You know, intuitively, the analysis of supply is very much like the analysis of demand.
Really, it's just looking at the flipside of the same coin.
Let’s look back at the key points of demand, and then turn those concepts around to apply
them to the seller, instead of the buyer.
Remember the Law of Demand?
Buyers like low prices and dislike high prices, other things being equal?
Well, what would a Law of Supply look like?
Think about it, what do sellers like better -- low prices are high prices?
Sellers prefer higher prices.
That is when they're happier to provide their product or service to the market.
So the Law of Supply might be something like, “more of the good will be provided, the
higher its price; less will be provided, the lower its price, ceteris paribus.”
This Law of Supply makes perfect sense, saying that there's a direct relationship between
price and quantity supplied.
Of course at lower prices suppliers are either unable (they can’t cover their costs), or
unwilling (not enough profit motive) to provide much product.
But at higher prices, the suppliers make a lot more profit, other things remaining equal,
and are much happier to provide the product to market.
OK, think back to demand again.
What factors or variables affect willingness to purchase?
Quantity demanded is affected by product price, price of substitutes, price of complements,
income, tastes, age, weather, and so on.
Well, guess what?
Suppliers’ decisions are affected by much more than the price tag, too.
Like what?
Good question -- what determines the suppliers’ willingness or ability to provide the product
to the market?
Price of the product, certainly; but more important is profitability, which is determined
not only by product price but also by costs of production.
Such as?
Wages, or cost of labor, rent, or cost of capital, cost of raw materials or natural
resources.
What about other costs besides the resources?
Taxes, paperwork, licensing -- in some businesses, you have to pass exams or be subject to periodic
audit or accreditation.
These are all costs.
What about variables that affect your ability to produce?
Worker strikes, natural disasters, shipping disruptions…
inability to get your resources results in an inability to produce, decreasing the amount
provided to the market.
On the other hand, better technology or worker productivity would be examples of variables
that would enhance production making more product available.
What else?
Expectations affect supply; heck, even weather affects supply.
Ultimately quantity supplied is a function of all these things: price, wages, taxes,
technology, weather…
Just remember, I only like to look at two things at any given time, so that I can draw
the relationship; in this case, price and quantity supplied.
Going back to our housing example, at a price of $100 per square foot, and considering wages
for carpenters, roofers, electricians, plumbers, lumber, copper, permits and fees, expectations
of home sales, etcetera – quantity supplied1 will be provided.
BUT, if price goes to $200 per square foot, all else staying the same, more houses will
be provided.
There are an infinite number of other prices, and associated quantities supplied, so the
supply line is the collection of all price-quantity supplied combinations.
Just as with demand, a change in price will not change the supply, but rather move along
the supply curve, resulting in a change in the quantity supplied.
Changing anything other than the product price will alter the underlying supply.
For example, what if the government imposes a higher minimum-wage?
As wage increases from W1 to W2, the quantity demanded of labor (since the employer demands
or purchases some amount of labor) decreases from L1 and L2.
With less labor to work with, the supply of the end product decreases.
Any cost increase makes business less profitable, which is a disincentive to produce.
What would happen if costs fall?
For example, if business taxes decrease, or if technology gets cheaper?
The bottom line is that you need to pay careful attention to the difference between a change
in supply and a change in quantity supplied.
NEXT TIME: Equilibrium TRANSCRIPT00EPISODE 13: SUPPLY