“Analyse the factors affecting supply and the elasticity of supply.”
Supply refers to the quantity of a good or service which producers are willing and able to produce at a given price over a given period and offer for sale in a market. It is assumed that producers are motivated by profit maximisation, which leads them to supply their goods and services at higher prices rather than low prices. Supply can be affected by factors such as the price of the good or service, the price of other goods and services, the prices of the factors of production, and changes in technology. Elasticity of supply measures the degree of responsiveness of quantity supplied to a change in the price of the commodity. The elasticity of supply can be affected by production time, the ability to hold inventory, and the extent of excess capacity. According to economic theory, the supply of a good increases when its price rises, while the supply of a good decreases when its price decreases.
Factors Affecting Supply
Shifts in the Supply (Context)
SHIFT (left figure 2 and right figure 3) ON SUPPLY CURVE
Shifts in the supply curve occur because of changes in supply conditions or the factors that affect supply. A shift to the right of the supply curve may result in greater production and a lower selling price in the market. An increase of supply is caused by a change in a factor affecting supply conditions, such as a fall in the prices of the factors of production or an improvement in technology. This means that not only are producers willing to sell more goods and services at the same prices, but they are also willing to sell the same quantities as before but at lower prices. A shift to the left of the curve may result in lower supply and a higher selling price in the market. A decrease in supply is caused by a factor affecting supply conditions such as a rise in production costs. This means that producers will be willing to sell less of the good or service at every possible price and only accept a higher price for any given quantity of the good or service.
Changes in the Price of the Good or Service
A producer will try to get as much mark up on a product or service and higher the price as they can because it creates greater the incentive to supply depending on supply costs. If the price of the product or service is high, then the supply would also increase as producers are always trying to maximise their profits, but if the price of the good or service is low, then the supply would also decrease as producers may not be able to meet target profit from higher supply which would cause a loss in the firm. However, if a cheaper product or service is receiving high sales and revenue, a firm may still try to increase their supply for that product or service. Although, the price would be lower, there would be an increased potential of making more profit as the sales revenue is relatively high. This is in the interest of a producer as it has the capability of providing a big return. The change of price of these products cause movements on the curve, as shown in Figure 4. Hence, the price of the good or service greatly impacts supply.
MOVEMENT ON SUPPLY CURVE
Changes in the Price of Other Goods and Services
Changes in the prices of competing or alternative goods and services in the market will affect the profitability of producing an existing good or service. If a firm is producing a good or service whose price falls relative to another product or service, this may reduce profitability of the firms supply. It would be in the firm’s interest to use more resources to produce another product or service which is higher priced that would in turn provide a higher guarantee of return. In this case the supply of the existing good or service may decrease in the market, as shown in Figure 2. On the other hand, if the price of the existing good or service supplied rises relative to other goods and services, other firms may switch to its production. In this case, the supply of the existing good or service will increase in the market, as shown in Figure 3. For example, if the price of polo shirts increased relative to t shirts, then a firm may start to produce polo shirts rather than t shirts. Thus, the price of other goods and services influence supply in great amounts.
Changes in the Prices of the Factors of Production
A rise in the four factors of production (i.e. wages, rent, interest, and profit) will raise production costs for the firm or industry and reduce profitability. The firm may respond by cutting back production and reducing supply in the market if they are not able to increase the price of their product or service to account for the increase in costs. For example, if wages increase in the job of producing hand-stitched furniture, the firm may decide to reduce its supply or try to increase the price of the product. This will cause a shift left, as shown in Figure 2. On the other hand, if the prices of the factors of production fall, leading to lower production costs for the firm, profitability is increased. The firm may react by increasing production and supply in the market which may lead to lower market prices. This will cause a shift right, as shown in Figure 3. Also, the quality and quantity of resources available may affect the overall production costs and supply in total. Ergo, the change in the prices of the factors of production impact supply.
Change in Technology
Technological advances may lead to lower production costs and new products which enable producers to increase supply. Usually, improvements in technology lead to increased efficiency and productivity of the factors of production, through improved production techniques, management structures, marketing techniques and a greater range of better quality products. This often leads to a shift right in the supply curve as seen earlier in Figure 3, as the production process is more efficient and reduces cost (i.e. wages) allowing firms to use the saved money to increase their supply. Nonetheless, the use of outdated technology by a producer or business relative to its competitors may lead to lower efficiency and productivity which can cause a reduction in supply in markets. In turn, this could lead to higher market prices. This would usually result is a shift left, as seen in Figure 2. Accordingly, the change in technology affects supply.
Factors Affecting Elasticity of Supply
The Price Elasticity of Supply (Context)
The price elasticity of supply refers to the responsiveness of the quantity supplied due to a change in the price of a good or service. Supply is price elastic if the change in the quantity supplied is proportionately greater than the initial change in price. Supply is price inelastic if the change in the quantity supplied is proportionately less than the initial change in price. Supply is unit elastic if the change in the quantity supplied is proportionately the same as the initial change in price.
Production Time Periods
In the market period supply cannot be adjusted due to changes in price, as the quantity supplied to the market is fixed, since inventories or stocks of unsold goods are finite. I the short run producers have both fixed and variable factors, but they are still able to adjust supply in response to small variations in price. Supply is more elastic in the short run than in the market period. In the long run, producers can very their output levels in response to small fluctuations in price. Supply is highly elastic in the long run, as it is completely variable. For example, a farmer could plant more apple trees to increase the potential supply of apples in the market in the future. Therefore, production time periods affect supply.
Inventories or the Ability to Hold Stocks
If producers can hold stocks of unsold goods or inventories, their supply will be more elastic than if they are not able to hold stocks which can supplement current levels of output or supply. If the prices of goods increase in the market, firms can respond by adding accumulated stocks on to the already available supply. This will eventually result in an increase in supply. The ability to hold stocks depends on the size of the good, and perishability. The size of the good depends as the business will have to store it in specific storages. If the goods are too big, the producer may have to place them in a warehouse rather than a small storage container. Also, perishability is a vital element is storing goods. Perishability refers to the fact that certain goods cannot be produced and stockpiled before consumption. For example, a cake is more perishable then an apple phone as it will go out of date faster and will not be fit for consumption. For the most efficiency, firms require their warehouses to be accessible and convenient. Therefore, production time periods affect supply.
The Extent of Excess Capacity
Excess capacity refers to the difference between the actual and potential output of a firm with a given level of plant capacity. If a firm has excess capacity, it may be able to take proper action when prices suddenly rise by using its existing plant to store more supply from increased production. Its supply will be more elastic than firms operating at full or maximum capacity. Firms which are operating at full capacity cannot increase output in the market period or short run. They will either must lower their prices to sell less profitable goods early to be able to stock the goods, or they will have to build supplementary storage capacity in the long run to increase production. Their supply will be less elastic relative to firms with some excess capacity in the market period of short run. Therefore, production time periods affect supply.
Ultimately, supply and elasticity of supply is controlled by price of the good or service in the market. Supply can be affected by factors such as the price of the good or service, the price of other goods and services, the prices of the factors of production, and changes in technology. Elasticity of supply can be affected by production time, the ability to hold inventory, and the extent of excess capacity. Through the analysis of the factors affecting supply and elasticity of supply, it is evident how producers must react to price fluctuations to match the market with the supply.