Lesson 11.

THE PRINCIPLE OF SUPPLY

Learning outcomes

After studying this unit, you should be able to:

Meaning of supply
Difference between supply and stock
Relationship between supply and price
Define the concept of elasticity of supply
locate the determinants of elasticity of supply

Introduction:
Friends after knowing the meaning and purpose of demand and
law of demand, elasticity of demand, know I think you should know what supply
is. Producers are going to produce on the basis of demand only. Goods are
needed to be supplied to meet the demand for the product.
Difference between Stock & Supply:

Like the term 'demand', the term 'supply' is also often misused in the ordinary
language. Supply of a commodity is often confused with the 'stock' of that
commodity available with the producers. Stock 'of a commodity, more or less,
will equal the total quantity produced during a period less the quantity already
sold out. But we know that the producers do not offer whole of their stocks for
sale in the market, A part of industrial produces is kept back in godowns and is
offered for sell in the market when It can fetch better prices, In other words the
amount offered for sale may be less (or at the most in rare circumstances equal
to) than the stocks of the commodity. The term 'supply' shows a relationship
between quantity and price. By supply we mean various quantities of a
commodity which producers will offer for sale at a particular time at
various corresponding prices. In simple words, supply ( like demand )
refers to the quantity of commodity offered for sale at some price during a
given period of time.

FACTORS ON WHICH SUPPLY OF A COMMODITY DEPENDS

It is also known as the determinants of supply. The Important determinants of

supply can be grouped together in a supply function as follows: ..
SN=f (PN,PR,F,T,G )
Supply function describes the functional relationship between supply of a
commodity (say N) and other determinants of supp1y, i.e., price of the
commodity (PN), price of a related commodity (PR), prices of the factors of
production (F), technical know-ho" (T) and goals or general objectives of the
Producer. Each of the_ factors influences supply in a different' way. To isolate
the effect of other factors we take these other factors as constant while
considering the relationship between supply and one of the above variables. For
example, if we want to study the relationship between price and supply of
commodity, N, we shall assume other factors PR, F, T and G to remain constant
or unchanged. We study below these relationships

(i) Price of the commodity, expressed as SN ft PN), i. e. other things

being equal, supply of commodity N depends upon the price of
commodity N. This sort of relationship is studied in what has' come to
be popularly known as the Law of Supply'. It implies that if the price of
a commodity goes up, its supply shall expand and vice versa.
(ii) Prices of related goods, expressed as SN = f(P R), 'j e., other things
being equal, supply of commodity N depends upon the prices of the
related goods. If the price of a substitute goes up, producers would, be
tempted to divert their available resources to the production of that
substitute.
(iii) Prices of factors of production, expressed as SN f(F), i, e, other
things being equal, supply of a commodity depends upon the prices of
factors of production. A rise in the price of one factor of production, will
cause a consequent increase in the cost of producing those com-
modities which use a great deal of that factor and only a small increase
in the costs of producing those commodities that use a small amount of
the factor.
(iv) State of technology, expressed as SN=f(T), i,e., the supply of a
commodity depends upon the state of technology. Over the the time
the technical know-how changes. Goals of firms, expressed as SN
1(6), j e., other things being equal the supply of a commodity depends
upon the ,goals of firms producing that commodity. Ordinarily; every
firm tries to attain. Maximum profits. Natural factors. The supply of the
agricultural' goods to a great extent depends upon the natural
conditions. Adequate rain, fertility of land irrigation facilities, favorable
climatic conditions etc., help in raising the supply of agricultural
produce., Contrary to that, heavy rains, floods, drought conditions, etc.,
adversely affect the agricultural production.
(v) Means of transportation and communication. Proper development
of means of transportation and communication helps in maintaining
adequate supply of the commodities. In case of short Supply, goods
can be rushed from the, surplus areas to the deficient areas. But if the
developed means of transportation are used to export goods, it will
create scarcity of goods .In the domestic market.
(vi) Taxation Policy. Imposition of heavy taxes on a commodity
discourages its production, and as a remit its supply diminishes. On
the other, hand, tax concessions of various kinds induce producers !o
raise the supply.
(vii) Future expectations of rise in prices. If the producers expect, an
increase in the price in the near future, then they will curtail the current
supply, so as to offer more goods in future at higher prices.

LAW OF SUPPLY
 Meaning:
It’s different from law of demand. Law of supply explains the
relationship between price of a commodity and its quantity supplied. Price and
supply are directly related. A rise in price induces producers to supply more
quantity or the commodity and a fall Prices, makes them reduce the supply. The
higher is the price of the commodity the larger is the profit that can be earned,
and, thus the greater is the incentive to the producer' to produce more of the
commodity and offer It in the Market. Likewise at lower prices, profit margin
shrinks and hence producers reduce the sale .

Supply schedule and supply curve

Law of supply can be illustrated with the help of a, schedule and supply curve. A
supply schedule is a tabular statement that gives a full account of supply of any
given commodity in a given market at a given time

It states what the volume of goods offered for sale would be at each of a series of
prices. Supply schedule is of two types:
(a) individual Supply schedule,
(b) market supply schedule.

Individual supply schedule states the quantities of a commodity a producer would

offer for sale at various prices. Suppose M/s. A.B.C. Ltd. are willing to sell 10,000
units of their product per week at price of Rs- 4 each. If the price goes up to Rs. 5
each, they may be willing to sell 12,000 units, and at Rs. 6 each, 15,000 units.
We record this relationship in Table 14'8. With the increase in price, the quantity
supplied increases and vica versa. A market supply schedule1 furnishes exactly
the same information.
A market supply schedule for a given commodity is the sum of individual supply
for all those firms which are engaged in the production of a given commodity
during a given period.

The market supply curve can be obtained by aggregating the individual supply
curves of the commodity.

The market supply curve also shows the same relationship between the price
and the quantity supplied the quantity supplied increases proportionately with the
increase in the/price
Activity
Qs=20p-100
So that at the price Rs. 1O/ per unit quantity supplied equals 20 x 10 - 100=100
at the price Rs 9 per unit 80 units will be supplied; Similarly different quantities
corresponding to different prices can be calculated.

SHIFT IN SUPPLY
 Movement along the same supply curve represents contraction or expansion in
supply as a result of a change in the price of a commodity. A shift in supply curve
occurs\ when the producers are wi1ling to offer more or less of a commodity
because of reasons other than the price of the commodity.

For example. An innovation or the discovery of a cheap raw material may result
in increased supplies of a given commodity. Increase in the supply of plastic
footwear in recent years is glaring illustration.

This change in supply which occurs because of a change in any of the

determinants of supply, other than the price, is known as increase or decrease in
supply,

(1 ) Increase in demand also increases the price the quantity sold and purchased
also increases
(2) Fall in demand brings down the equilibrium price and the quantity sold and
purchased also declines.

Increase in Supply.
(1) Shift in the supply curve to the right (increase in supply). brings down the
equilibrium price; the amount sold and purchased increases.
Activity:
I. Mathematically, the effect of the shift in demand can be presented as follows:
Suppose, the original demand equation is Qd=110-lOp and, the original supply
equation is Q.=10p-l00 The equilibrium price and the equilibrium quantity will be
7 and 40 respectively.

Suppose, the new demand equation, exhibiting an increases in demand is

Qd=140 - 10p
and the supply equation remains unchanged. The new equilibrium will be
determined as fol1ows :
140 - 10p=20p-100
OR
30p=240 .
:. p=8
. -'.
Substituting p=8 to either the demand or supply equation we get the equilibrium
quantity as 60.

2. Mathematically, this effect can be shown as follows:

Suppose the supply equation changes to
Qs=20p - 40
And the demand equation remains unchanged
Qd=110 - 10p
(2) Shirt in the supply curve to left ( fall in supply ) increases the equilibrium
price. The quantity sold and purchased diminishes.

Simultaneous change in the Demand and the Supply

So far we have been discussing the effect of change either in demand or in

supply on the equilibrium price and the quantity sold and purchased. It is also
possible that demand and supply may change simultaneously
We may discuss the change in both the demand and the supply as follows:

(1) If the increase or decrease in the demand and the supply is pf equal
magnitude, then the price at old and new equilibrium will remain equal.
(2) If the increase in the demand is of greater magnitude than in supply, then
the new equilibrium price will be higher than the old equilibrium price, and
vice versa.
(3) If the supply increases in greater proportion than the demand, the new
equilibrium price will be lower than the old equilibrium price.

It may be observed in all the conditions that the price mechanism brings demand
and supply in equilibrium.

The new equilibrium price will be

110-10p=20p-40
Or 30p= 150
Or p=5
Substituting p=5 in either of the equations we get the equilibrium quantity as 60,
i.e. increase in supply leads to a fall in price, but the quantity demanded and
supplied increase.

QUESTIONS

1. Distinguish between substitution and income effects of a price change.

2. Why does demand curve always slope downwards from left to right ? Are there
any exceptions to it ? Explain with example.
3. Distinguish between 'change in demand' and 'change io quantity demanded'
Bring out the factors which cause change in demand. .
4. Discuss the, law of supply with the help of a schedule, and a curve. What are
the factors on which the supply of a commodity depends?
5. Is the equilibrium price always stable 1 What is the effect of the following
changes on the equilibrium price:
(i) When the demand of a commodity alone increases.
(ii) When the supply of a commodity alone increases.
 (iii) When the demand and supply both increase.

Meaning of ELASTICITY OF SUPPLY

Meaning :
Like demand, quantity supplied of different commodities responds in
different proportions to the price changes. For example, if the price of wheat
rises. the farmers may be tempted to sell more in the market, and keep less for
themselves. On the other hand, if the price of cars rises, the car manufacturers
may not probably be in a position to offer more cars for sale, because they may
not be keeping stocks of cars. Similarly, supply of cloth may increase in response
to the increase in prices and so on. Elasticity of supply of a commodity measures
changes in the quantity supplied as a result of a change in the price of
commodity.
Elasticity of supply is measured as a percentage change in amount supplied
divided by the percentage change in price of the commodity. In short,

Es= Percentage change in quantity supplied.

Percentage change in price

Es= ( ∆q / q ) X ( p / ∆p ) OR (∆q/∆p) X ( p/q )

where p and q are the original price and quantity supplied respectively, and ∆p
and ∆q the change in price and quantity supplied.
This method of measurement of the elasticity of supply can be illustrated as
follows:

Suppose, a producer is willing to supply 100 quintals of wheat at the price of

Rs. 110 per quintal If the price increases to Rs. 120 per quintal, he is willing to
supply 25 quintals of wheat. Calculate the elasticity of supply of wheat.
Elasticity of supply of wheat will be calculated as fol1ows :

Es= (∆q/∆p) x ( p/q ) = (25/10) x ( 110/100 ) = 2.75

Es=2.'75 will mean that if the price of wheat goes up by one per cent supply of
wheat will increase by 2.'75 per cent. The value of elasticity coefficient varies
between zero and infinity. The various results are tabulated below:
Elasticity of Supply

Elasticity Terminology Description

Perfectly inelastic Quantity supplied does

1. Es=Zero not change.

Quantity supplied
Less than unit
changes by a smaller
elastic or inelastic
2. Es<l percentage change
than price.

Unit elastic Quantity supplied

changes in the same
3. Es=l
proportion as price.

4. Es>l More than unit elastic

5. Ese;: Perfectly elastic

Factors Influencing Elasticity of Supply

Elasticity of supply depends upon a number of factors, some of which are as
follows:

1. Nature of the Commodity. The first and foremost determinant of the

elasticity of supply is the nature of the commodity. Commodities on the basis of
their nature can be classified as (1 ) perishable, ,and (ii) durable. Perishable
products cannot be stored, and hence their supply does not' respond in an
effective manner to the change in their price. Hence, their supply is inelastic in
nature. Durable products, on the other hand, can be stored; hence, their supply is
generally elastic, i,e., 'supply responds to the change in prices.

2. Time. Supply of a commodity, in the ultimate analysis, depends upon its

production. Production always involves a time-lag which may. vary from a few
days 10 a few years, Moreover, increased production of a commodity may
contemplate a change in the very size (If the plant, which in turn may be a long,
time-consuming process. Hence, supply of a commodity may be less elastic in
the short run, as time progresses supply may become more elastic.
 3. Techniques of Production. Simple techniques of production are, by and
large, less expensive in nature, If demand conditions so require, the production
and the supply of such commodities as involve simple: techniques of production
could be easily increased. In other words, supply of such like commodities is
generally elastic in nature, On the other hand, if the technique of production of a
commodity is cumbers me, complex and time-consuming in nature it may not be
possible to change the supply in response to varying price-demand conditions.
Supply of such commodities would generally be Jess elastic,
4. Estimates of Future Prices. Future expectations of price changes may also
inl1ucllcc supply of a commodity. If the producers expect the prices to, rise in
future they may hold on to the stocks or the commodities and
 POINTS TO PONDER

Slide 1
supply
Meaning: by supply we mean various
quantities of commodities which producers
will offer for sale at a particular time at
various corresponding prices.
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Slide 2 ___________________________________
Supply function
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Sn = f ( Pn,
Pn, Pr, F, T, G)
Where Sn = supply of a commodity ___________________________________
Pn = price of a commodity
Pr = price of related goods ___________________________________
F = factors of productions
T = technical know how
G = goals or general objective of
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producers
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Slide 3 ___________________________________
Determinants of supply
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Price of the commodity
Price of related goods
Prices of the factors of production
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Technical know how
Goals or general objective of the firm ___________________________________
Natural factors
Taxation policies
Future expectation of rise in price ___________________________________
Means of transportation and communication
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Slide 4
Law of supply
it explains the relationship between price of
a commodity and its quantity supplied.
Slide 5
Assumptions of law of supply
Based on the assumption that there is direct
relationship between price and supply.
i.e. with increase in price supply is
increasing and with decrease in price
supply is decreasing.
Slide 6
Supply schedule
a supply schedule is a tabular statement
that gives a full account of supply of any
given commodity in a given market at a
given time
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Slide 7
Supply curve
supply curve exhibits the information
graphically instead of arithmetically. It
shows the relationship between price and
the quantity supplied.
Slide 8
Shift in supply curve
A shift in supply curve occurs when the
producers are willing to offer more or less
of a commodity because of reasons other
than the price if the commodity.
It is also known as the increase or decrease
in supply.
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