of factors of
production etc. is called as increase and decrease in
supply.
Expansion or contraction in supply
The change in supply due to change in the price of that
commodity is shown with the same supply curve. Increase in price of
the commodity results in an upward or rightward movement on the
same supply curve. It is called as expansion of supply. Fall in price of
the commodity results in a downward or leftward movement on the
same supply curve. It is called contraction of supply. The following
diagrams illustrate expansion and contraction of supply.
Increase and Decrease in supply
Change in supply due to change in other factors except price of the
commodity is called increase and decrease in supply. When there is a change
in other factors and if the price remains constant, the change in supply can be
shown with the shift in the supply curve. If the supply curve shifts
rightwards or downwards it is called increase in supply. If the supply
curve shifts leftwards or upwards, it is called decrease in supply. It can
be illustrated with the help of following diagrams.

Increase in supply Decrease in supply

No of units No of units
Causes for increase (downward or rightward shift) in
supply curve

1. Decrease in the price of other goods

2. Fall in the price of factors of production used for producting
the good
3. Improvements in technology
4. Reducing indirect taxes
5. Granting of subsidy
6. Competition
7. Favourable climate
8. Increase in the number of firms sellers
Causes for decrease (upward or leftward shift) in supply
curve

1. Increase in the price of other goods

2. Increase in the price of factors of production used for
producing the commodity
3. Increasing indirect taxes
4. Non availability of subsidy
5. Imperfect competition
6. Unfavourable climate failure of monsoon
7. Fall in the number of firms and sellers
Meaning of Elasticity of Supply.

It measures the responsiveness or sensitiveness in

quantity supplied as a result of change in price of the
commodity. It is denoted by the letters Es. It is always
positive as there is a positive relationship between price and
quantity supplied.

Methods of measuring Elasticity of Supply(Es)

There are two methods of measuring elasticity of supply.
1. Percentage Method
2. Proportionate method
Under percentage method Es is estimated by dividing
Es = Percentage change in quantity supplied
Percentage change in price
Proportionate Method

Under this method, price elasticity is measured by

dividing proportionate change in quantity demanded by
proportionate change in price

Es = proportionate change in quantity supplied

Proportionate change in price

Change in quantity supplied

Es = Initial quantity supplied
Change in price
Initial price
Using symbols:
Es = ∆Q / Q1
∆P / P1
Es = ∆Q * P1
∆P Q1
Change in quantity supplied
i.e. ES = Change in Price
Initial price
Initial Quantity supplied
1. When the price of a commodity increases by 20 percent the
quantity supplied increases by 22 percent. Find the elasticity of
supply.
2. The price of a commodity increases from Rs.50 and 65, the supply
increases from 450 units 660 units. Find elasticity of supply by
using point method

Problem 1.
Es = percentage change in quantity in supplied = 22 = 1.1
Percentage change with price 20
Problem 2.
Initial price = 50 New price = 65
Initial quantity supplied = 450 New quantity supplied = 660
Change of price (∆P )= 65 – 50 = 15
Change in quantity supplied(∆Q) = 660 -450 = 210
Es =( 210/ 15) / (50 /450) =1.54
 Arc Method
Elasticity of supply can also be estimated by using Arc method or
midpoint method by taking both the prices and both the quantity supplied.
The formula for estimating elasticity is:
∆Q * P1 + P2
∆P Q1 +Q2

The price of a commodity increases from Rs.50 and 65, the

supply increases from 450 units 665 units. Find elasticity of
supply by using mid point method or Arc method

Initial price = 50 New price = 65 Therefore P1 +P2 = 50+65 = 115

Initial quantity supplied = 450 New quantity supplied = 65
Therefore Q1+Q2 = 450 + 665 = 1115
Change of price (∆P )= 65 – 50 = 15
Change in quantity supplied(∆Q) = 665 -450 = 215
Es = 215 * 115 = 1.44
15 1115
 Differentiation Method

Elasticity of supply can also be estimated by using

differentiation if the supply function is given. Supply function
explain the functional relationship between price(independent
variable) and quantity supplied (dependent variable).The formula
for estimating elasticity of supply is
Es = dQ * P
dP Q
Where dQ/dP is the derivative of the supply function and P is the
price and Q is quantity supplied.
Problem:
Given the supply function Q= -200 + 10P2. Find the elasticity of supply
when price is 6.

Es = dQ * P
dP Q
When Price is 6, the quantity supplied is = -200 + 10(6)^2
= -200 + 360 = 160
Therefore P= 6, Q = 160
dQ = dq(-200 +10P2) = 20p
dP
Substituting all these values,
Es = (20 * 6) (6/160) =6
Exercises

Suppose the price of a commodity X increases from Rs

1000 to Rs 1050 permit and consequently supply rises from
1250 units to 1500 units Calculate Elasticity Supply by using
point method and midpoint method

Given the supply function Qs = -500 + 10 P^2, find price

elasticity when the price is Rs. 5. (2) (2.5)(4.5) (2.6)

When price increases from Rs. 20 to 30,the quantity

supplied increases by 36 units. The elasticity of supply is 0.6
Find the initial supply and initial supply.(based on Point
method) (120, 156) (130, 156), (110, 146) (100, 36)
 Types of Elasticity of Supply

On the basis of value of elasticity of supply, it can be

classified into five different types. They are:
1. Perfectly elastic of supply
2. Perfectly Inelastic supply
3. Inelastic supply
4. unitary elastic supply and
5. Elastic supply
 Perfectly elastic supply
For any small increase in the
price, if supply increases in very Es = ∞
large amount, the supply is said
to be perfectly elastic.

Es = ∞

The supply curve is

horizontal.
In the very long period or
secular period, the supply is
said to be perfectly elastic
 Perfectly inelastic supply
If the supply of a commodity
Es = 0
remains constant for any change
in the price, the commodity is said
to have perfectly inelastic
supply. Here
Es = zero.

The supply curve is vertical.

In the very short period or
market period the supply is
perfectly inelastic since the supply
cannot adjusted in the very short
period.
It is alos applicable in the case of
perishable goods.
 Inelastic supply
If the change in price causes less
than proportionate change in supply, it Es <1
is said to be inelastic supply. In other
words, if the percentage change in price
(25%) causes less percentage in quantity
supplied (20%), it is said to have inelastic
supply. i.e. ∆Q/Q < ∆P/P
Therefore Es <1

The supply curve is more steeper

and cuts horizontal axis if it is extended.
In the short-run, supply is inelastic as the
firm can only employ variable factor. The
supply can be increased only to some
extent. Here the supply curve is more
steeper
 Unitary elastic supply
If the change in price causes Es = 1
equal proportionate change in
supply, it is said to be unitary
elastic supply. In other words, if the
percentage change in price (20%) is
equal to the percentage in supply
(20%), it is said to have elastic
supply.

i.e. ∆Q/Q =∆P/P.

Therefore Es =1
The supply curve is passing
through the origin
 Elastic supply
If the change in price causes
more than proportionate change Es >1
in supply, it is said to be elastic
supply. In other words, if the
percentage change in price (20%) is
greater than the percentage in supply
(25%), it is said to have elastic
supply. i.e.
∆Q/Q > ∆P/P
Therefore Es >1
The supply curve is more flatter
and cuts vertical axis if it is extended.
In the long-run, supply is elastic
as the firm can employ more of all
the factors. The supply curve is
more flatter
 Measurement of elasticity of supply

The supply function is given as Q = - 100+10p

Find the elasticity of supply when p = 18

When p=18 Q =-110+10(18)

Q=80
dQ/dP=d/dp (-110+10p)
=10
Es= 10(18/80)=18/8=2.25
 Factors affecting Elasticity of supply

Factors affecting ES:

1. Cost of Production
2. Time period
3. Number of producers
4. Capacity utilization
5. Availability of Raw materials
6. Inexpensive storage of goods
7. Factor substitution
8. Occupational mobility
9. Expectations about future prices
 Cost of Production

Increasing cost of production – producers have less

incentive to increase the production. They will not increase the
production - Supply is inelastic.
If there are constant costs or negligible rise in
cost, producers have more incentive to produce – supply is
elastic
 Time Period

Very short period - supply is perfectly inelastic

Short period – supply is elastic
Long period – supply is highly elastic
Very long period – supply is perfectly elastic
 Number of Producers and Barriers to Entry

Large Number of producers: High degree of

competition among them – Elasticity of supply is higher
Fewer barriers to entry – supply is elastic.
Few sellers – inelastic supply.
More barriers to entry – inelastic supply.
 Capacity utilization

If firms are not working to full capacity and spare

production capacity is available, they can increase output
without rise in costs. Greater the spare capacity greater is
the elasticity of supply.
Lesser the capacity utilization lesser the elasticity of
supply.
 Availability and cost of Raw materials and inputs:

If Key raw materials and inputs are easily available –

supply is elastic
If procurement of resources is difficult and
uneconomical, the cost of production increases and supply
will become less elastic.
 Cost of storage

Cost of storage: Firms have adequate stocks of raw materials,

components and finished goods, they will be able to respond
with higher supply as price rises.
Those commodities which can be easily and
inexpensively stored may have elastic supply.
Those commodities which can not be easily stored
and expensive inelastic.
 Factor substitution

Factor Substitution:
If factors of production can be easily substituted – the supply becomes
more elastic ( the firms will be able to produce quickly and respond
to increase in price)
If production involves use of raw materials which are in short supply, or
those which take long delivery time or which are highly specialized-
then supply elasticity is inelastic
If factors of production cannot be substituted – the supply is
inelastic
 Occupational Mobility

Occupational mobility: If labour and capital are occupationally

mobile – supply is elastic
Products which are more continuously produced – elastic supply
Products which are infrequently produced – inelastic supply

Expectation of future prices

Expectation future prices:

Expectation of substantial increase in price in future
will make the sellers respond less to a current rise in price.
Therefore Supply becomes inelastic.
 Equilibrium Price

Here we have to discuss how demand and supply

determine equilibrium price. Equilibrium price in a market is
determined by the intersection between demand and supply. It is
also called market equilibrium. At this price, the amount the
buyers want to buy is equal to the amount that sellers want to
sell. It is a unique point at which both consumers and suppliers
are satisfied with price and quantity .
The determination of market price is the central theme of
micro economic analysis. Hence micro economic theory is called
price theory
 Equilibrium Price

Price Quantity Quantity Impact on

Demanded Supplied Price

10 20 100 Downward
8 40 80 Downward
6 60 60 Equilibrium
4 80 40 Upward
2 100 20 Upward
Market Equilibrium and Social Efficiency
 Market Equilibrium and Social Efficiency

Social efficiency represents the net gains to society from

all exchanges that are made in a particular market. It has two
components
1. Consumer surplus
2. Producer surplus

Consumer surplus is a measure of consumer welfare.

There is a welfare gain to the producer when they participate in
the market. It is called as producers surplus. Producer surplus is
the difference between the total revenue that a producer receives
from selling their goods minus the sum of marginal cost of
producing that goods. It is sum of the the difference between
the actual price in the market and the price the producer is
ready to sell.
Consumers surplus and Producers surplus