Theory of Supply

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Meaning of Supply

Supply in economics refers to the quantity of a commodity offered for sale at various prices during a particular time. Supply links with three basic things; the first supply is the desired quantity. It means supply is all about how much quantity the sellers are willing to sell and not how much they actually sell. The second is that the supply is always expressed regarding some price. It is always expressed at a certain price. With a change in price, supply will also change. Third; supply is a flow concept or it is a flow variable. Thus, supply refers to the amount that producers or sellers are willing to sell during a specific time like per week, per month, and so on. The supply of a commodity does not mean the entire stock of the commodity but only the amount that the entrepreneur is willing to bring into the market at a particular price. The theory of supply includes several aspects of supply.

Types of Supply

There are two types of supply as;

Joint supply

It refers to the goods supplied or offers into the market jointly. For example, wool and mutton, wheat and straw, etc supply jointly into the market.

Composite supply

If the supply is made available by various sources then such supply is called composite supply. For example, the supply of light may be from electricity, gas, kerosene, candles, etc. Whatever they are either rival or substituted sources of supply, the supply is composite.

Stock versus Supply

Supply is different from stock. The stock of a commodity is the total amount of the commodity available to its producers at any given time. It is called the potential supply available with the producer. The supply of the commodity does not cover the entire stock of the commodity. It means supply is the only quantity that is not included in stock.

The stock of the commodity is the total amount of it with the producers, while supply is the part of the stock which offers for sale in the market. Therefore a stock is the quantity available with the producers and also known as intended or potential supply. Stock does not have any time dimension as it is expressed at a point of time like the stock of food grains on 23rd August 2020. But the concept of supply has always time dimensions as it is expressed over some time like the supply of food grains per day.

Individual and Market Supply

When the number of commodities that one single seller or producer is willing to produce and offer for sale in the market, it is individual supply. The single seller or a producing unit is called a firm in economics. Thus, an individual supply is the quantity of a commodity that a firm is willing to produce and offer for sale at a particular price during a specific period.

All the firms producing a common or identical commodity will form an industry. Thus the quantity that all the producers are willing to produce and offer for sale at a particular price during a specified period is market supply or supply of the industry. The total of supply made by different business firms in the market supply or industry supply.

Determinants of Supply

The quantity of supply that an individual firm or all the firms willing to offer into the market for sale may affect by many factors. Such affecting factors are the determinants of supply or market supply. Determinants of supply have a significant place in the theory of supply. The major determinants of supply are briefly explained with the following points;

Price of the Commodity

It is the most influencing determinants of quantity supply.  Other things remaining the same higher quantity will supply with the higher price and smaller quaintly will supply at a lower price. The higher price will ensure a higher profit and the possibility of higher profit encourages producers to supply more at a higher price.

Goals of the Firms

The objective of the producing firm also determines the supply quantity in the market. The goal of the firms may be profit maximization, sales revenue maximization, or risk minimization. In general, most business firms have a profit maximization goal. Thus if the firm has set its objective to maximize the profit larger quantity will be supplied. If the firm has a motive of maximizing the sales revenue then they produce more and supply more quantity than profit-maximizing quantity. Similarly, if the firm wants to minimize the risk then a small quantity will supply by the firm.

Input Prices

The price of the factor of production, raw materials, etc. also affects the supply quantity. If the producers have to pay higher prices for inputs needed for production its cost of production will be higher. Given the price of the commodity, the higher cost of production reduces the margin to the producer. This will lead to a lower amount of supply in the market. Therefore, there is an indirect relation between change in the price of factors and quantity supply into the maker.    

Price of Related Goods

The supply of any one commodity is also affected by the price of related goods like substituted goods. For a producer, the producer always can shift the production from one commodity to another. If the prices of other related commodities are increasing and the price of the commodity under consideration remains constant, the producer will find it more profitable to produce and sell other commodities. With this, the supply of the commodity under the study will fall. For example, a farmer can grow various vegetables in a particular fixed piece of land. If the market price of onion rises the farmer will produce and supply more onion in the place of tomato and other types of vegetables by diverting resources from the production of other vegetables to the production of onion. Therefore the supply of any commodity is inversely related to the change in the price of substitute products.

Production Techniques

The improvement and innovation in the technique of production may reduce the cost of production and increase the profit to the producers. An increase in profitability will lead to an increase in the supply of products in the market. Therefore improved technology and improved technique of production will lead to a higher supply of the product.

Nature of Industry

The nature of the industry, whether it is monopolistic or competitive also affects the quantity supply in the market. The monopoly firm or industry may restrict the supply to generate more and more profit. Similarly, if the firm or industry is perfectly competitive then it cannot restrict the supply.  Therefore, a competitive firm will supply more and a monopoly firm will supply a low quantity of output in the market.

Government Policies

It includes the tax and subsidy policy of the government. The taxation policy of the government like indirect tax will increase the price of the product. The imposition of a heavy tax on production will increase the production cost and will reduce the supply. The reduction of taxation will, therefore, increase the quantity supply in the market. On the other hand, if the government provides a subsidy to the producer then it will reduce the production cost and the producer can supply more quantity of output into the market.

Expectations About Future Price

If the producers expect an increase in the price soon then the current supply will be reduced and they will hoard the production with an expectation to sell it at higher prices.  On the other hand, if they expect a fall in price soon then there will increase in quantity supply in the present time.

Availability of Transport and Communication Facilities

If there is easy and wider availability of services like transportation and communication from the area of production to the area of consumption then supply will increase and vice versa. Transportation helps to carry goods from one place to another (market reaches higher) and communication also helps in promoting the availability of the goods and expand the size of the market too. This will lead to an increase in the market supply of goods.

Natural Causes/Factors

The natural factors or causes are also a major determinant of supply. Especially in the agricultural supply natural causes like drought, flood, unfavorable climate conditions, favorable monsoon, etc. directly affect the supply of agricultural output in the economy. Adequate timely rain and favorable climatic situations will increase the supply of agricultural supply.

Supply Function

The supply function is the functional relationship between the supply of goods or services and all factors affecting its level. The market supply function for merchandise is a relationship between the supply quantity and all the factors influencing the quantity supply of that product or all the determinants of supply. Thus it establishes the mathematical or algebraic relationship between determinants of supply as independent variables and supply of the same commodity as the dependent variable in the theory of supply. It also shows the schedule of quantity supplied of a commodity at various levels of prices. In general form it can be expressed as;

Qx=f (Px, PR, PI, TEC, W, Z)…… (i)

Where,

Qx= quantity supply of product X; f= functional relation; Px= price of product X; PR= the price of related products; PI= prices of inputs used in the production process of product X; TEC= current state of technology; W= weather or natural factors and Z= other factors affecting the supply of product X.

The generalized supply function revealed in equation (i) lists the variables that influence the supply of a product. For making the supply function useful in managerial decision making, the supply function of the product under study must be made explicit. To make it explicit let us consider the example of a car industry and supply function of the car industry can be specified as;

Qx=a1P+ a2PT+a3WL+a4r+a5T ……… (ii)

The equation (ii) states that the number of cars supplied during a given time Qx is a linear function of the average price of cars, P; the average price of trucks, PT; average wages of labor, WL; average interest rate or cost of capital, r; and the government taxes on car producers and suppliers, T. a1, a2, a3, a4 and a5 are the parameters of the supply function. We can estimate the value of these parameters by collecting the data on the corresponding variables.

Types of Supply Function

Single-Variable Supply Function (or Short Term Supply Function)

The single variable supply function establishes the mathematical relationship between price and the quantity supply. In such a supply function, there is only one independent variable; price, and one dependent variable; quantity supply. Mathematically it;

  • Price supply function

Qx=f (Px)

Where,

Qx= supply of good X; f= functional relationship; Px= price of good X.

  • Cost-supply function

Qx=f (C)

Where,

Qx= supply of good X; f= functional relationship; C= cost of production

These functions show the short-run behavior of the firms about supply. Thus, a single variable supply function is also called a short-run supply function.

Multi-Variable Supply Function or Long Term Supply Function

This function establishes the functional relationship between all the determinants of supply and supply of a particular commodity. It observes the composite effect of all factors affecting the supply on the supply for a long period. Mathematically it can be written as;

 Qx=f (Px, PR, PI, TEC, W, Z)

Where all the variables represent the usual meaning

Linear Supply Function

Ifthe slope of the supply curve remains constant or the same throughout its length, it is called a linear supply function. Mathematically, the linear supply function is written as;

Sx=a+bPx

Where,

Sx= quantity supplied of commodity X; a=autonomous supply; Px= price of commodity X; a= autonomous supply; b= slope of supply.

Non-Linear Supply Function

If the slope of the supply curve changes at its different points then it is called a non-linear supply curve. Mathematically, it is written as;

Sx=aPbx

Where the parameters and variables represent the usual meaning

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