Factors affecting supply
The determinants of the market supply of a good, say good X are:
Price of commodity (Px). The amount supplied of a particular commodity depends mainly on the price of that commodity. Producers are encouraged to supply more of the commodity if the price is very attractive. Producers will be reluctant to supply a commodity as the price declines. This illustrates the law of supply, which states that the higher the price, the greater the amount of the commodity supplied and vice versa.
Cost of production (C). Regardless of the price that the firm can command for its product, price must exceed the cost of producing the output for the firm to make a profit. The supply decision is likely to change in response to changes in the cost of production.
Cost of production depends on a number of factors, including the available technologies and the price of the inputs needed by the firm. All things that a firm uses to produce its output, such as materials, labour and machines are called the firm's inputs.
Other things being equal, the higher the price of any input used to make a product, the less will be the profit from making the product. The higher the price of any input used by a firm, the less the firm will produce and offer for sale at any given price of the product.
A decrease in the cost of production increases the supply of a particular commodity and an increase in the cost of production reduces its supply.
Availability of inputs (I). The more available the inputs, the greater the supply of a particular commodity. Scarcity of factor inputs reduces its supply.
Technology (T). At any time, what is produced and how it is produced depend on what is known. Over time, knowledge changes and so do the quantities of individual products supplied. Any technological innovation that decreases production costs will increase the profits at any given price.
The adoption of a better technology has an effect of reducing the costs of production. A reduction in costs increases the supply of a particular commodity. Inefficient technology reduces the supply.
Prices of related products. Firms often react to changes in the prices of related products. For example, if land can be used for either beans or maize production, an increase in maize prices may cause individual farmer to shift acreage out of bean production into maize production.
Thus, an increase in maize prices affects the amount of beans supplied. Two cases can be considered:
Thus, an increase in maize prices affects the amount of beans supplied. Two cases can be considered:
- Substitutes (PS) The increase in the price of a substitute will lead to a decrease in the supply of the commodity in question and vice versa.
- Complements (Pc) The increases in price of a complement leads to an increase in the supply of the commodity in question and vice versa.
The number of producers (N). For given prices and technology, the total amount of any product supplied depends on the number of firms producing that product and offering it for sale.
A greater number of producers increases supply and vice versa. For example we expect that if the number of telecommunication service providers increase, then the supply of communication services will increase.
A greater number of producers increases supply and vice versa. For example we expect that if the number of telecommunication service providers increase, then the supply of communication services will increase.
Working conditions - terms of service (W). Favourable terms of service for employees increase supply of a particular commodity and vice versa. This includes the pay of the workers and other working conditions like lunch and transport allowances.
Demand (D). Demand has an effect on the supply of a particular product. An increase in demand for a particular commodity increases its supply and vice versa.
Government policy (G). Taxation reduces supply of a commodity in question and subsidization increases its supply.
Objectives of a firm (F0). Supply of a commodity in question reduces if the objective of a firm is profit maximization. If the firm is interested in sales revenue maximization or in larger market share, supply is likely to increase. Profit maximization normally reduces the supply.
Gestation period (Gp). This is the production period. A longer gestation period reduces supply of a particular commodity and a shorter gestation period increases the supply. The supply of bread which has a shorter gestation period, is more than the supply of cars with a longer gestation period.
Natural factors (Nf). Natural conditions such as weather may have an effect on the supply of the commodity [especially agricultural commodities]. Favourable natural factors increase supply of a particular commodity, and vice versa.
Using a functional notation, we can write the following supply function for good X:
Sx = f(Px, C, I, T, Ps, Pc, N, W, D, G, F0, Gp, Nf)
Using a functional notation, we can write the following supply function for good X:
Sx = f(Px, C, I, T, Ps, Pc, N, W, D, G, F0, Gp, Nf)
Changes in the amount (quantity) of the commodity supplied
Changes in the amount of the commodity supplied are due to changes in the price of the commodity in question. All other factors affecting supply are assumed constant. Changes in the amount supplied are concerned with movements along supply curves (Figure 2.13).
A decrease in the amount of the commodity supplied is concerned with the movement along a supply curve downwards (ba). It is caused by a fall in the price. At OP1, the amount supplied is OQ-j, while at a higher price of OP2 more of the commodity OQ2 is supplied. A movement upwards along the supply curve (ab) is referred to as an increase in the amount supplied and it is due to an increase in the price of the commodity. This is the law of supply.
At a constant price OP1 more can be supplied due to:
- A decrease in the cost of production.
- More availability of factors of production.
- Efficient technology.
- A fall in the price of a substitute.
- A rise in the price of a complement.
- Favourable terms of service/working conditions.
- An increase in the number of firms/producers.
- An increase in demand.
- Short gestation period,
- Favourable natural conditions in case of agricultural commodities.
- At a constant price OP1 less is supplied due to:
- An increase in the cost of production,
- Scarcity of factors of production, (raw materials], Inefficient technology.
- A rise in the price of a substitute,
- A fall in the price of a compliment.
- Unfavourable terms of service/bad working conditions,
- A decrease in the number of firms/producers.
- A decrease in demand.
- Long gestation period.
- Unfavourable natural conditions in case of agricultural commodities.