Your Comprehensive Study Guide to the Law of Supply!
Hey everyone! Welcome to your study notes for the "Law of Supply". In the last chapter, we looked at the world through the eyes of consumers (demand). Now, it's time to switch hats and think like a producer or a business owner. It's all about making and selling things!
In this chapter, we'll explore:
- What the Law of Supply is and why it makes sense.
- The big difference between a 'change in quantity supplied' and a 'change in supply'. (A super common exam topic!)
- The key factors that can make a business want to supply more or less of a product.
- How we get from one firm's supply to the entire market's supply.
Don't worry if some of these terms sound tricky. We'll break them down with simple language and everyday examples. Let's get started!
1. What is Supply? The Law of Supply
Defining Supply
In economics, supply isn't just about how much of a product a company has. It's about how much of a good or service a producer is both willing AND able to sell at different possible prices during a specific period of time.
The "willing and able" part is key. A factory might be able to produce 1 million face masks, but they might not be willing to sell them if the price is too low.
The Law of Supply
This is the main rule for this chapter, and it's quite intuitive!
The Law of Supply states that, ceteris paribus, when the price of a good increases, the quantity supplied of that good also increases. When the price decreases, the quantity supplied decreases.
In simple terms: Higher Price = Higher Quantity Supplied. They move in the same direction!
Why does this happen? The Profit Motive!
It's all about making money. When the price of a product goes up, but the cost to make it stays the same, producers can make more profit on each item sold. This gives them a powerful incentive to produce and sell more.
Example: Imagine you run a small bakery. If the price of egg tarts suddenly goes up from $8 to $12, you'd be much more motivated to bake and sell more egg tarts because you'll earn more profit on each one!
Ceteris Paribus - The Golden Rule
You'll see this Latin phrase a lot. Ceteris Paribus means "all other things being held constant". When we talk about the Law of Supply, we are assuming that ONLY the price of the good is changing. We pretend that things like worker salaries, rent, and technology are not changing at the same time.
The Supply Schedule and Supply Curve
We can show the Law of Supply in two ways:
- Supply Schedule: A table showing the quantity supplied at different prices.
- Supply Curve: A graph showing the same information. It's an upward-sloping line.
Example: A Bakery's Supply of Egg Tarts
Supply Schedule
| Price per Tart | Quantity Supplied per Day |
|---|---|
| $6 | 50 |
| $8 | 100 |
| $10 | 150 |
| $12 | 200 |
Supply Curve
If you plotted these points on a graph (with Price on the Y-axis and Quantity on the X-axis), you'd get an upward-sloping line. This visual shape is a key feature of supply!
A Deeper Look: Marginal Cost and Supply
Why is the supply curve upward sloping? As a firm produces more, it often gets a bit more expensive to produce each extra unit (this is related to the 'Law of Diminishing Marginal Returns'). A firm will only produce that extra unit if the price is high enough to cover that extra cost. Therefore, the firm's marginal cost schedule (the cost of producing one more unit) is its supply schedule!
Key Takeaway for Section 1
The Law of Supply shows a positive relationship between a good's price and the quantity producers are willing to sell, because higher prices mean higher potential profits. A supply curve slopes upwards. Simple!
2. The BIG Difference: Change in Quantity Supplied vs. Change in Supply
This is one of the most important concepts in this topic, and a common place for students to get confused. Don't worry, we'll make it crystal clear!
Change in Quantity Supplied
This happens when there is a change in the price of the good itself, and nothing else.
- It is represented by a MOVEMENT ALONG the existing supply curve.
- If price goes up, we move UP the curve (an extension or increase in quantity supplied).
- If price goes down, we move DOWN the curve (a contraction or decrease in quantity supplied).
Example: If the price of smartphones increases from $5,000 to $6,000, phone manufacturers will produce more. This is a movement up along the supply curve. The supply curve itself has not moved.
Change in Supply
This happens when a factor OTHER THAN THE PRICE of the good changes. (We'll cover these factors in the next section!)
- It is represented by a SHIFT of the ENTIRE supply curve.
- An increase in supply means the curve shifts to the RIGHT. (Producers are willing to sell more at EVERY price level).
- A decrease in supply means the curve shifts to the LEFT. (Producers are willing to sell less at EVERY price level).
Example: If a new, super-efficient machine for making smartphones is invented, manufacturers can produce them more cheaply. They are now willing to supply more phones at all price levels. The whole supply curve shifts to the right.
Quick Review & Memory Aid
MOVEMENT is caused by Price (of the good itself).
SHIFT is caused by Something Else (Stuff Except Price).
Common Mistakes to Avoid!
A classic exam question might say, "The price of iPhones has fallen. Does this cause a change in the supply of iPhones?"
The correct answer is NO! It causes a change in the QUANTITY SUPPLIED of iPhones (a movement down along the curve). Be very precise with your language!
Key Takeaway for Section 2
Movement along the curve = change in quantity supplied (caused by price).
Shift of the whole curve = change in supply (caused by non-price factors).
3. Factors that SHIFT the Supply Curve (The "Shifters")
So, what are those "other factors" that can cause the entire supply curve to shift? Let's look at the main ones. (Remember, a change in any of these means ceteris paribus is no longer true!)
1. Cost of Production
This is a big one. If it becomes cheaper or more expensive to make something, it directly affects supply.
- Lower Costs: If costs go down (e.g., lower wages, cheaper raw materials, lower rent), production is more profitable. Supply increases (shifts RIGHT).
- Higher Costs: If costs go up (e.g., minimum wage increase, higher electricity bills), production is less profitable. Supply decreases (shifts LEFT).
2. Technology
Improvements in technology almost always lead to lower production costs and higher efficiency.
- Better Technology: (e.g., a faster computer, a more efficient robot in a factory). This lowers costs and increases supply (shifts RIGHT).
3. Price of Related Goods
Sometimes, the production of one good is linked to another.
- Competitive Supply: When two goods use the same resources to be produced. Example: A farmer can use their land to grow either potatoes or carrots. If the price of potatoes rises, they will supply more potatoes. To do this, they must use land that was for carrots, so the supply of carrots decreases (shifts LEFT).
- Joint Supply: When two goods are produced together from the same source. Example: Beef and leather both come from cows. If the price of beef increases, ranchers will raise more cows. This increases the quantity supplied of beef, AND it also increases the supply of leather (shifts RIGHT) as a by-product.
4. Price Expectation (of Producers)
What firms think will happen to the price in the future affects what they do now.
- Expect Future Price to Rise: A producer might hold back some of their product now to sell it later at the higher price. This means the supply TODAY decreases (shifts LEFT). Example: A property developer might delay selling new flats if they expect prices to be much higher next year.
5. Weather
This is especially important for agricultural goods.
- Good Weather: Favourable conditions (e.g., enough rain for crops) will increase supply (shifts RIGHT).
- Bad Weather: A typhoon, drought, or flood will destroy crops and decrease supply (shifts LEFT).
Did you know?
The factors we've just discussed affect Individual Supply. When we talk about Market Supply (which we'll cover next), there is one more important shifter!
Key Takeaway for Section 3
Any change in production costs, technology, related goods' prices, future expectations, or weather will cause the entire supply curve to shift either left (decrease) or right (increase).
4. From Individual to Market Supply
This is a nice, simple step. The market supply is just the total supply of all individual producers in a market.
Horizontal Summation
To get the market supply, we simply add up the quantities that each individual producer is willing to sell at each price level. This process is called horizontal summation.
Let's go back to our bakery example. Imagine there are only two bakeries in the market: "Your Bakery" and "Best Bakery".
Supply Schedules
| Price per Tart | Your Bakery's Qs | Best Bakery's Qs | Market Qs (Total) |
|---|---|---|---|
| $8 | 100 | 80 | 180 (100 + 80) |
| $10 | 150 | 130 | 280 (150 + 130) |
| $12 | 200 | 180 | 380 (200 + 180) |
See? We just added the quantities horizontally across the table to get the total market supply.
The Extra Shifter for Market Supply: Number of Sellers
This is the factor that affects market supply but not individual supply.
- More Sellers: If new firms enter the market, the total market supply will increase (shift RIGHT), even if each individual firm's supply stays the same.
- Fewer Sellers: If firms go out of business and leave the market, the total market supply will decrease (shifts LEFT).
Key Takeaway for Section 4
Market supply is the horizontal sum of all individual supplies. Therefore, a change in the number of firms in the market is a key factor that shifts the market supply curve.
Chapter Summary
Well done for making it through! You now understand the producer's side of the market.
- The Law of Supply states that higher prices lead to a higher quantity supplied (a positive relationship).
- A change in the good's own price causes a movement along the supply curve (change in quantity supplied).
- A change in non-price factors (like costs, tech, etc.) causes a shift of the supply curve (change in supply).
- Market supply is found by horizontally summing up all the individual firms' supply curves.
Keep these core ideas in mind, especially the difference between a movement and a shift, and you'll be in great shape for your exams!