supply determinants

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SUPPLY DETERMINANTS: Five ceteris paribus factors that affect supply, but which are assumed constant when a supply curve is constructed. They are resource prices, production technology, other prices, sellers' expectations, and number of sellers. Changes in the supply determinants cause shifts of the supply curve and disruptions of the market. Supply determinants are five ceteris paribus factors that are held constant when a supply curve is constructed. They are held constant to isolate the law of supply relation between supply price and quantity supplied . When the determinants change they cause a change in the location of the supply curve. In effect, supply determinants can be said to "determine" the position of the supply curve. What They Are The five ceteris paribus supply determinants are resource prices, production technology , other prices, sellers' expectations, and number of sellers. Resource Prices: The prices paid for the use of labor , capital , land , and entrepreneurship affect production cost and the ability to supply a good. If resource prices increase, then production cost is higher and the sellers are inclined to offer less of the good for sale. If resource prices decrease, then production cost is lower and the sellers are inclined to offer more of the good for sale. Production Technology: The information available concerning production techniques affects the ability to supply a good. Technology is what producers know about the ways to combine inputs into the production of outputs. An advance in technology makes it possible to sell more of a good. A decline in technology means producers can sell less of a good.

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Page 1: Supply Determinants

SUPPLY DETERMINANTS:

Five ceteris paribus factors that affect supply, but which are assumed constant when a supply curve is constructed. They are resource prices, production technology, other prices, sellers' expectations, and number of sellers. Changes in the supply determinants cause shifts of the supply curve and disruptions of the market. Supply determinants are five ceteris paribus factors that are held constant when a supply curve is constructed. They are held constant to isolate the law of supply relation between supply price and quantity supplied. When the determinants change they cause a change in the location of the supply curve. In effect, supply determinants can be said to "determine" the position of the supply curve.

What They Are

The five ceteris paribus supply determinants are resource prices, production technology, other prices, sellers' expectations, and number of sellers.

Resource Prices: The prices paid for the use of labor, capital, land, and entrepreneurship affect production cost and the ability to supply a good. If resource prices increase, then production cost is higher and the sellers are inclined to offer less of the good for sale. If resource prices decrease, then production cost is lower and the sellers are inclined to offer more of the good for sale.

Production Technology: The information available concerning production techniques affects the ability to supply a good. Technology is what producers know about the ways to combine inputs into the production of outputs. An advance in technology makes it possible to sell more of a good. A decline in technology means producers can sell less of a good.

Other Prices: The supply for one good is based on the prices paid for other goods that use the same resources for production. A change in the price of a substitute good (or substitute-in-production) induces sellers to alter the mix of goods purchased. An increase in the price of a substitute motivates sellers to sell more of this good and less of the substitute good. A change in the price of a complement good (or complement-in-production) induces sellers to supply more or less of both goods. An increase in the price of a complement motivates sellers to sell more of this good as they sell more of the complement good.

Sellers' Expectations: The decision to sell a good today depends on expectations of future prices. Sellers seek to sell the good at the highest possible price. If sellers expect the price to decline in the future, they are inclined to sell more now. If they expect the price to rise in the future, they are inclined to sell less now.

Page 2: Supply Determinants

Number of Sellers: The number of sellers willing and able to sell a good affects the overall supply. With more sellers, there is more supply. With fewer sellers, there is less supply.

How They Work

These five supply determinants cause the supply curve to shift. This can be illustrated using the positively-sloped supply curve for Wacky Willy Stuffed Amigos presented in this exhibit. This supply curve captures the specific one-to-one, law of supply relation between supply price and quantity supplied. The supply determinants are assumed to remain constant with the construction of this supply curve.

The supply determinants are assumed constant for two reasons:

One: To isolate the law of supply relation between supply price and quantity supplied

Two: To systematically analyze what happens to supply when each determinant changes.

Reason number two provides a powerful analytical tool. By turning supply determinants off and on, allowing each to change one at a time, a more thorough understanding of the supply side of the market can be had.

Now, consider how changes in the supply determinants shift the supply curve. A change in any of the five determinants can cause either an increase in supply or a decrease in supply.

Increase in Supply: An increase in supply is a rightward shift of the supply curve. An increase in supply means that for any price, for every price, sellers are willing and able to sell more of the good. Click the [Increase] button to demonstrate.

Decrease in Supply: A decrease in supply is a leftward shift of the supply curve. A decrease in supply means that for any price, for every price, sellers are willing and able to sell less of the good. Click the [Decrease] button to demonstrate.

Two Changes

Shifts of the supply curve caused by changes in the supply determinants suggest two related notions--a change in supply and a change in quantity supplied.

A Change in Supply: This a change in the overall supply relation, a change in all price-quantity pairs. It is caused by a change in one of the five supply determinants and is indicated by a shift of the supply curve.

Supply Determinants

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A Change in Quantity Supplied: This is a change in the specific amount of the good that sellers are willing and able to purchase. It is caused by a change in the supply price and is indicated by a movement along the supply curve from one point to another.

Price elasticity of supplyFrom Wikipedia, the free encyclopediaJump to: navigation, search Not to be confused with price elasticity of demand.

In economics, price elasticity of supply (PES) is an elasticity defined as a numerical measure of the responsiveness of the supply of a given good to a change in the price of that good.[1]

Calculation

Price elasticity of supply is a measure of the sensitivity of the quantity of a good supplied in a market to changes in the market price for that good, ceteris paribus.[2]

Per the law of supply, there is an expectation that, in a given market, when price increases, supply will also increase.[2][3] PES is a numerical measure (coefficient) of by how much that supply is affected.[1] Mathematically:[2][4]

In other words, PES is the percentage change in supply one would expect after a 1% change in price.[2] For example, if, in response to a 10% rise in the price of a good, the quantity supplied increases by 20%, the price elasticity of supply would be 20%/10% = 2.[5]

Interpretation

PES values are almost universally positive, due to the law of supply, and the upwards-sloping supply curve that results from this.[6] They are not tied to any specific units.[2] However, the exact value can yield more inferences about the good in question.

When the coefficient is small (less than one), the supply of that good is described as inelastic; when the coefficient is great (greater than one), the supply is described as elastic.[2] Coefficients of zero indicated goods the supplies of which do not respond to price changes: they are "fixed" in supply. Such goods often have no labor component or are not produced, limiting the short run prospects of expansion. If the coefficient is exactly one, the good is said to be unitary elastic.

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The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down.

Determinants

Availability of raw materials: for example, availability may cap the amount of gold that can be produced in a country regardless of price. Likewise, the price of Van Gogh paintings is unlikely to affect their supply.[7]

Length and complexity of production: Much depends on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings - no special structures are needed. Thus the PES for textiles is elastic. On the other hand, the PES for specific types of motor vehicles is relatively inelastic. Auto manufacture is a multi-stage process that requires specialized equipment, skilled labor, a large suppliers network and large R&D costs.[8]

Time to respond: The more time a producer has to respond to price changes the more elastic the supply.[7][8] Supply is normally more elastic in the long run than in the short run for produced goods, since it is generally assumed that in the long run all factors of production can be utilised to increase supply, whereas in the short run only labor can be increased, and even then, changes may be prohibitively costly.[2] For example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price of soybeans because of the time it would take to procure the necessary land.

Excess capacity: A producer who has unused capacity can (and will) quickly respond to price changes in his market assuming that variable factors are readily available.[2]

Inventories: A producer who has a supply of goods or available storage capacity can quickly increase supply to market.

Various research methods are used to calculate price elasticities in real life, including analysis of historic sales data, both public and private, and use of present-day surveys of customers' preferences to build up test markets capable of modelling such changes. Alternatively, conjoint analysis (a ranking of users' preferences which can then be statistically analysed) may be used.[9]

Graphical representation

It is important to note that elasticity and slope are, in the most part, unrelated. Thus, when supply is represented linearly, regardless of the slope of the supply line, the coefficient of elasticity of any linear supply curve that passes through the origin is 1 (unit elastic);[10] the coefficient of elasticity of any linear supply curve that cuts the y-axis is greater than 1 (elastic), and the coefficient of elasticity of any linear supply curve that cuts the x-axis is less than 1 (inelastic).[citation needed] Likewise, for any given supply curve, it is likely that PES will vary along the curve.[2]

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Selected Supply Elasticities Heating Oil

o 1.57 (Short Run) [11]

Gasoline o 1.61 (Short Run) [11]

Tobacco o 7.0 (Long Run) [11]

Housing o 1.6-3.7 (Long Run) [11]

Cotton o 0.3 (Short Run) [12]

o 1.0 (Long Run) [12]

Steel o 1.2 (Long Run, from Minimills) [13]

Supply (economics)From Wikipedia, the free encyclopediaJump to: navigation, search

In economics, supply is the amount of some product producers are willing and able to sell at a given price all other factors being held constant. Usually, supply is plotted as a supply curve showing the relationship of price to the amount of product businesses are willing to sell.

Supply schedule

A supply schedule is a table which shows how much one or more firms will be willing to supply at particular prices.[1] The supply schedule shows the quantity of goods that a supplier would be willing and able to sell at specific prices under the existing circumstances. Some of the more important factors affecting supply are the goods own price, the price of related goods, production costs, technology and expectations of sellers.

Factors affecting supply

Innumerable factors and circumstances could affect a sellers willingness or ability to produce and sell a good. Some of the more common factors are:

Goods own price: The basic supply relationship is between the price of a good and the quantity supplied. Although there is no "Law of Supply", generally, the relationship is positive or direct meaning that an increase in price will induce and increase in the quantity supplied.[2]

Price of related goods:[2] For purposes of supply analysis related goods refer to goods from which inputs are derived to be used in the production of the primary good. For example, Spam is made from pork shoulders and ham. Both are derived from Pigs. Therefore pigs would be considered a related good to Spam. In this

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case the relationship would be negative or inverse. If the price of pigs goes up the supply of Spam would decrease (supply curve shifts up or in) because the cost of production would have increased. A related good may also be a good that can be produced with the firm's existing factors of production. For example, a firm produces leather belts. The firm's managers learn that leather pouches for smartphones are more profitable than belts. The firm might reduce its production of belts and begin production of cell phone pouches based on this information. Finally, a change in the price of a joint product will affect supply. For example beef products and leather are joint products. If a company runs both a beef processing operation and a tannery an increase in the price of steaks would mean that more cattle are processed which would increase the supply of leather.[3]

Technology. Technology is the way inputs are combined to produce a final good. [4]A technological advance would cause the average cost of production to fall which would be reflected in an outward shift of the supply curve.[2]

Expectations: Sellers expectations concerning future market condition can directly affect supply.[5] If the seller believes that the demand for his product will sharply increase in the foreseeable future the firm owner may immediately increase production in anticipation of future price increases. The supply curve would shift out. Note that the outward shift of the supply curve may create the exact condition the seller anticipated, excess demand.[6]

Price of inputs: Inputs include land, labor, energy and raw materials. [7]If the price of inputs increases the supply curve will shift in as sellers are less willing or able to sell goods at existing prices. For example, if the price of electricity increased a seller may reduce his supply because of the increased costs of production. The seller is likely to raise the price the seller charges for each unit of output.[6]

Government policies and regulations:Government intervention can have a significant effect on supply.[8] Government intervention can take many forms including environmental and health regulations, hour and wage laws, taxes, electrical and natural gas rates and zoning and land use regulations.[9]

It should be emphasized that this list is not exhaustive. All facts and circumstances that are relevant to a seller's willingness or ability to produce and sell goods can affect supply.[10] For example, if the forecast is for snow retail sellers will respond by increasing their stocks of snow sleds or skis or winter clothing or bread and milk.

Supply function/equation

The supply function is the mathematical expression of the relationship between supply and those factors that affect the willingness and ability of a supplier to offer goods for sale. For example, Qs = f( P, P⎮ rg S ) is a supply function where P equals price of the good Prg equals the price of related goods and S equals the number of producers. The vertical bar means that the variables to the right are bring held constant. The supply equation is the explicit mathematical expression of the functional relationship. For example, Qs = 325 + P - 30 Prg + 20S. 325 is y-intercept it is the repository of all non-specified factors that affect demand for the product. P is the price of the own good. The

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coefficient is positive following the general rule that price and quantity supplied are directly related. Prgis the price of a related good. Typically the relationship is negative because the good is an input or a source of inputs.

Supply curve

The relationship of price and quantity supplied can be exhibited graphically as the supply curve. The curve is generally positively sloped. The curve depicts the relationship between two variables only; price and quantity supplied. All other factors affecting supply are held constant. However, these factors are part of the supply curve and are present in the intercept or constant term.[11]

Movements versus shifts

Movements along the curve occur only if there is a change in quantity supplied caused by a change in the goods own price.[12] A shift in the supply curve, referred to as a change in supply, occurs only if a non price determinant of supply changes.[13] For example, if the price of an ingredient used to produce the good, a related good, were to increase, the supply curve would shift in.[14]

Inverse Supply Equation

By convention economist graph the dependent variable on the y axis and the independent variable on the x axis. This means that the equation depicted is the inverse equation. The form of the inverse supply equation is Ps = f(Q). An example of an inverse supply equation would be Ps = Q/2 + Y/40.[15]

Marginal costs and short-run supply curve

A firm's short-run firm supply curve is the marginal cost curve above the shutdown point (the SRMC above the minimum average variable costs). The portion of the SRMC below the shutdown point is not part of the supply curve because the firm is not producing any output.[16]

Shape of the short-run supply curve

The law of diminishing marginal returns (LDMR) shapes the SRMC curve. The LDMR states that as production increases eventually a point (the point of diminishing marginal returns) will be reached after which additional units of output will be successively smaller. The mathematical relationship is MR = MC = w/MPL where w is the wage rate and MPL. Beyond the point of diminishing marginal returns the marginal product of labor will continually decrease. As MPL decreases with a constant wage rate MC will increase.

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From firm to market supply curve

The market supply curve is the horizontal summation of firm supply curves.[17]

The shape of the market supply curve

There is no law of supply that “requires” that the market supply curve have a positive slope; the curve may slope down or up or be horizontal or vertical.[18]

Elasticity

Price elasticity of supply measures the responsiveness of quantity supplied to changes in price, as the percentage change in quantity supplied induced by a one percent change in price. It is calculated for discrete changes as (∆Q/∆P) x P/Q and for smooth changes of differentiable supply functions as (∂Q∕∂P) x P/Q. Since supply is usually increasing in price, the price elasticity of supply is usually positive. For example if the PES for a good is 0.67 a 1% rise in price will induce a two-thirds increase in quantity supplied.

Significant determinants include: Reaction time: The PES coeffiecient will largely be determined by how quickly producers react to price changes by increasing (decreasing) production and delivering (cutting deliveries of) goods to the market.

Complexity of Production: Much depends on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings - no special structures are needed. Thus the PES for textiles is elastic. On the other hand, the PES for specific types of motor vehicles is relatively inelastic. Auto manufacture is a multi-stage process that requires specialized equipment, skilled labor, a large suppliers network and large R&D costs.Time to respond: The more time a producer has to respond to price changes the more elastic the supply. For example, a cotton farmer cannot immediately respond to an increase in the price of soybeans.Excess capacity: A producer who has unused capacity can quickly respond to price changes in his market assuming that variable factors are readily available.Inventories: A producer who has a supply of goods or available storage capacity can quickly respond to price changes.

Other elasticities can be calculated for non-price determinants of supply. For example, the percentage change the amount of the good supplied caused by a one percent increase in the price of a related good is an input elasticity of supply if the related good is an input in the production process.[citation needed] An example would be the change in the supply for cookies caused by a one percent increase in the price of sugar.

Elasticity along linear supply curves

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The slope of a linear supply curve is constant. The coefficient of elasticity is usually not. If the linear supply curve intersects the y-axis PES will be infinitely elastic at the point of intersection.[19] The coefficient of elasticity decreases as one move "up" the curve. [20]If the linear supply curve intersects the x axis PES will equal zero at the point of intersection and will increase as one moves up the curve. [21]If the linear supply curve intersects the origin PES equals one at the point of origin and along the cuve.

Market structure and the supply curve

There is no such thing as a monopoly supply curve.[22] Perfect competition is the only market structure for which a supply function can be derived. A function is a rule which assigns to each value of a variable one and only one value of the function.[23] In a perfectly competitive firm the price is given. A manager of a competitive firm can tell you precisely what quantity of goods will be supplied for any price by simply referring to the firm's marginal cost curve. To generate his supply function the seller could simply initially set price equal to zero and then incrementally increase the price at each price level he could calculate the quantity supplied using the supply equation Following this process the manager could trace out the complete supply function. A monopolist cannot replicate this process. A change in demand can result in the "changes in price with no changes in output, changes in output with no changes in price or both".[22] There is simply not a one to one relationship between price and quantity supplied.[24]There is no single function that relates price to quantity supplied.

Law of supplyn economics, the law of supply is the tendency of suppliers to offer more of a good at a higher price.[1] The relationship between price and quantity supplied is usually a positive relationship. A rise in price is associated with a rise in quantity supplied. As firms produce more output, their total costs rise proportionately faster. The ratio of the change in total costs to the change in quantity is increasing. This ratio defines the firm's marginal cost of production (the additional cost of producing another unit of output). Because marginal costs rise and quantity produced rises, firms need to charge a higher price for each extra unit of output they produce.

Supply and demandFrom Wikipedia, the free encyclopediaJump to: navigation, search For other uses, see Supply and demand (disambiguation).

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The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity.

The graphical representation of supply and demand

The supply-demand model is a partial equilibrium model representing the determination of the price of a particular good and the quantity of that good which is traded. Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Determinants of supply and demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply schedule

The supply schedule, depicted graphically as the supply curve, represents the amount of some good that producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all determinants of supply other than the price of the good in question, such as technology and the prices of factors of production, remain the same.

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Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive.

By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitor—that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless.

Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve.

Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts.

Demand schedule

The demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, personal tastes, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.[1]

Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves.[2] Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time.

As described above, the demand curve is generally downward-sloping. There may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price).

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By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitor—that is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless.

As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve.

Micro Economics

Equilibrium

Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves.

Changes in market equilibrium

Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium.

Demand curve shifts

Main article: Demand curve

An outward (rightward) shift in demand increases both equilibrium price and quantity

When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve

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being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. In the example above, there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2).

If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand.Supply curve shifts

Main article: Supply (economics)

An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity

When the suppliers' unit input costs change, or when technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2—an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1

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to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions.

If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed.

Elasticity

Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how strongly the quantities supplied and demanded respond to various factors, including price and other determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or demanded) divided by the percentage change in the causative variable. For discrete changes this is known as arc elasticity, which calculates the elasticity over a range of values. In contrast, point elasticity uses differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes.

Often, it is useful to know how strongly the quantity demanded or supplied will change when the price changes. This is known as the price elasticity of demand or the price elasticity of supply. If a monopolist decides to increase the price of its product, how will this affect the amount of their good that customers purchase? This knowledge helps the firm determine whether the increased unit price will offset the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the quantity demanded.

Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity supplied goes from 100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2%/5% or 0.4.

Since the changes are in percentages, changing the unit of measurement or the currency will not affect the elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did, demand or supply is said to be inelastic. If supply is perfectly inelastic;that is, has zero elasticity, then there is a vertical supply curve.

Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can respond to market conditions by varying their holdings of physical capital, and because in the long run new firms can enter or old firms can exit the market.

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Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How strongly would the demand for a good change if income increased or decreased? The relative percentage change is known as the income elasticity of demand.

Another elasticity sometimes considered is the cross elasticity of demand, which measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complements and substitute goods. Complements are goods that are typically utilized together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other, and if the price of one good rises, one may purchase less of it and instead purchase its substitute.

Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the causative percentage change in the price of the other good. For an example with a complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -2.0.

In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium position instantly, without spending any time away from equilibrium. Any change in market conditions would cause a jump from one equilibrium position to another at once. In real economic systems, markets don't always behave in this way, and markets take some time before they reach a new equilibrium position. This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be expected to know every relevant condition in every market. Ultimately both producers and consumers must rely on trial and error as well as prediction and calculation to find the true equilibrium of a market.

Vertical supply curve (perfectly inelastic supply)

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When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price.

If the quantity supplied is fixed no matter what the price, the supply curve is a vertical line, and supply is called perfectly inelastic.

As a hypothetical example, consider the supply curve of land. No matter how much someone is willing to pay for additional parcels, more land cannot be created. Even if no one wanted any of the land, there would still be a supply of land. Therefore, land has a vertical supply curve, with zero elasticity.

Other markets

The model of supply and demand also applies to various specialty markets.

The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.[3]

A number of economists (for example Pierangelo Garegnani[4], Robert L. Vienneau[5], and Arrigo Opocher & Ian Steedman[6]), building on the work of Piero Sraffa, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley [7] argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White [8] argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory.

This criticism of the application of the model of supply and demand generalizes, particularly to all markets for factors of production. It also has implications for monetary theory[9] not drawn out here.

In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand,[10] the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.[11]

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Empirical estimation

Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables.

Macroeconomic uses of demand and supply

Demand and supply have also been generalized to explain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. Demand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates.

History

The power of supply and demand was understood to some extent by several early Muslim economists, such as Ibn Taymiyyah who illustrates:

"If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down."[12]

The phrase "supply and demand" was first used by James Denham-Steuart in his Inquiry into the Principles of Political Economy, published in 1767. Adam Smith used the phrase in his 1776 book The Wealth of Nations, and David Ricardo titled one chapter of his 1817 work Principles of Political Economy and Taxation "On the Influence of Demand and Supply on Price".[13]

In The Wealth of Nations, Smith generally assumed that the supply price was fixed but that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later called the law of demand. Ricardo, in Principles of Political Economy and Taxation, more rigorously laid down the idea of the assumptions that were used to build his ideas of supply and demand. Antoine Augustin Cournot first developed a mathematical model of supply and demand in his 1838 Researches into the Mathematical Principles of Wealth, including diagrams.

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During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons, Carl Menger, and Léon Walras. The key idea was that the price was set by the most expensive price, that is, the price at the margin. This was a substantial change from Adam Smith's thoughts on determining the supply price.

In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming Jenkin in the course of "introduc[ing] the diagrammatic method into the English economic literature" published the first drawing of supply and demand curves therein,[14] including comparative statics from a shift of supply or demand and application to the labor market.[15] The model was further developed and popularized by Alfred Marshall in the 1890 textbook Principles of Economics.[13]

Supply creates its own demand

"Supply creates its own demand" is the formulation of Say's law by John Maynard Keynes, and is considered by him one of the defining characteristics of classical economics. The rejection of this doctrine is a central component of The General Theory of Employment, Interest and Money (1936) and a central tenet of Keynesian economics.

Keynes's rejection of Say's law is on the whole accepted within mainstream economics since the 1940s and 50s, in the neoclassical synthesis, but debate continues between more Keynesian economists and more neoclassical economists – see saltwater and freshwater economics.

The exact phrase "supply creates its own demand" does not appear to be found in the writings of classical economists;[1] similar sentiments, though different wordings, appear in the work of John Stuart Mill (1848), whom Keynes credits and quotes, and his father, James Mill (1808), whom Keynes does not.

Keynes's interpretation is rejected as a misinterpretation or caricature of Say's law by proponents of same – see Say's law: Keynes vs. Say – and the advocacy of the phrase "supply creates its own demand" is today most associated with supply-side economics, which retorts that "Keynes turned Say on his head and instead stated that 'demand creates its own supply'".

Keynes's formulation

Keynes coined the phrase thusly (emphasis added):

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; —meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

In J. S. Mill's Principles of Political Economy the doctrine is expressly set forth:

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What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the productions of other people consist of what he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. (Principles of Political Economy, Book III, Chap. xiv. § 2.)

—The General Theory of Employment, Interest and Money, John Maynard Keynes, Chapter 2, Section VI, p. 18

To summarize, Keynes states that classical economics, by which he means the economics of Say, David Ricardo, and successors,[2] notably John Stuart Mill, believe that "supply creates its own demand", meaning

in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

Keynes then restates this in the language of Keynesian economics as:

(3) [S]upply creates its own demand in the sense that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment.—The General Theory of Employment, Interest and Money, John Maynard Keynes, Chapter 2, Section VII

Other sources

Another source widely cited as a classical expression of the idea, and the original statement of Say's law in English, is by James Mill, in Commerce Defended (1808):

The production of commodities creates, and is the one and universal cause that creates a market for the commodities produced.—James Mill, Commerce Defended (1808), Chapter VI: Consumption, p. 81

Keynes does not cite a specific source for the phrase, and, as it does not appear to be found in the pre-Keynesian literature,[1] some consider its ultimate origin a "mystery".[3] The phrase "supply creates its own demand" appears earlier, in quotes, in a 1934 letter of Keynes,[3] and has been suggested that the phrase was an oral tradition at Cambridge, in the circle of Joan Robinson,[3] and that it may have derived from the following 1844 formulation by John Stuart Mill:[4]

Nothing is more true than that it is produce which constitutes the market for produce, and that every increase of production, if distributed without miscalculation among all kinds of

Page 20: Supply Determinants

produce in the proportion which private interest would dictate, creates, or rather constitutes, its own demand.—John Stuart Mill, Essays On Some Unsettled Questions of Political Economy (1844), "Of the Influence of Consumption On Production",

Price Elasticity of Supply

A Primer on the Price Elasticity of Supply

From Mike Moffatt, former About.com Guide

See More About: price elasticity of supply elasticity formulas elasticity

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The Price Elasticity of Supply measures the rate of response of quantity demand due to a price change. If you've already read The Price Elasticity of Demand and understand it, you may want to just skim this section, as the calculations are similar. (Your course may use the more complicated Arc Price Elasticity of Supply formula. If so you'll need to see the article on Arc Elasticity) We calculate the Price Elasticity of Supply by the formula:

PEoS = (% Change in Quantity Supplied)/(% Change in Price)

Page 21: Supply Determinants

Calculating the Price Elasticity of Supply

You may be asked "Given the following data, calculate the price elasticity of supply when the price changes from $9.00 to $10.00" Using the chart on the bottom of the page, I'll walk you through answering this question.

First we need to find the data we need. We know that the original price is $9 and the new price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the chart we see that the quantity supplied (make sure to look at the supply data, not the demand data) when the price is $9 is 150 and when the price is $10 is 110. Since we're going from $9 to $10, we have QSupply(OLD)=150 and QSupply(NEW)=210, where "QSupply" is short for "Quantity Supplied". So we have:

Price(OLD)=9Price(NEW)=10QSupply(OLD)=150QSupply(NEW)=210

To calculate the price elasticity, we need to know what the percentage change in quantity supply is and what the percentage change in price is. It's best to calculate these one at a time.

Calculating the Percentage Change in Quantity Supply

The formula used to calculate the percentage change in quantity supplied is:

[QSupply(NEW) - QSupply(OLD)] / QSupply(OLD)

By filling in the values we wrote down, we get:

[210 - 150] / 150 = (60/150) = 0.4

So we note that % Change in Quantity Supplied = 0.4 (This is in decimal terms. In percentage terms it would be 40%). Now we need to calculate the percentage change in price.

Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

By filling in the values we wrote down, we get:

[10 - 9] / 9 = (1/9) = 0.1111

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We have both the percentage change in quantity supplied and the percentage change in price, so we can calculate the price elasticity of supply.

Final Step of Calculating the Price Elasticity of Supply

We go back to our formula of:

PEoS = (% Change in Quantity Supplied)/(% Change in Price)

We now fill in the two percentages in this equation using the figures we calculated.

PEoD = (0.4)/(0.1111) = 3.6

When we analyze price elasticities we're concerned with the absolute value, but here that is not an issue since we have a positive value. We conclude that the price elasticity of supply when the price increases from $9 to $10 is 3.6.

How Do We Interpret the Price Elasticity of Supply?

The price elasticity of supply is used to see how sensitive the supply of a good is to a price change. The higher the price elasticity, the more sensitive producers and sellers are to price changes. A very high price elasticity suggests that when the price of a good goes up, sellers will supply a great deal less of the good and when the price of that good goes down, sellers will supply a great deal more. A very low price elasticity implies just the opposite, that changes in price have little influence on supply.

Often you'll have the follow up question "Is the good price elastic or inelastic between $9 and $10". To answer that, use the following rule of thumb:

If PEoS > 1 then Supply is Price Elastic (Supply is sensitive to price changes) If PEoS = 1 then Supply is Unit Elastic If PEoS < 1 then Supply is Price Inelastic (Supply is not sensitive to price

changes)

Recall that we always ignore the negative sign when analyzing price elasticity, so PEoS is always positive. In our case, we calculated the price elasticity of supply to be 3.6, so our good is price elastic and thus supply is very sensitive to price changes.

Next: Income Elasticity of Demand

Data

Price Quantity Demanded Quantity Supplied$7 200 50$8 180 90$9 150 150

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$10 110 210$11 60 250