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.

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.

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

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.