Now that we’re done with demand, let’s talk about supply, the other half of the corner stone of economics. If you understand the basic concept of demand and how that works, you shouldn’t have any problems understanding supply. A lot of this will seem very familiar.
In economics, the textbook definition of supply refers to the various quantities of a good or service that producers are willing and able to sell over a range of prices during a specified period of time. Again, there are four important parts to this definition.
“These two words are pretty much the only difference between the supply definition and the demand definition, isn’t it?” you ask.
Good observation. As far as the words in the definition go, this is the only difference from demand. Rather than talking about consumers and how much they’re willing to buy, we’re now talking about producers and how much of their good or service they’re willing to sell.
Willing and Able
Similar to demand, in order for someone to count as a supplier in a market economy, they must be willing and able to produce whatever they’re trying to supply. Just wanting something isn’t enough; you have to have the means to be able to make and sell it.
Various Quantities, Range of Prices
Supply refers to not just one price, but an entire series of prices and how much producers intend sell at each of those corresponding prices. Note that supply by itself does not tell you what the market price for the good or service is; it only tells you what suppliers plan to sell at each price point.
Specified Period of Time
Supply without a time constraint is meaningless. Are we looking at how much suppliers are willing to produce per week? Hour? Year? Without the time frame, there’s no way to tell if the supply is large or small.
The easiest way to understand supply and how it works is to take a look at an example. Below is the supply schedule for Not A Real Company, Inc. (henceforth known as Narc Inc.) for the pounds of bacon they can supply a week. It’s listed in three forms: as an equation, a table, and a graph.
The equation, table, and graph all tell the same story. Let’s start with the table. The table shows how much bacon Narc Inc. will sell at any given price. When the price per pound of bacon is $10, NARC Inc. is willing to produce and sell 20 pounds of bacon. When it’s at $8, they’ll sell 15 pounds of bacon a week. When it’s at $2 per pound, they’re not willing to produce any bacon at all. So on and so forth. Like I mentioned earlier, supply by itself does not show you what the prevailing market price is. Just by looking at the table or graph, we can’t tell how much bacon is selling for at the moment; all we can see is how much Narc Inc. is willing to produce and sell at any particular price.
“I’m noticing a pattern here, you quip. This time, the quantity supplied moves in the same direction price does. As the price goes up, the quantity supplied goes up too.
Another good observation. As the price of bacon rises, the amount that NARC Inc. is willing sell goes up. As the price falls, the amount of bacon NARC Inc. is willing to sell goes down. In other words, there is a direct (or positive) relationship between price and quantity supplied. We economists call this relationship the law of supply.
The law of supply states that all else equal, as price increases, quantity supplied increases and as price decreases, quantity supplied decreases. You can easily see this relationship in the graph because the line is upward sloping and in the equation because the slope is positive.
For a business, the price that a product gets sold for is equivalent to the revenue that it brings in. So the higher the price, the higher the revenue, which potentially means higher profit. Remember that profit is the self interest motivator for businesses, so the higher the price, the more incentive firms have to produce. This is one aspect that helps explain the law of supply. The upward sloping supply curve also has something to do with the concept of increasing marginal costs which deals with firms facing higher production costs as they increase output, but that’s something we’ll dive into another time.
We derive market supply the same way that we derive market demand. To go from an individual’s supply curve to the market’s all we have to do is sum up how much suppliers are willing to supply at every price point and use that data to create a new schedule. Graphically all you’re doing is horizontal summation; for every Y value, you’re adding up all the corresponding X values to come up with a new X value.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
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