2.2 Supply

• Supply is the amount of a good/service that a producer is willing and able to supply at a given price in a given time period
• The law of supply states that there is a positive (direct) relationship between quantity supplied and price, ceteris paribus
• The law of supply is based on two key assumptions

  • The law of diminishing marginal returns
  • Increasing marginal costs
• The Law of Diminishing Marginal Returns

  • As more of a variable factor of production (e.g. labour) is added to fixed factors (e.g. capital), there will initially be an increase in productivity
  • However, a point will be reached where adding additional units of the factor (e.g. hiring an extra worker) begins to decrease productivity due to the relationship between labour and capital
• Increasing Marginal Costs

  • The concept that as a producer increases the quantity of a good/service supplied, the additional cost of producing each additional unit also increases
  • This relationship is reflected in the upward-sloping supply curve, indicating that producers are willing to supply a greater quantity at higher prices to justify the higher costs of production
• There are several factors that will change the supply of a good/service, irrespective of the price level. Collectively these factors are called the non-price determinants of supply and include

  • Changes to the costs of production
  • Changes to indirect taxes and subsidies
  • Changes to technology
  • Changes to the number of firms
  • Weather events
  • Future price expectations
  • Goods in joint and competitive supply
• Four Factors of Production: Capital, Entrepreneurship, Land, Labour (CELL)
• Land - Includes all natural resources such as minerals, oil, gas, water, forests, wildlife, fertile land, etc.
• Capital - The stock of produced means of production, including buildings, machinery, tools, vehicles, etc.
• Labour - The workforce or human resource available for employment
• Entrepreneurship - The ability to organise and manage productive activities, taking risks and making decisions about what goods or services to produce, how much to charge, when to expand, etc.
• Changes to costs of production - If the price of raw materials or other costs of production change, firms respond by changing supply
• Indirect taxes - Any changes to indirect taxes change the costs of production for a firm and impact supply
• Subsidies - Changes to producer subsidies directly impact the costs of production for the firm
• New technology - New technology increases productivity and lowers costs of production. Ageing technology can have the opposite effect
• Change in the number of firms in the industry - The entry and exit of firms into the market has a direct impact on the supply. E.g. If ten new firms start selling building materials in Hanoi, the supply of building material will increase
• Weather events - Droughts or flooding can cause a supply shock in agricultural markets. A drought will cause supply to decrease. Unexpectedly good growing conditions can cause supply to increase
• Future price expectations - If firms expects the price of a good/service to increase in the future, they will start supplying more. If firms expects the price of a good/service to decrease in the future, they will start supplying less
• Goods in joint supply -When there is an increase of supply of one good in joint supply (e.g. beef), possibly due to higher prices, there will be an increase in supply of the other good too (e.g. leather)
• Goods in competitive supply - Farmers can produce many goods which are competitive in supply. E.g. A farmer can grow wheat or potatoes. When they increase the supply of potatoes, the supply of wheat decreases