Last Updated on: 4th September 2024, 02:04 pm
Supply Analysis
Supply Analysis
In this part, we discuss about Supply Analysis and related topics
- Supply
- Elasticity of Supply
- Degrees of Elasticity of Supply
- Measurement of Elasticity of Supply
- Change in Elasticity of Supply
Supply
Supply of goods refer to the quantity offered for sale in a given market, at a given time, at various prices.
Law of Supply
There is a direct relationship between the price and quantity supplied. When the price of a commodity increases, more profit can be earned by producing and selling more. Similarly when the price, decreases, profitability will be less and producer will be interested to sell less. So, according to the law of supply, increase in price brings increase in supply or vice versa.
Supply Schedule
| Price (Rs/Kg) | Quantity (Kg) |
| 10 | 15 |
| 12 | 20 |
| 15 | 25 |
| 17 | 30 |
| 19 | 35 |
Determinants of Supply
Supply of a product is influenced by various factors like
- Price of the commodity: Supply of a goods increase with a rise in its price, as the producer earn more profits at a higher price, other things remaining the same.
- Price of factors of production: An increase in the price of one or more factors of production leads to a rise in the cost of production. This reduces profitability. When cost of production increase, supply falls.
- Price of related goods: If the price of substitute goods increases, its quantity supplied shall be more than the goods in question. Therefore, producers will tend to shift their resources to the production of the substitute goods, provided other things remain the same.
- Government Policy: Different taxes such as excise duty; sales tax, import duties etc. levied by the Government, increases the cost of production, causing adverse impact on supply.
Limitation of Law of Supply
- Climate Condition: Supply of a commodity depends upon its production, which again depend on other factors. Supply cannot be enhanced, beyond a certain limit. Therefore, the supply of such products will always be restricted. Howsoever, the prices may rise.
- Static situation: Law of supply assumes only a static situation. It does not consider changes in the factors like income level, tastes and preferences of buyers and sellers, change in the cost of factors of production, change in the level of technology etc.
- Price change Anticipation: Law of supply is not applicable if there is an expectation of price change of a commodity in near future. If the price of a commodity declines, but there is a expectation that the price will fall further, the supply of that commodity will not reduce; rather it will increase because the producers would not like to store it for future.
- Artistic goods: Law of supply does not apply on artistic goods, as the supply of these products cannot be changed easily. So, Price increase does not bring increase in supply of Artistic Goods.
Supply Curve Slope
Law of supply explains direct relationship between price of a commodity and its supply.
Supply of a commodity rises due to increase in its price and declines on a decrease in its price.
- When the price of a commodity rises, it motivates the producers to produce and also sellers to sell more to earn more profit.
- If the price of a commodity falls, producers and sellers would like to reduce the supply as it will reduce their profit margin.
Due to a direct relationship between price and supply of a commodity, supply curve slopes upward.
Elasticity of Supply
Elasticity of Supply is the responsivenessof the quantity supplied of a commodity, due to change in its price.
Elasticity of Supply is defined as the percentage change in quantity supplied divided by percentage change in price.
Formula
EP = (% Change in Quantity Supplied) / (% Change in Price)
EP = ∆q / ∆p x p /q, where
EP = Elasticity of Supply, q = quantity, p = price, ∆q = change in supply quantity, ∆p = change in price
As per law of supply, Price & Quantity are directly related. So, Elasticity will be positive.
Example
| Quantity | Price |
| 500 | 10 |
| 800 | 15 |
% Change in qty Supplied = (800 – 500) / 500 = 60% % Change in Price = (15-10) / 10 = 50% So, EP = 60% / 50% = 1.2
Degrees of Elasticity of Supply
Degrees of Elasticity of Supply
| Coeff. of ES | Types of ES | Situation | Shape of Supply Curve |
| ES = 0 | Indicates Perfectly inelastic supply | Occurs when to a percentage change in price, there is no change in quantity supplied | Shape of Supply Curve is Parallel to price axis |
| 0<ES<1 | Indicates Inelastic supply (or less than unitary elastic) | Occurs when to a percentage change in price, there is lesser change in quantity supplied | Shape of Supply Curve is Upward sloping originating from x-axis (intercept on X axis) |
| ES = 1 | Indicates Unitary elastic supply | Occurs when to a percentage change in price, there is equal change in quantity supplied. | Shape of Supply Curve is Upward sloping originating from origin |
| 1<ES<µ | Indicates Elastic supply (or more than unitary elastic) | Occurs when to a percentage change in price, there is more than proportionate change in quantify supplied. | Shape of Supply Curve is Upward sloping originating from negative of X axis. |
| ES = µ | Indicates Perfectly elastic supply | This occurs when there is infinite change in quantity supplied at a price | Parallel to quantity axis. |
Measurement of Elasticity of Supply
The elasticity of supply can be measured with reference to a given point on the supply curve (point elasticity) or between two points on the supply curve (Arc elasticity).
- Point elasticity: Point elasticity can be measured with the help of the following formula:
Es = (dq / dp) x (p/q)
Where, dq / dp = differentiation of quantity with respect to price, p = price, q =quantity.
- Arc elasticity: In this method the average of the two prices and two quantities is used;
Es = {(q2 –q1)/(q2 + q1)}x {(p2 – p1)/ (p2 + p1)}
Where, p2 = new price, p1= original price, q1 = new quantity supplied, q2 = original quantity supplied
Example
Original price Rs.800/-, New Price Rs.1,000/-, Original Quantity 4,000 kg, New Quantity 5,000 kg.
Elasticity of supply under Arc elasticity method is computed as
Es = {(5,000 – 4,000) / (5,000 + 4,000)} x {(1,000 – 800) / (1,000 + 800)}
= {(1,000/9,000) x (200/1,800)} = 1/81 = .0123 = 1.23%
Determinants of Elasticity of Supply
Different types of factors influence the elasticity of supply, such as,
- Price Movement: If firms expect the prices to rise in future, they may hold the stocks of the commodity and not make available for sale in the market. So, supply would be inelastic. Similarly when prices are expected to fall in future, supply would be elastic.
- Production Techniques: If production and supply of goods require simple technique, then supply can easily be increased in response to a change in its price. So it will have elastic supply. If the production technique of a commodity is complicated and time consuming, it would not be possible to change the supply in response to varying price-demand condition. Therefore, in this situation supply will be elastic.
- Nature of the commodity: Perishable commodities have inelastic supply as their supply cannot be increased substantially on price change. Durable goods on the other hand, generally have elastic supply.
- Time Factor: Longer the time period involved in the production of a commodity, more is the time available for changing the size of plant and making other cost adjustments. Consequently, supply of the commodity would be more elastic. On the other hand, shorter the time period involved in production, the supply of a commodity would be more inelastic.
Change in Supply
The supply of a commodity may change to change in Price or due to change in other factors
Movement in Supply Curve : This is caused by Change in Supply due to price alone
- Expansion of supply: When supply of a commodity increase on increase in its price, it is called expansion of supply. It is shown by upward movement of supply curve.
- Contraction of supply: When supply of a commodity decrease on fall in its price, it is called contraction of supply. It is shown by downward movement of supply curve.
Shifting of Supply Curve : This is causeddue to change in factors other than price. It occurs due to various factors like change in income, change in taste, upgradation of technology etc. It makes the supply curve shift either leftward or rightward of the original supply curve. This is called shifting of the supply curve.
- Increase in Supply: When supply of a commodity increase due to change in any factor other than price, it is called increase in supply. It is shown by rightward shift of supply curve.
Factors for increase in Supply : Improvement in technique of production, Fall in price of substitute goods, Fall in cost of production, Favourable changes in govt policy, Fall in the expected price of the good.
- Decrease in Supply: When the supply of a commodity decrease due to a change in any factor other than price, it is called as decrease in supply. It is shown by leftward shift of the supply curve.
Factors for decrease in supply : Obsolete technique of production, Increase in price of substitute goods, Increase in the cost of production, Increase in the expected price of the good, Unfavourable changes in govt. policy.
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