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Supply

Is ‘supply’ the same as the ‘quantity supplied’? Why is the supply curve not curved at all? In this explanation about the firms’ supply, we will answer these and other questions. You will be introduced to the supply curve and learn the difference between the movements along and shifts in a supply curve. We will also discuss the main supply determinants alongside real-world examples.

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What is supply?

As generally used by economists, the term ‘supply’ is the total quantity of all goods and services that all firms on the market collectively intend to sell at a given price level. Therefore, when used by economists, the term ‘supply’ generally means ‘market supply’. Individual firm supply, in contrast, is the quantity of goods and services that a single firm intends to sell. If you sum up all the individual firms’ supply, then you will receive the aggregate market supply.

Supply is the total quantity of all goods and services that all firms on the market collectively intend to sell at a given price level.

The law of supply

The law of supply states that as the price of a good rises, the quantity supplied increases as the firms are willing to produce more units of a good at higher prices. The reverse is also true. As the price of a good falls, the quantity supplied decreases as the firms are willing to produce fewer units of a good at lower prices. This relationship explains why the supply curve is upward sloping.

Figure 1 illustrates a supply curve. On the horizontal axis, there is the quantity supplied. On the vertical axis, there is the price. The curve is upward sloping as the firms are prepared to supply more units of a good or service at higher prices.

Fig. 1 - Supply curve

The main assumption behind the supply curve is that each firm’s main objective is profit maximisation. This means that the firm will continue to supply a good or service only until it makes a profit on the last unit sold. When the profit on the last unit sold becomes zero, the firm will stop producing.

Total revenue vs profit

The assumption that all firms are profit maximisers underpins the microeconomic analysis behind firms’ choices.

The total revenue of a firm is not the same as its profit. The profit is the total costs of production subtracted from the total revenue.

Total revenue is the total value received by a firm. It is calculated by multiplying the price by the total output sold.

Total costs of production are the sum of all the expenses that the firm incurs during a production process.

If the firm doesn’t grow and utilise economies of scale, increased output will lead to increased production costs. The firm can only cover those costs if it raises the price for subsequent units of output. This results in an upward-sloping supply curve.

This is known as the law of diminishing marginal returns. In the short run, the marginal cost, or the cost of an additional unit of output produced increases as the firm’s output increases. A firm's marginal cost can be shown graphically. In a perfectly competitive market, the marginal cost curve is the firm’s supply curve. Thus, the firm will reach a point at which it will not be able to cover the increased costs unless it raises the price at which it sells its output.

To learn more about firms’ supply curve in a perfectly competitive market check out our explanation on the Market Structures.

Economies of scale occur when the firm becomes larger and increases its output, but its long-run average costs decrease. This happens due to efficiency gains, technological advancements, and other favourable factors which occur in the long run. Internal economies of scale happen within the firm. External economies of scale happen in the industry and benefit individual firms. Economies of scale is a concept that relates to the long run.

The law of diminishing returns states that adding another factor of production into the production process causes a smaller and smaller increase in output. In other words, the productivity with which each additional (marginal) unit of output is produced declines. The law of diminishing marginal returns is a concept that relates to the short run and not the long run as in the long run all the production factors are variable and Economies of Scale may occur.

Supply curves and supply function

The supply curve is a curve that shows which quantity the firms are prepared to supply at various price levels.

The supply curve is usually drawn as an upward-sloping straight line. It slopes upwards due to the law of supply, which states that the firms are prepared to supply more units of a good at higher prices. In some cases, the curve won’t be straight or linear, hence the name: the supply curve. In this explanation, we will stick to linear supply curves.

Supply curve diagram

We can represent the supply curve for a good or service on a diagram. Figure 2 below depicts a market supply curve. On the vertical axis, there is the price, and on the horizontal axis, there is the quantity supplied. At price P1 the quantity that firms on the market are prepared to supply is Q1. As the quantity supplied is directly proportionate to the price of a good, then an increase in the price from P1 to P2 will increase the quantity that the firms are prepared to supply from Q1 to Q2.

Fig. 2 - The supply curve and a price increase

A numerical example of the supply curve

There is a general equation for the linear supply curves.

The linear supply function is:

Price (P) = c + d * Quantity supplied (Q) or

P = c + d * Q

where c and d are constants.

Constant c accounts for non-price factors that shift the supply curve, whilst constant d accounts for the slope of the supply curve.

Consider the following equation, illustrated in Figure 3 below:

P = 10 + 2*Q

It follows that: c = 10 and d = 2

Fig. 3 - A numerical example of the supply curve

The supply curve crosses the vertical axis at point A where the price P=10 and the quantity supplied Q=0.

A general way of finding where the supply curve crosses the vertical axis is:

set Q=0 and find P from the equation. Alternatively, set P=c (where c is a constant from the general equation for P).

You can find any point on the supply curve by inserting the known variables into the supply equation. For example, if the market price is P=50, then the quantity that the firm will be prepared to supply is equal to Q=(P-10)/2=(50-10)/2=20.

What is the difference between changes in supply and changes in quantity supplied?

Supply is not the same as the quantity supplied. As we said before, when the economists use the term ‘supply’ they refer to a range of quantities supplied at various price levels. The supply curve illustrates the supply. The quantity supplied is a single quantity that can be ‘read off’ the supply curve at a particular price level.

Think of supply as a range of points on a curve, whereas the quantity supplied is a single point on the supply curve.

Movements along and shifts of the supply curve

Various factors that affect the supply curve. Changes in the price will lead to a movement along the supply curve, whilst changes in all other factors will lead to parallel shifts in the supply curve.

Movement along the supply curve

Supply is affected by many factors, but these are kept constant when the supply curve is drawn as a function of price (ceteris paribus condition). Subsequently, any changes in the price will lead to a movement along the supply curve.

The phrase ‘ceteris paribus’ is Latin for ‘other things equal’. Economists use it to assume that other factors that affect supply are kept constant.

When the price decreases, the quantity supplied decreases leading to a movement along the supply curve known as a contraction of supply. Figure 4 illustrates the contraction of supply.

Fig. 4 - Contraction of supply

A decrease in the price of carrots from P1 to P2 will lead to a fall in the quantity supplied from Q1 to Q2 and a movement along the supply curve from point 1 to point 2, or a contraction of supply.

When the price increases, the quantity supplied increases leading to a movement along the supply curve known as an extension of supply. The extension of supply is illustrated in Figure 5 below.

Fig. 5 - Extension of supply

An increase in the price of books from P1 to P2 will lead to an increase in the quantity supplied from Q1 to Q2 and a movement along the supply curve from point 1 to point 2 or an extension of supply.

Parallel shifts in the supply curve

When non-price factors (also known as the conditions of supply), which are normally held constant when drawing the supply curve, change the supply curve shifts.

A shift to the right is known as an outward shift. It occurs when any factor affecting supply causes an increase in the quantity supplied at each price level. As Figure 6 shows, the initial supply curve S1 shifts in parallel to the right to S2. At a fixed price level P the quantity supplied increases from Q1 to Q2. The same is true for any other price level due to the parallel nature of the shift.

Fig. 6 - Outward shift of supply curve

A decrease in the costs of raw materials, such as wood for furniture, would shift the supply curve to the right. This is because it costs the producers/firms less to make more furniture, so they will increase their supply. Thus, the quantity supplied increases from Q1 to Q2.

A shift to the left is known as an inward shift. It occurs when any factor affecting supply causes a decrease in the quantity supplied at each price level. As Figure 7 shows, the initial supply curve S1 shifts to the left (S2). At a fixed price level P the quantity supplied decreases from Q1 to Q2. The same is true for any other price level due to the parallel nature of the shift.

Fig. 7 - Inward shift of supply curve

An increase in the cost of energy would result in producers incurring higher costs of production. Producers will reduce their supply to protect profit margins, causing a shift in the supply curve to the left. This results in less quantity supplied at each price level.

Multiple factors affecting the supply curve simultaneously

If there are multiple factors affecting the supply curve at once, the final supply curve will be a sum of all these factors together, taking their magnitude into account.

Consider Figure 8. Imagine there is an outward shift in the supply curve (think of a factor that could cause that). The supply curve shifts from S1 to S2, which results in more quantity supplied (Q2 compared to Q1) at any given price level P.

However, there is also a negative factor that suppresses supply and shifts it inwards. The magnitude of this negative shock is greater than that of the positive shock. The supply curve shifts from S2 to S3 resulting in less quantity supplied (Q3 compared to Q2) at any given price level P. Overall, the resulting shift in the supply curve is negative (S3 is to the left of S1) due to the magnitude of the negative shock being greater than that of the positive shock.

Fig. 8 - Multiple factor shift of supply curve

During the recent pandemic, the UK government offered a support scheme for restaurants, which aimed to keep businesses in operation by covering a part of employees’ wages. This policy aimed to shift the supply curve of the restaurants from S1 to S2. However, there were also significant issues with supply due to logistics, resource availability, and labour shortages caused by the pandemic. This shifted the supply curve inwards from S2 to S3. Although the government provided support for the businesses, the overall effect on the supply of restaurants was negative due to the magnitude of the negative supply-side shock caused by the other pandemic-related issues.

What are the main supply determinants?

Supply determinants (also known as supply conditions) are all the other factors that affect supply apart from the price.

The main supply determinants

The most prominent supply conditions (or supply determinants) are listed below in two categories: production costs and other factors.

Production costs (often firm-specific)

1. Cost of labour. If the wages of workers employed by the firm increase, the firm’s supply curve will shift inwards.
2. Cost of raw materials. If the price of raw materials increases, the firm’s supply curve will shift inwards.
3. Cost of energy. If the price of energy decreases, the firm’s supply curve will shift outwards.
4. Borrowing costs. Businesses often have to borrow money from a bank to finance their expenditures. If there is a decrease in the interest rate on the bank loan, the firm’s supply curve will shift outwards.
5. Labour productivity. If the productivity of labour increases, the firm’s supply curve will shift outward as they will produce more output per unit of time

Other factors (often affect the market supply)

1. Technology. An improvement in technology will shift the market supply curve outwards, as new technology often introduces improvements and efficiency into the production processes.
2. Taxes and subsidies. If the government raises corporate tax, the market supply curve would shift inwards. However, if the government provides a subsidy to a particular sector of the economy, the market supply curve for that sector would shift outwards.
3. Natural conditions. Natural conditions are important for industries such as agriculture. If there are significant adverse weather conditions in a particular year, the market supply curve for agricultural output will shift inwards.

Check your understanding. Think of how the above examples affect the supply curve of a firm or a market supply curve. Think of more examples of non-price factors that may shift the supply curve. Can you name any specific and recent real-world examples of such shifts? Can you differentiate between short-term and long-term shifts in supply?

Supply - Key takeaways

• As generally used by economists, the term ‘supply’ is the total quantity of all goods and services that all firms on the market collectively intend to sell at a given price level.
• The law of supply states that as the price of a good rises, the quantity supplied increases as the firms are willing to produce more units of a good at higher prices. As the price of a good falls, the quantity supplied decreases as the firms are willing to produce fewer units of a good at lower prices.
• Total revenue is the total value received by a firm calculated as the price multiplied by the total output sold.
• The total costs of production are the sum of all the expenses that the firm incurs during a production process.
• The supply curve is a curve that shows which quantity the firms are prepared to supply at various price levels.
• There is a general equation for the linear supply curves.
• Changes in the price will lead to a movement along the supply curve, whilst changes in all other factors will lead to parallel shifts in the supply curve.
• The main supply determinants are cost of labour, cost of raw materials, cost of energy, borrowing costs, labour productivity, technology, taxes and subsidies, and natural conditions.

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What is supply?

The term ‘supply’, as generally used by economists, is the total quantity of all goods and services that all firms on the market collectively intend to sell at a given price level.

What are the determinants of supply?

Supply determinants (also known as supply conditions) are all the other factors, apart from the price, that affect supply. These are usually held constant when the supply curve is drawn as a function of price.

What is supply function in economics?

The linear supply function is: Price (P) = c + d * Quantity supplied (Q)  or

P = c + d * Q where c and d are constants.

What are types of supply?

There are two types of supply: individual firm supply and market supply. Individual firm supply is the quantity of goods and services that a single firm intends to sell at a given price level. Market supply is the total quantity of all goods and services that all firms on the market collectively intend to sell at a given price level.

How does supply affect a business?

Businesses often have to borrow money from a bank to finance their expenditures. If there is a decrease in the interest rate on the bank loan, the supply curve of a firm will shift outwards.

Test your knowledge with multiple choice flashcards

How is the supply curve most often drawn?

The supply can be drawn as an upward-sloping curve.

If there is a decrease in the interest rate on the bank loan, the firm’s supply curve will shift inwards.

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