Causes of extensions and contractions in supply

Allocation of Resources – Supply (IGCSE 0455 2 Supply)

1. What is Supply?

• Individual supply: the quantity of a good that one producer is willing and able to sell at each price, ceteris paribus.
• Market supply: the total quantity supplied by all producers in the market at each price.
  Market supply = Σ (individual supplies) at a given price.

The market‑supply curve is upward‑sloping because a higher price gives producers a greater incentive to increase output.

Mathematically (syllabus notation):

$$Q_s = f\big(P,\; \text{input prices},\; \text{technology},\; \text{expectations},\; \text{number of sellers},\; \text{taxes/subsidies},\; \text{regulation}\big)$$

2. Movements Along the Supply Curve (Change in the Good’s Own Price)

A movement along the curve occurs **only** when the price of the good itself changes, while all other determinants remain constant.

Price change	Direction of movement	Result for quantity supplied
Price rises	Upward along the curve	Quantity supplied increases
Price falls	Downward along the curve	Quantity supplied decreases
No price change	No movement	Quantity supplied unchanged

3. Shifts of the Supply Curve (Change in Non‑Price Determinants)

A shift occurs when any determinant **other than the good’s own price** changes. The whole curve moves:

• Right‑hand shift – called an extension.
• Left‑hand shift – called a contraction.

Determinant	Effect on supply	Resulting shift	Typical example
Input‑price fall (raw material, labour, energy)	Lower marginal cost	Extension (right)	Cheaper wheat → more bread supplied
Input‑price rise	Higher marginal cost	Contraction (left)	Higher oil price → less gasoline supplied
Technology improvement	More efficient production	Extension	Robotic assembly line in car factories
Technology setback or obsolescence	Less efficient production	Contraction	Factory fire destroys equipment
Number of sellers – entry of new firms	More producers in the market	Extension	New mobile‑phone manufacturers appear
Number of sellers – exit of existing firms	Fewer producers	Contraction	Bankrupt dairy farms leave the market
Expectations of future price – expected fall	Produce more now to avoid lower future price	Extension	Farmers plant extra wheat anticipating a price drop
Expectations of future price – expected rise	Withhold output for later sale	Contraction	Oil firms store crude for later sale
Taxes (indirect tax) – introduction	Higher marginal cost	Contraction	Excise duty on cigarettes
Subsidies – introduction	Lower marginal cost	Extension	Government subsidises solar panels
Regulation – stricter standards	Higher compliance cost	Contraction	Emission caps on factories
Regulation – relaxation of standards	Lower compliance cost	Extension	Fewer permits required for food‑processing plants
Government intervention – maximum price (price ceiling)	Legal limit below equilibrium price	Contraction (quantity supplied falls)	Rent control on apartments
Government intervention – minimum price (price floor)	Legal limit above equilibrium price	Extension (quantity supplied rises)	Minimum wage for agricultural workers
Privatisation	State‑owned firm becomes private → profit motive increases	Extension	Privatised electricity company expands output
Nationalisation	Private firm taken into public ownership → profit motive may fall	Contraction	Nationalised railways reduce service frequency
Direct provision (state supplies the good)	Government becomes a producer, often at a set price	Extension (if government adds to total supply)	State‑run hospitals increase health‑service output
Quotas (output limits)	Legal limit on total quantity that can be produced	Contraction	Fishing quota on cod reduces total catch

4. Price Changes – Causes & Consequences

• Causes of a price change (syllabus wording):
  • Movement along the supply curve (change in the good’s own price).
  • Shift of the demand curve – caused by a change in consumer preferences, income, price of related goods, expectations, or number of buyers.
  • Shift of the supply curve – caused by any of the non‑price determinants listed above.
• Consequences of a price rise:
  • Quantity supplied ↑ (movement up the supply curve).
  • Quantity demanded ↓ (movement down the demand curve).
  • Producer total revenue may rise or fall depending on the price elasticity of supply.
• Consequences of a price fall:
  • Quantity supplied ↓ (movement down the supply curve).
  • Quantity demanded ↑ (movement up the demand curve).
  • Producer total revenue again depends on the price elasticity of supply.

5. Price Elasticity of Supply (PES)

Definition (exact syllabus wording): PES measures the responsiveness of the quantity supplied to a change in price.

Formula (percentage‑change form):

$$\text{PES} = \frac{\% \Delta Q_s}{\% \Delta P}$$

where %Δ = (new – old) / old × 100.

5.1 Calculating PES – Worked Example

Initial situation	After price change
Price = £10 per kg Quantity supplied = 200 kg	Price rises to £12 per kg Quantity supplied rises to 260 kg

Step 1 – %ΔP

$$\% \Delta P = \frac{12-10}{10}\times 100 = 20\%$$

Step 2 – %ΔQs

$$\% \Delta Q_s = \frac{260-200}{200}\times 100 = 30\%$$

Step 3 – PES

$$\text{PES} = \frac{30\%}{20\%}=1.5$$

Interpretation: PES > 1 → elastic supply. Producers are relatively responsive to price changes.

5.2 Interpretation of PES Values

• Elastic supply (PES > 1): large response; usually due to spare capacity, easy access to inputs, or short‑run flexibility.
• Unit‑elastic supply (PES = 1): proportional response.
• Inelastic supply (PES < 1): small response; common when production relies on fixed factors, specialised skills, or scarce inputs.
• Perfectly elastic supply (PES = ∞): producers will supply any quantity at a given price but none at a lower price (e.g., competitive market with abundant capacity).
• Perfectly inelastic supply (PES = 0): quantity supplied does not change regardless of price (e.g., unique artwork, fixed‑supply natural resource).

5.3 Why PES Matters – Relevance to Decision‑Makers

• Workers: In industries with elastic supply, a rise in wages is more likely to be absorbed without large price increases for the product.
• Firms: Knowing the elasticity helps a firm decide whether to increase output when prices rise or to wait for a more favourable market.
• Government: PES indicates how a tax, subsidy or price control will affect market quantities and therefore tax revenue, unemployment, or shortages.
• Policy‑makers: Inelastic supply of essential goods (e.g., electricity) means price controls can cause severe shortages, whereas elastic supply makes the market more adaptable.

6. Distinguishing Between a Movement Along the Curve and a Shift

• Movement along the supply curve: caused only by a change in the good’s own price; the curve itself does **not** move.
• Shift of the supply curve: caused by a change in any non‑price determinant (input price, technology, number of sellers, expectations, government intervention, etc.); the whole curve moves right (extension) or left (contraction).

7. Summary Checklist for Exam Answers (Supply)

1. State whether the change is a movement along the curve, an extension (right‑hand shift), or a contraction (left‑hand shift).
2. Identify the specific determinant that has changed (price of the good, input price, technology, number of sellers, expectations, government intervention, etc.).
3. Explain the direction of the shift and why it occurs, using the correct terminology.
4. Provide a real‑world example where appropriate.
5. For elasticity questions, calculate PES using PES = %ΔQs ÷ %ΔP, state whether supply is elastic, unit‑elastic or inelastic, and mention the key factor(s) influencing that elasticity.
6. Always differentiate a shift from a movement along the curve.