Definition of supply

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Allocation of Resources – Supply

Learning Objectives

  • State the definitions of individual and market supply and show how market supply is derived by horizontal summation.
  • Draw and label a supply diagram correctly.
  • Distinguish between movements along the supply curve and shifts of the curve.
  • Explain the determinants that cause shifts in supply.
  • Define, calculate and interpret price elasticity of supply (PES).
  • Understand how supply interacts with demand to determine market price and the consequences of price changes for producers.
  • Connect the concept of supply to later parts of the Cambridge IGCSE 0455 syllabus (price‑elasticity of demand, market failure, macro‑supply‑side policy).

1. Definitions of Supply

1.1 Individual Supply

Individual supply is the quantity of a good or service that a single producer is willing and able to sell at each possible price during a given period, ceteris paribus (all other factors remaining constant).

1.2 Market Supply

Market supply is the horizontal summation of the individual supply schedules of all producers in a market. It shows the total quantity that all sellers together are willing and able to sell at each price.

Numerical example: If three firms supply the following quantities at a price of $10:

FirmQuantity supplied at $10
Firm A40 units
Firm B60 units
Firm C30 units

Market supply at $10 = 40 + 60 + 30 = 130 units. Repeating this for each price gives the market‑supply schedule, which is then plotted as the market‑supply curve.

2. The Supply Diagram

2.1 How to draw a supply curve (step‑by‑step)

  1. Draw two perpendicular axes.
  2. Label the vertical axis Price (P) and the horizontal axis Quantity Supplied (Qs).
  3. Mark a series of price points on the vertical axis (e.g., $5, $10, $15).
  4. For each price, plot the corresponding quantity supplied (use a table or data set).
  5. Connect the points with a smooth line that slopes upwards from left to right – this is the individual supply curve.
  6. To obtain the market‑supply curve, repeat the process using the summed quantities of all firms; the shape remains upward‑sloping.

2.2 Movements along the supply curve

A movement along the curve occurs when price changes** while all other determinants stay the same**. The curve itself does **not** shift.

Example: If the price of a widget rises from $10 to $12, the quantity supplied might rise from 100 units to 130 units. On the diagram this is shown as a movement from point A to point B on the same curve.

2.3 Shifts of the supply curve

When any determinant **other than price** changes, the whole supply curve shifts:

  • Right‑shift (increase in supply): the curve moves outward; at every price a larger quantity is supplied.
  • Left‑shift (decrease in supply): the curve moves inward; at every price a smaller quantity is supplied.

Real‑world example: The introduction of a faster production technology reduces unit costs. This causes a right‑shift because producers can now supply more at each price.

2.4 Price determination (equilibrium and disequilibrium)

Supply interacts with demand to set the market price. The point where the supply curve meets the demand curve is the equilibrium price (Pe) and the corresponding equilibrium quantity (Qe). If the actual price is above Pe, there is a surplus (quantity supplied > quantity demanded) and producers will tend to lower price, moving the market back toward equilibrium. If the price is below Pe, there is a shortage and producers will raise price, again moving toward equilibrium.

2.5 Consequences of a price change for producers

  • Revenue effect: Total revenue = Price × Quantity supplied. A higher price may increase revenue even if quantity supplied falls, and vice‑versa.
  • Producer surplus: The area above the supply curve and below the market price represents the extra benefit producers receive because they are paid more than the minimum they would have accepted.
  • Production decisions: Anticipated price changes influence whether firms expand capacity, invest in new technology, or exit the market.

3. Determinants of Supply

Determinant Effect on Supply (ceteris paribus)
Input (factor) prices Higher input costs → supply decreases; lower input costs → supply increases.
Technology Improved technology → supply increases; outdated technology → supply decreases.
Number of sellers More sellers → supply increases; fewer sellers → supply decreases.
Expectations of future price Expect higher future price → current supply may fall (producers hold stock); expect lower future price → current supply may rise.
Taxes and subsidies Higher taxes → supply decreases; subsidies → supply increases.
Government regulations Stringent regulations (e.g., quotas) → supply decreases; deregulation → supply increases.
Spare capacity Excess capacity allows firms to increase output quickly → supply becomes more elastic (right‑shift).

4. Price Elasticity of Supply (PES)

4.1 Definition

Price elasticity of supply measures the responsiveness of the quantity supplied to a change in price.

4.2 Formula

\[ \text{PES} = \frac{\%\Delta Q_s}{\%\Delta P} \]

where \(\%\Delta Q_s\) is the percentage change in quantity supplied and \(\%\Delta P\) is the percentage change in price.

4.3 Interpretation of PES values (Cambridge wording)

  • PES = 0 – perfectly inelastic supply (quantity supplied does not change with price).
  • 0 < PES < 1 – inelastic supply.
  • PES = 1 – unitary elastic supply.
  • PES > 1 – elastic supply.
  • PES = ∞ – perfectly elastic supply (any price above a minimum elicits an unlimited quantity).

4.4 Determinants of PES

Determinant Typical effect on PES
Time‑frame Supply is more elastic in the long run because firms can adjust plant size, enter or exit markets.
Spare capacity Excess capacity → higher PES; capacity already fully utilised → lower PES.
Availability of inputs Readily available inputs → higher PES; scarce inputs → lower PES.
Flexibility of production techniques Flexible (e.g., modular) processes → higher PES.

4.5 Worked example (calculating PES)

Suppose the price of a good rises from $20 to $25 (a 25 % increase) and the quantity supplied rises from 200 units to 260 units (a 30 % increase).

\[ \text{PES} = \frac{30\%}{25\%} = 1.2 \]

Because PES > 1, supply is elastic over this price range.

4.6 Diagrammatic illustration of PES

On a supply diagram, a more elastic supply curve is flatter (shallower slope), while a more inelastic supply curve is steeper. Two curves drawn on the same axes illustrate the difference:

  • Curve A – steep → inelastic supply.
  • Curve B – flat → elastic supply.

5. Links to Other Syllabus Areas

5.1 Price elasticity of demand (PED)

While this note focuses on supply, the concept of elasticity is analogous to price elasticity of demand. Both are examined in the exam, and the same formulaic approach (percentage change in quantity / percentage change in price) is used.

5.2 Market failure and mixed economies

Supply curves are used when discussing market failure (e.g., external costs shift the supply curve upward) and the role of government in mixed economies (taxes, subsidies, regulation). Understanding how the supply curve shifts helps students analyse the impact of policy measures.

5.3 Real‑world context – firms and labour

Supply decisions are made by firms (production of goods) and by households in the labour market (supply of labour). Wage changes affect the labour‑supply curve in the same way price changes affect a product‑supply curve.

5.4 Extension – macro‑economic supply‑side policy

Supply‑side policies such as infrastructure investment, deregulation or tax cuts aim to shift the aggregate‑supply curve to the right, increasing the economy’s productive capacity.

6. Summary

  1. Individual supply = quantity a single producer will sell at each price; market supply = horizontal summation of all individual supplies.
  2. The supply curve slopes upward because higher prices encourage greater output.
  3. Price changes cause movements along the curve; changes in any other determinant shift the whole curve.
  4. Key determinants of supply: input prices, technology, number of sellers, expectations, taxes/subsidies, regulations, and spare capacity.
  5. Price elasticity of supply (PES) quantifies how responsive supply is to price changes; it depends on time‑frame, spare capacity, input availability and production flexibility.
  6. Elastic supply (PES > 1) is shown by a flatter curve; inelastic supply (PES < 1) by a steeper curve.
  7. Supply interacts with demand to determine equilibrium price and quantity, and price changes affect revenue, producer surplus and future production decisions.

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