3 – Market Supply and Equilibrium

Introduction

True, demand is what drives the economy, but supply must match that demand. For example, if there is a high demand for mobile phones in an economy, there must be a sufficient supply to meet that demand. If there is insufficient supply, the demand will not be met. For example, suppose you want to buy a tennis ball, but the shopkeepers inform you that there are no balls available in the market due to a lack of supply. We are all subjected to such situations regularly.

3.1 Market Supply

The quantity of output that producers are willing and able to make available to consumers at a specific price over a given period is referred to as supply. In some ways, supply is the inverse of demand. Individuals’ supply of factors of production or market inputs mirrors other people’s demand for these factors. For instance, if we want to rest rather than weed the garden, we hire someone; we demand labour. However, for many goods, the supply process is more complicated than the demand process.

Stock refers to the total quantity of a particular commodity available to the firm at a particular time.

Supply refers to the quantity of a commodity that a firm is willing and able to offer for sale at each possible price during a given period of time.

Market supply refers to the quantity of a commodity that all firms are willing and able to offer for sale at each possible price during a given period of time.

Supply is more than just the number of commodities on a shopkeeper’s shelf, such as “10 oranges” or “10 packets of chips,” because supply represents the entire relationship between the quantity available for sale and all possible prices charged for that good. The quantity supplied is the specific quantity desired to sell a good at a given price. When describing the quantity supplied, a time period is usually included. For example, if an umbrella costs $100, the quantity supplied is 500 umbrellas per week.

The supply of manufactured goods (tangibles) is typically indirect, whereas the supply of non-manufactured goods (intangibles) is more direct. Individuals supply their labour directly to the goods market through services. An independent contractor, for example, may repair a washing machine. The contractor provides his labour.

Factors affecting personal (individual) supply:

(a) Price of the commodity:

There is a positive correlation between the commodity’s price and supply. It implies that when a commodity’s price rises, its supply rises as well, and vice versa.

(b) Price of the factors of production:

Since the cost of factors (rent, wages, interest, and profit) makes up the cost of producing a commodity, this also affects supply. A rise in the cost of a production factor may cause a decrease in the output of a good, moving the supply curve to the left.  In contrast, if the prices of factors decrease, a producer may offer more of a good at a given price, moving the supply curve to the right.

(c) State of technology:
When a company advances technologically, production costs go down, increasing the company’s profit margin and moving the supply curve to the right in the process. The supply of items manufactured using outdated and subpar technology will result in higher production costs and a decline in overall output, which will cause the supply curve to move to the left.

(d) Unit tax:
A unit tax is an output tax levied by the government on each unit sold.
Thus, a rise in the unit tax will result in an increase in the firm’s production costs and a leftward shift in the supply curve. In the same way, a fall in the unit tax will result in a decrease in the firm’s production costs and a rightward shift in the supply curve.

(f) Objective of the firm:
A company may occasionally be persuaded to expand the supply of a good not because it is more profitable but rather because doing so gives it a good name in the market. Similarly, a business might boost output merely to hit its maximum sales or employment targets.

Factors affecting Market supply:

(a) Commodity price;

(b) production factor price;

(c) technology state;

(d) unit tax;

(e) other goods price; and

(f) firm objective

(g) Number of Firms in the Market:

More firms increase market supply; losses may decrease if firms exit the industry.

(h) Future Expectations Regarding Price:

Expectations of price changes influence current market supply. Rise expectations lead to a decrease, and fall expectations lead to an increase.

(i) Means of Transportation and Communication:

Infrastructure development ensures a consistent commodity supply, especially in transportation and communication.

The Law of Supply:

Other things being equal, the Law of Supply states that the higher the price of a commodity, the higher the quantity supplied, and vice versa. A commodity’s supply and price have a positive relationship.

Price, like quantity demanded, is the most important determinant of quantity supplied. Supply refers to the entire supply curve in graphical terms because a supply curve tells us how much of a commodity will be sold at various prices. A point on a supply curve is referred to as the quantity supplied. If the price of a good rises, individuals and businesses can reorganise their activities to supply more of that good to the market, substituting the production of that good for the production of other goods.

There is another explanation for the firms. Assuming that a firm’s costs remain constant, higher prices result in higher profits (the difference between revenues and costs). According to the law of supply, output increases as prices rise in anticipation of higher profits.

Supply Curve

 

 

 

 

 

 

 

 

 

 

The law of supply also assumes that all other variables remain constant. Other variables, such as the price of production inputs, technology, producer expectations, and the number of producers in the market, may change, causing a shift in supply. This will be covered in the following section.

• A supply schedule is a table that lists the various prices for a good or service as well as the quantity supplied.
• The sum of all individual supplies at a given price is referred to as the market supply. The horizontal sum of the individual supply curves yields the market supply curve.
• For example, consider the transition from a supply schedule to a supply curve.

Let’s look at how a supply curve is constructed using the figures from the supply schedule.

Price of X (in )	Quantity Supplied of X (in units)
10	200
20	250
30	300
40	350
50	400

From Supply Schedule to Supply Curve

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Causes Behind the Law of Supply:

1. Change in Stock:

-As prices rise, sellers are inclined to deplete their existing stock to capitalize on higher returns.

-Conversely, when prices drop, sellers aim to accumulate stock to mitigate potential losses.

2. Profit and Loss:

-Price fluctuations directly impact production decisions. A surge in prices prompts producers to increase production for greater profits, and vice versa.

3. Entry or Exit of Firms:

-Rising commodity prices attract new entrants seeking profits, boosting overall supply.

-Falling prices lead marginal or inefficient firms to exit the market, reducing supply.

Exceptions to the Law of Supply:

1. Future Expectations:

-The law may not hold when there are anticipations of further price changes.

-For instance, if sellers foresee future price drops, they may willingly sell more even at lower prices.

2. Agricultural Goods:

-The supply of agricultural goods is influenced more by natural factors (droughts, floods) than by market prices.

3. Perishable Goods:

-Perishable items like milk, vegetables, and fish are impervious to price changes as they cannot be stored for extended periods.

4. Rare Articles:

-Precious and rare goods, such as high-quality art and poetry by esteemed poets, defy the law of supply. Their supply remains unchanged even with rising prices.

5. Backward Countries:

-In underdeveloped nations lacking essential resources, the law of supply loses applicability. Prices alone cannot stimulate production due to resource constraints.

3.2 Market Equilibrium

In a free market, the interaction of supply and demand determines price. We can highlight three dynamic supply and demand laws.

1. Prices tend to rise when the quantity demanded exceeds the quantity supplied; prices tend to fall when the quantity supplied exceeds the quantity demanded.

2. In a market, the greater the difference between quantity supplied and quantity demanded, the greater the pressure on prices to rise (if there is excess demand) or fall (if there is insufficient demand) (if there is excess supply).

3. Prices do not tend to change when the quantity supplied equals the quantity demanded.

Market Supply and Demand for Commodity X

Price of Commodity	Total Quantity Supplied per Month	Total Quantity Demanded per Month	Surplus or Shortage
5	12,000	2,000	+10,000
4	10,000	4,000	+6,000
3	7,000	7,000	0
2	4,000	11,000	-7,000
1	1,000	16,000	-15,000

In the realm of market dynamics, understanding price theory is crucial. It serves as the linchpin, unravelling the intricate dance between supply and demand in a competitive market. Let’s delve into a practical example to demystify this concept.

At the core of price theory is the equilibrium price—a delicate balance where the quantity producers are willing to supply meets the demand from consumers. Consider a specific scenario at a price of 3 units. Here, a fascinating harmony emerges.

At this precise price point, the quantity producers are eager to supply perfectly aligns with consumers’ willingness to buy. This synchronization ensures there’s neither a surplus nor a shortage of commodity X at this delicate equilibrium.

Understanding the repercussions of surplus and shortage is pivotal. A surplus prompts prices to spiral downward, while a shortage propels them upward. Yet, at the equilibrium price of 3 units, this delicate balance negates both extremes, maintaining stability.

This magical price, the equilibrium price, signifies a state of balance—a still point in the ever-moving market dynamics. At 3 units, there’s no impetus for the actual price of commodity X to deviate. It stands as a testament to the delicate dance between the supply decisions of producers and the demand decisions of buyers.

In essence, equilibrium represents a situation where there is no inherent tendency for change. It is a state of unwavering stability where market forces find equilibrium and neither producers nor consumers exert a force strong enough to shift the balance.

In conclusion, price theory unfolds as a captivating narrative of supply and demand, with the equilibrium price as its pièce de résistance. At 3 units, it orchestrates a delicate dance, ensuring neither surplus nor shortage disrupts the market’s rhythm. Understanding this artistry is key to navigating the intricate world of market dynamics.

Equilibrium Point

 

 

 

 

 

 

 

 

 

 

 

 

 

Graphically, when supply and demand curves meet, they show the equilibrium point (E).

Let’s talk about prices. If the market price is OP1, consumers want OQ1, but producers are ready with OQ2. This creates an extra, Q1Q2. Surpluses usually bring prices down, so the market price falls.

Now, if the price drops to OP2, producers supply OQ1, but consumers want OQ2. This results in a shortage, Q1Q2. Shortages typically make prices go up, so the market price is expected to rise.

But there’s a special price, OPe, where the quantity supplied equals the quantity demanded. There are no extras or shortages, and prices stay the same. This perfect balance is called the equilibrium position.

In simpler terms, the equilibrium point is where supply and demand match, preventing prices from going too high or too low.

Price Ceiling and Price Floors

When the price is artificially held below the equilibrium price and is not allowed to rise, this is referred to as a price ceiling. Price ceilings can be found in a variety of contexts. The government is involved in most price ceilings in some way.

Rent controls, for example, are common in many cities. This means that a government agency determines the maximum rent that can be charged. This rent is typically allowed to increase by a certain percentage each year to keep up with inflation. The rent, however, is less than the equilibrium rent.

If the price ceiling is set higher than the market price, there is no direct effect. If the price ceiling is set lower than the market price, a “shortage” occurs; the quantity demanded exceeds the quantity supplied. There are several options for resolving the shortage. One method is “queuing”; people must wait in line for the product, and only those who are willing to wait in line for the product will receive it. Sellers may only sell the product to family and friends or to those willing to pay more “under the table.” Another effect could be that sellers reduce the quality of the goods they sell. Price ceilings tend to create “black markets.”

                                       

 

 

 

 

 

 

 

 

Price Ceiling and Price Floor

When the price is artificially held above the equilibrium price and is not allowed to fall, a price floor exists. Price floors can be found in a variety of contexts. In some cases, private businesses keep the price floor, while in others, the government keeps the price floor. Private businesses used to maintain a price floor, which was referred to as “fair trade.” In the case of fair trade, the manufacturer would charge a price that was higher than the equilibrium price for the product. The manufacturer then informed the retail stores that the price could not be reduced because the store would be unable to sell any of the manufacturer’s products.

A “price floor” is a minimum amount that must be paid for a good or service. If the price floor is lower than the market price, there is no direct effect, but a surplus will be generated if the market price is lower than the price floor. Price floors are well-known in the form of minimum wage laws.