Drawing and interpretation of the supply diagram

Cambridge IGCSE Economics (0455) – The Allocation of Resources: Supply

Learning objectives (linked to AO1‑AO3)

• AO1 – Knowledge: Define the key concepts of supply, draw and label a supply diagram, and list the factors that shift supply.
• AO2 – Application: Convert a supply schedule into a supply curve, and apply the diagram to a real‑world change (e.g., a fall in input cost).
• AO3 – Analysis & Evaluation: Explain why the supply curve slopes upwards, analyse the impact of price changes on total revenue, evaluate the importance of price elasticity of supply (PES) and discuss the role of supply in a market economy.

1. The law of supply

Ceteris paribus (all other factors unchanged), the quantity supplied of a good rises when its price rises and falls when its price falls.

Mathematically:

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

2. Individual and market supply

• Individual (or firm) supply: the quantity of a good that one producer is willing and able to sell at each price in a given period.
• Market supply: the sum of the quantities that all producers in the market are willing and able to sell at each price.

Supply schedule (example – wheat, 1 t = 1 000 kg)

3. Drawing the supply curve

1. Label the vertical axis Price (P) and the horizontal axis Quantity supplied (Q_s).
2. Choose at least three price‑quantity pairs that obey the law of supply (e.g., (£50, 2 t), (£70, 3 t), (£90, 4 t)).
3. Plot the points on the graph.
4. Join the points with a smooth upward‑sloping line – this is the Supply curve (S).
5. Mark a point (e.g., A) on the curve to illustrate a movement along the curve.

Diagram tip (AO3): Use a solid line for the initial supply curve and a dashed line for any shifted curve. Clearly label each curve (S₁, S₂ …) and any points (A, B).

4. Movements along the supply curve

5. Shifts of the supply curve

A shift means that at every price, producers are willing to supply a different quantity.

6. Price changes – causes and consequences

• Cause of a price change: a shift in either the demand curve (e.g., change in consumer income) or the supply curve (e.g., input‑price change).
• Consequences for the supply side:

  • If demand shifts right, the equilibrium price rises → movement up along the existing supply curve (higher Q_s).
  • If supply shifts right, the equilibrium price falls → movement down along the new supply curve (lower P, higher Q_s).

• Impact on revenue: a higher price can increase total revenue when supply is elastic, but may reduce revenue when supply is inelastic (see section 8).
• Market adjustment: surplus (price above equilibrium) puts downward pressure on price; shortage (price below equilibrium) puts upward pressure on price until the market returns to equilibrium.

7. The price mechanism and equilibrium

• Price mechanism: the interaction of supply and demand that determines the market price and quantity.
• Equilibrium (P*, Q*): the point where quantity supplied equals quantity demanded; there is no tendency for the price to change.
• Disequilibrium:

  • Excess supply (surplus) – price > P*; quantity supplied > quantity demanded; pressure for price to fall.
  • Excess demand (shortage) – price < P*; quantity demanded > quantity supplied; pressure for price to rise.

8. Effect of a price change on total revenue (TR)

Total revenue = Price × Quantity sold.

When the supply curve is elastic (relatively flat), a price rise leads to a proportionally larger increase in quantity supplied, so TR rises. When the curve is inelastic (steep), the quantity response is small and TR may fall.

9. Price elasticity of supply (PES)

• Definition (AO1): PES measures the responsiveness of quantity supplied to a change in price.
• Formula (AO2):

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

  =\frac{\displaystyle\frac{Q2-Q1}{Q1}}{\displaystyle\frac{P2-P1}{P1}}\$\$

• Interpretation (AO3):

  • PES > 1 – elastic supply (large response).
  • PES = 1 – unit‑elastic supply.
  • 0 < PES < 1 – inelastic supply (small response).
  • PES = 0 – perfectly inelastic (quantity does not change).
  • PES = ∞ – perfectly elastic (any price above a minimum induces supply).

• Determinants of PES (AO1):

  • Time horizon – supply is more elastic in the long run.
  • Availability of spare capacity.
  • Ease of storing the product.
  • Mobility of factors of production.
  • Nature of the good (agricultural vs. manufactured).

• Significance for firms and governments (AO3):

  • Firms use PES to decide whether to increase output after a price rise or to cut output after a price fall.
  • Governments consider PES when designing taxes or subsidies – a tax on a good with inelastic supply will raise revenue with little change in quantity, whereas a subsidy on an elastic‑supply good will lead to a large increase in output.

• Worked example (AO2):

  Price rises from £20 to £25; quantity supplied rises from 100 to 130 units.

  \$\%\Delta P=\frac{25-20}{20}\times100=25\%\$

  \$\%\Delta Q_s=\frac{130-100}{100}\times100=30\%\$

  \$\text{PES}=\frac{30\%}{25\%}=1.2\;(\text{elastic})\$

  Interpretation: producers can increase output relatively easily when price rises.

• Diagram tip (AO3): On a supply‑demand graph, draw a steep supply curve for inelastic supply and a flatter curve for elastic supply. Show the same price change on both curves to illustrate the different movements in quantity.

10. The role of supply in a market economic system

11. Exam technique – linking command words to AO levels

12. Example exam question (8 marks) and mark scheme

Question: “Draw a supply diagram for wheat. Show and label how a fall in the price of fertilizer would affect the diagram. Explain the economic reasoning behind the shift.”

Mark scheme (summarised):

1. (2 marks) Correctly labelled axes and an upward‑sloping supply curve S₁.
2. (1 mark) Point A marked on S₁ (demonstrates understanding of movement along the curve – optional but earns the mark).
3. (2 marks) New supply curve S₂ drawn to the right of S₁, clearly labelled “after fertilizer price falls”.
4. (3 marks) Explanation:

   • Fall in fertilizer cost → lower marginal cost of producing wheat (AO1).
   • At each price, producers can now supply a larger quantity (AO2).
   • Therefore the supply curve shifts right (increase in supply) – link to the law of supply and state “ceteris paribus” (AO3).

13. Quick revision checklist (AO1‑AO3)

• Can you define individual supply and market supply?
• Can you produce a simple supply schedule and convert it into a supply curve?
• Do you know the difference between a movement along the curve (price change) and a shift of the curve (non‑price factor)?
• Can you list at least four factors that shift supply and state the direction of each shift?
• Are you able to explain how a change in price (caused by a demand or supply shift) moves the equilibrium and creates surplus or shortage?
• Do you understand how price changes affect total revenue for elastic versus inelastic supply?
• Can you calculate and interpret the price elasticity of supply using the formula?
• Are you comfortable evaluating the importance of PES for firms’ production decisions and for government policy (taxes, subsidies)?
• Can you discuss the advantages and disadvantages of a market system in relation to supply?
• Do you know which command words require definition, explanation, analysis or evaluation?