Causes of decreases and increases in supply

Allocation of Resources – Supply

Objective

To understand the causes of decreases and increases in supply, how these are shown on supply curves and schedules, and how supply interacts with demand to determine market price and quantity. The note also covers price elasticity, market‑economic systems and market failure – all required by the Cambridge IGCSE 0455 syllabus.

1. The Law of Supply

The law of supply states that, ceteris paribus, the quantity supplied of a good rises when its price rises and falls when its price falls.

Mathematically:

$$Q_s = f(P)\qquad\text{with}\qquad \frac{dQ_s}{dP}>0$$

where Q_s = quantity supplied and P = market price.

2. Individual vs. Market Supply

• Individual supply: the quantity of a good that a single producer is willing and able to sell at each price.
• Market supply: the horizontal sum of the individual supply curves of all producers in the market.

Example: If Firm A supplies 10 units at £5 and Firm B supplies 15 units at the same price, the market supply at £5 is 10 + 15 = 25 units.

3. Supply Schedule and Supply Curve

The above schedule can be plotted to obtain the upward‑sloping supply curve.

4. Movement Along the Supply Curve vs. Shift of the Supply Curve

• Movement along the supply curve (price change of the good itself): causes a change in the quantity supplied but the curve itself does not move.
• Shift of the supply curve (any other factor): changes the quantity supplied at every price, moving the whole curve right (increase) or left (decrease).

Diagrams should be labelled “Movement along the supply curve” and “Shift of the supply curve” to match syllabus terminology.

5. Interaction of Supply and Demand – Price Determination

When the supply curve (S) intersects the demand curve (D) the market is in equilibrium (E), giving equilibrium price P_e and quantity Q_e.

• Right‑hand shift (increase in supply): new equilibrium at a lower price and higher quantity (P↓, Q↑).
• Left‑hand shift (decrease in supply): new equilibrium at a higher price and lower quantity (P↑, Q↓).

If price is set above P_e a surplus occurs (downward pressure on price); if set below, a shortage occurs (upward pressure on price). Arrows on the diagram show the direction of movement toward the new equilibrium.

6. Factors that Increase Supply (Right‑hand Shift)

1. Improvement in technology – lowers production costs.
2. Decrease in input prices – e.g., cheaper raw materials or wages.
3. Increase in the number of sellers – more firms enter the market.
4. Expectations of lower future prices – producers sell more now.
5. Government subsidies – reduce the effective cost of production.
6. Favourable weather (agri.) – raises output.

7. Factors that Decrease Supply (Left‑hand Shift)

1. Technological setbacks – raise production costs.
2. Increase in input prices – higher wages or raw‑material costs.
3. Decrease in the number of sellers – firms exit the market.
4. Expectations of higher future prices – producers hold back output.
5. Government taxes or removal of subsidies – increase production cost.
6. Adverse weather (agri.) – reduces output.

8. Summary Table of Supply Shifters

9. Consequences of Supply Shifts for Revenue and Expenditure

• Right‑hand shift: equilibrium price falls, so consumers spend less per unit (higher consumer surplus). Producers receive a lower price per unit but sell a larger quantity; total revenue may rise or fall depending on the price elasticity of demand.
• Left‑hand shift: equilibrium price rises, reducing consumer surplus. Producers receive a higher price per unit but sell less; total revenue again depends on demand elasticity.

10. Price Changes – Causes and Consequences (Recap)

• Change in market price of the good: moves producers along the existing supply curve (no shift).
• Shift in supply:
  • Right‑hand shift → lower equilibrium price, higher equilibrium quantity.
  • Left‑hand shift → higher equilibrium price, lower equilibrium quantity.
• Government intervention:
  • Subsidy → right‑hand shift, price falls for consumers.
  • Tax → left‑hand shift, price rises for consumers.
• Expectations of future price affect current supply decisions and therefore current price.

11. Price Elasticity of Demand (PED)

12. Price Elasticity of Supply (PES)

13. Market Economic System

A market economic system is one in which resources are allocated primarily through the interaction of buyers and sellers in markets, with prices acting as signals.

• Advantages: efficient allocation of resources, encourages innovation, consumer choice.
• Disadvantages: can lead to inequality, may under‑provide merit goods, can produce negative externalities.

14. Market Failure

Market failure occurs when the free market does not allocate resources efficiently. The main types relevant to IGCSE are:

• Public goods – non‑rival and non‑excludable (e.g., street lighting).
• Merit goods – under‑consumed if left to the market (e.g., vaccinations).
• Demerit goods – over‑consumed if left to the market (e.g., cigarettes).
• Externalities – costs or benefits that affect third parties.
  • Negative externality example: pollution from a factory.
  • Positive externality example: education improving societal productivity.
• Monopoly – a single seller can restrict output and raise price.

15. Mixed Economic System

A mixed economy combines elements of a market system with government intervention to correct market failures.

Typical interventions include taxes, subsidies, price controls, and regulation of monopolies.

16. Diagrammatic Representation

17. Quick Revision Questions

1. Explain why a fall in the price of labour causes a right‑hand shift of the supply curve for a manufacturing firm.
2. Identify two factors that would shift the supply curve of wheat to the left and explain the likely impact on market equilibrium price and quantity.
3. How does a government subsidy differ from a tax in terms of its effect on the supply curve and on the market price faced by consumers?
4. Using a demand‑supply diagram, describe what happens to price and quantity when a new tax is imposed on producers of cigarettes.
5. What is the difference between a shortage and a surplus, and how do they affect the direction of price movement in the short run?
6. Define price elasticity of demand and state what happens to total revenue when demand is elastic and price falls.
7. Define price elasticity of supply and give an example of a factor that makes supply highly elastic.
8. List one advantage and one disadvantage of a market economic system.
9. Give an example of a negative externality and suggest a government intervention to correct it.
10. Why might a mixed economy be preferred to a pure market economy?