Cambridge IGCSE0455

Supply

Economics 0455 Chapter Notes

What this chapter covers

Supply - Individual and market supplySupply - Movements along a supply curveSupply - Shifts of a supply curve
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In this chapter

  1. 1Understanding Supply and the Supply Curve
  2. 2Price Changes and Movements on the Curve
  3. 3Shifts of the Entire Supply Curve
  4. 4Calculating Price Elasticity of Supply (PES)
  5. 5Interpreting PES: From Inelastic to Elastic
  6. 6What Determines Price Elasticity of Supply?

1. Understanding Supply and the Supply Curve

Supply refers to the quantity of a good or service that producers are willing and able to sell at different prices in a specific time period. The fundamental principle governing supply is the 'Law of Supply', which states that, ceteris paribus (all other factors being equal), as the price of a product increases, the quantity supplied of that product will also increase. This positive relationship exists because higher prices offer producers the chance to make greater profits, incentivising them to produce more. A supply schedule is a table showing the quantity supplied at various prices, which can be plotted on a graph to create a supply curve. This curve will always slope upwards from left to right, visually representing the Law of Supply.

Key term

Supply: The quantity of a good or service that producers are willing and able to offer for sale at various prices over a given period of time.

Fun fact

In 2021, a global shortage of shipping containers dramatically increased the cost and reduced the supply of goods worldwide, showing how logistics can be as important as production.

Worked example 14 marks

The table shows the market supply schedule for silver-plated tankards. Plot this information on a graph to create the market supply curve.

Price of tankards $Market supply per month
201,600
161,100
12700
8300
6100
  1. 1

    Step 1: Draw the axes for your graph. Label the vertical (Y) axis 'Price ($)' and the horizontal (X) axis 'Quantity Supplied per month'.

  2. 2

    Step 2: Choose an appropriate scale for both axes. For price, you could go from 0 to 22 in increments of 2. For quantity, you could go from 0 to 1800 in increments of 200.

  3. 3

    Step 3: Plot the first point from the schedule: Price = $6, Quantity = 100.

  4. 4

    Step 4: Plot the remaining points: ($8, 300), ($12, 700), ($16, 1,100), and ($20, 1,600).

  5. 5

    Step 5: Join the plotted points with a line or smooth curve. Label this line 'SS' for Supply Curve.

  6. 6

    Step 6: Observe that the curve slopes upwards from left to right, confirming the Law of Supply.

Recap

  • Supply is the willingness and ability of producers to sell a product.
  • The Law of Supply states that as price rises, quantity supplied rises.
  • A supply schedule is a table of data, while a supply curve is a graphical representation.
  • The supply curve slopes upwards from left to right due to the profit incentive.
  • The relationship assumes 'ceteris paribus' – that no other factors affecting supply have changed.

Quick check

  1. State the Law of Supply.1 mark
  2. Why do producers aim to supply more when prices are high?1 mark

2. Price Changes and Movements on the Curve

When the price of a product changes, and all other factors remain constant, we see a movement along the existing supply curve. This is known as a 'change in quantity supplied'. There are two types of movement:

  1. Extension of Supply: This occurs when the price of the good increases. Producers are now willing to supply more at the higher price, so there is a movement *up* along the supply curve to a higher quantity.
  2. Contraction of Supply: This occurs when the price of the good decreases. The lower price reduces the profit incentive, so producers supply less. This is shown as a movement *down* along the supply curve to a lower quantity.

Key term

Extension of Supply: An increase in the quantity supplied of a product resulting from an increase in its price, shown as a movement up along the supply curve.

Examiner insight

Examiners award marks for the precise use of language. Correctly distinguishing between a 'contraction in supply' and a 'decrease in supply' demonstrates clear understanding.

Common pitfall

The most common mistake is confusing a 'change in quantity supplied' (a movement along the curve due to price) with a 'change in supply' (a shift of the entire curve due to non-price factors).

Worked example 13 marks

Using the supply schedule for tankards, describe the effect on quantity supplied if the price falls from $16 to $8. What is the economic term for this change?

Price of tankards $Market supply per month
161,100
8300
  1. 1

    Step 1: Identify the initial quantity supplied at a price of $16. According to the table, it is 1,100 tankards per month.

  2. 2

    Step 2: Identify the new quantity supplied when the price falls to $8. The table shows this is 300 tankards per month.

  3. 3

    Step 3: Describe the change: The quantity supplied decreases from 1,100 to 300 tankards.

  4. 4

    Step 4: State the economic term. This movement down along the supply curve, caused by a fall in price, is called a 'contraction of supply'.

Recap

  • A change in the price of the good itself causes a movement along the supply curve.
  • An increase in price leads to an extension of supply (a move up the curve).
  • A decrease in price leads to a contraction of supply (a move down the curve).
  • This concept is different from a 'shift' in the supply curve.
  • The terms 'extension' and 'contraction' are specific to movements along the curve.

Quick check

  1. What causes an extension in supply?1 mark
  2. What is the term for a fall in quantity supplied due to a lower price?1 mark

3. Shifts of the Entire Supply Curve

A 'change in supply' occurs when a factor *other than the product's own price* affects producers' willingness or ability to sell. This causes the entire supply curve to shift.

  • An Increase in Supply: The curve shifts to the right (from SS to S1S1). This means producers are now willing to supply a greater quantity at every price level.
  • A Decrease in Supply: The curve shifts to the left (from SS to S2S2). This means producers will supply a smaller quantity at every price level.

Key factors that shift the supply curve include:

  1. Costs of Production: Lower costs (e.g., cheaper raw materials, lower wages) increase supply. Higher costs decrease supply.
  2. Technology: Improvements in technology make production more efficient, increasing supply.
  3. Taxes and Subsidies: A tax on producers increases costs and decreases supply. A subsidy (a government payment to producers) lowers costs and increases supply.
  4. Weather/Climate: Crucial for agricultural products. Good weather increases supply; bad weather (drought, floods) decreases it.
  5. Global Factors: Events like wars, trade sanctions, or natural disasters can disrupt supply chains and decrease supply.

Key term

Change in Supply: A shift of the entire supply curve to the right (increase) or left (decrease), caused by a change in a non-price factor affecting production.

Worked example 14 marks

A period of severe frost damages a large portion of the potato crop. Using a diagram, explain the effect on the market supply of potatoes.

  1. 1

    Step 1: Draw a standard supply and demand diagram. Label the axes 'Price' and 'Quantity'. Draw an initial upward-sloping supply curve and label it 'SS'.

  2. 2

    Step 2: Identify the non-price factor. The severe frost is a natural event that damages crops, making it harder and more costly for farmers to supply potatoes.

  3. 3

    Step 3: Determine the direction of the shift. This event will cause a decrease in supply.

  4. 4

    Step 4: Show the shift on the diagram. Draw a new supply curve to the left of the original curve and label it 'S1S1'.

  5. 5

    Step 5: Explain the diagram. The shift from SS to S1S1 shows that at any given price, fewer potatoes are now supplied. For example, at price P1, the quantity supplied has fallen from Q1 to Q2.

Worked example 23 marks

The government provides a subsidy to producers of solar panels. How will this affect the market supply of solar panels?

  1. 1

    Step 1: A subsidy is a payment from the government to a producer. This effectively lowers the producer's cost of production.

  2. 2

    Step 2: With lower production costs, producing solar panels becomes more profitable at every price point.

  3. 3

    Step 3: This incentivises existing producers to make more and may attract new producers to the market, leading to an increase in supply.

  4. 4

    Step 4: The supply curve for solar panels will shift to the right.

Recap

  • A shift in supply is caused by a non-price factor.
  • An increase in supply is a shift to the right.
  • A decrease in supply is a shift to the left.
  • Key shifters include production costs, technology, taxes, subsidies, and weather.
  • A rightward shift means more is supplied at every price.

Quick check

  1. List two factors that could cause the supply of cars to increase.2 marks
  2. Does a new tax on producers shift the supply curve left or right?1 mark

4. Calculating Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) measures how much the quantity supplied of a product responds to a change in its price. It helps us understand the *degree* of responsiveness. Is the supply response big or small? The calculation is done using a formula that compares the percentage change in quantity supplied to the percentage change in price.

PES = (% Change in Quantity Supplied) / (% Change in Price)

% Change in Quantity Supplied = ((New Quantity - Original Quantity) / Original Quantity) × 100

% Change in Price = ((New Price - Original Price) / Original Price) × 100

Key term

Price Elasticity of Supply (PES): A measure of the responsiveness of the quantity supplied of a good or service to a change in its price.

Examiner insight

Examiners look for the full working, including the calculation of both percentage changes and the final PES formula. Simply writing the answer is not enough.

Common pitfall

A common error is dividing the change in quantity by the change in price directly, instead of using the percentage changes. You must calculate the percentages first.

Worked example 13 marks

The price of a bunch of carnations rises from 100 cents to 200 cents. In response, the quantity supplied by growers increases from 10,000 to 12,000 bunches per month. Calculate the PES for carnations.

  1. 1

    Step 1: Calculate the percentage change in quantity supplied. Change = 12,000 - 10,000 = 2,000. % Change = (2,000 / 10,000) × 100 = 20%.

  2. 2

    Step 2: Calculate the percentage change in price. Change = 200 - 100 = 100 cents. % Change = (100 / 100) × 100 = 100%.

  3. 3

    Step 3: Apply the PES formula. PES = (% Change in Quantity Supplied) / (% Change in Price) = 20% / 100%.

  4. 4

    Step 4: State the final answer. PES = 0.2.

Worked example 24 marks

The price of man-made rubber increases from 80 cents to 100 cents per kg. The quantity supplied rises from 2,000 to 2,800 units per month. Calculate the PES and state whether supply is elastic or inelastic.

  1. 1

    Step 1: Calculate the % change in quantity supplied. Change = 2,800 - 2,000 = 800. % Change = (800 / 2,000) × 100 = 40%.

  2. 2

    Step 2: Calculate the % change in price. Change = 100 - 80 = 20 cents. % Change = (20 / 80) × 100 = 25%.

  3. 3

    Step 3: Apply the PES formula. PES = 40% / 25% = 1.6.

  4. 4

    Step 4: Interpret the result. Since the PES value (1.6) is greater than 1, the supply of man-made rubber is price elastic.

Recap

  • PES measures the responsiveness of quantity supplied to a price change.
  • The formula is % change in quantity supplied divided by % change in price.
  • Always calculate the percentage change relative to the original value.
  • The PES value will be positive because of the Law of Supply.
  • A PES value greater than 1 is elastic; less than 1 is inelastic.

Quick check

  1. If price increases by 20% and quantity supplied increases by 10%, what is the PES?2 marks

5. Interpreting PES: From Inelastic to Elastic

The numerical value of PES tells us about the nature of supply. We can categorise it into five types:

  1. Price Inelastic Supply (PES < 1): The percentage change in quantity supplied is *less than* the percentage change in price. This means producers are not very responsive to price changes. The supply curve is steep. Example: Agricultural goods like fresh fruit.
  2. Price Elastic Supply (PES > 1): The percentage change in quantity supplied is *greater than* the percentage change in price. Producers are very responsive to price changes. The supply curve is relatively flat. Example: Mass-produced goods like T-shirts.
  3. Unitary Elastic Supply (PES = 1): The percentage change in quantity supplied is *exactly equal to* the percentage change in price. Any straight-line supply curve that starts from the origin (0,0) has unitary elasticity.
  4. Perfectly Inelastic Supply (PES = 0): Quantity supplied does not change at all, regardless of the price. The supply curve is a vertical line. Example: The number of seats in a specific theatre for tonight's show.
  5. Perfectly Elastic Supply (PES = ∞): Producers are willing to supply any amount at a single price, but nothing at any other price. The supply curve is a horizontal line. This is a theoretical concept, but it can apply to a single firm in a perfectly competitive market.

Key term

Price Inelastic Supply: Where the percentage change in quantity supplied is less than the percentage change in price (PES < 1), often represented by a steep supply curve.

Examiner insight

Students who can accurately sketch and label the different types of PES curves, especially the special cases of perfectly inelastic (vertical) and perfectly elastic (horizontal), demonstrate a high level of understanding.

Fun fact

The supply of land in a city centre is almost perfectly inelastic. No matter how much prices rise, you can't create more land, which is why city-centre property is so expensive.

Worked example 13 marks

An art gallery has a single, unique painting by a deceased artist for sale. Explain the price elasticity of supply for this painting and sketch its supply curve.

  1. 1

    Step 1: Identify the key constraint. There is only one painting, and since the artist is deceased, no more can ever be produced.

  2. 2

    Step 2: Determine the responsiveness of supply. The quantity supplied is fixed at 1. It cannot increase or decrease, no matter how high or low the price goes.

  3. 3

    Step 3: Conclude the PES value. Since the quantity supplied does not respond to price changes, the PES is 0. This is perfectly inelastic supply.

  4. 4

    Step 4: Sketch the supply curve. Draw a graph with 'Price' on the Y-axis and 'Quantity' on the X-axis. The supply curve will be a vertical line at Quantity = 1.

Recap

  • PES < 1 means supply is inelastic (steep curve).
  • PES > 1 means supply is elastic (flat curve).
  • PES = 1 means supply is unitary elastic.
  • PES = 0 means supply is perfectly inelastic (vertical curve).
  • PES = ∞ means supply is perfectly elastic (horizontal curve).

Quick check

  1. If PES = 0.4, is supply elastic or inelastic?1 mark
  2. What does a vertical supply curve signify?1 mark

6. What Determines Price Elasticity of Supply?

The price elasticity of supply for a product is determined by several practical factors that affect a producer's ability to change their output level quickly. The main determinants are:

  1. Time Period: This is the most important factor. In the *short run*, it is difficult for firms to change their production levels significantly (e.g., build a new factory, grow more crops). So, supply is typically inelastic. In the *long run*, firms have enough time to adjust all factors of production, making supply more elastic.
  2. Availability of Stocks: If a firm has a large inventory of finished goods, it can respond to a price increase very quickly by selling its stock. High stock levels make supply more elastic.
  3. Spare Production Capacity: If a factory is only running at 70% capacity, it's easy to increase output by using the idle machinery and workers. Firms with spare capacity have a more elastic supply.
  4. Factor Mobility: This refers to how easily factors of production (labour, capital) can be moved from one use to another. If it's easy to get more raw materials and hire workers with the right skills, supply will be more elastic.

Key term

Factor Mobility: The ease with which factors of production, such as labour and capital, can be moved from one productive use to another.

Examiner insight

Examiners appreciate answers that apply the determinants of PES to specific real-world examples, rather than just listing the factors.

Worked example 14 marks

Explain why the PES for fresh fish is likely to be more inelastic than the PES for canned fish.

  1. 1

    Step 1: Consider the production process for fresh fish. The amount of fish caught on a given day is largely fixed once the boats return to harbour. It is difficult to instantly increase the catch in response to a price rise on that day. This makes short-run supply highly inelastic.

  2. 2

    Step 2: Consider the supply of canned fish. Producers of canned fish can hold large inventories (stocks) of their product.

  3. 3

    Step 3: Compare their responsiveness. If the price of canned fish rises, suppliers can immediately release more from their warehouses to the shops. This ability to use stocks makes the supply of canned fish much more price elastic than that of fresh fish.

  4. 4

    Step 4: Conclude by linking to the determinant. The key difference is the availability of stocks, which is high for canned fish but non-existent for fresh fish on the day.

Recap

  • Supply is more elastic in the long run than in the short run.
  • Firms with high levels of stock have more elastic supply.
  • The existence of spare production capacity increases PES.
  • High mobility of factors of production (labour, capital) makes supply more elastic.
  • Complex production processes tend to lead to more inelastic supply.

Quick check

  1. Is the supply of nuclear-powered submarines likely to be price elastic or inelastic? State one reason.2 marks
  2. How does time affect PES?1 mark

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define the law of supply and explain, with reference to the profit motive, why the supply curve is typically upward sloping.3 marks
  2. Using a clearly labelled diagram, explain the difference between a 'contraction in supply' and a 'decrease in supply'.4 marks
  3. When the price of a product rises from $40 to $50, a firm increases its monthly output from 800 units to 900 units. Calculate the Price Elasticity of Supply (PES) for this firm.3 marks
  4. Explain two reasons why the supply of manufactured goods, such as smartphones, is likely to be more price elastic than the supply of agricultural goods, like avocados.4 marks
  5. What is meant by 'perfectly inelastic supply'? Give a real-world example and draw the corresponding supply curve.3 marks
  6. Analyse, using a supply and demand diagram, how a government subsidy given to producers of renewable energy would affect the market for that energy.6 marks
  7. The price of cobalt, a key raw material in batteries, doubles. Explain the likely impact on the market supply of electric cars.3 marks
  8. Explain how (a) the availability of spare production capacity and (b) the time period under consideration affect the price elasticity of supply for a product.4 marks
  9. A firm making handmade wooden chairs discovers a new, faster wood-curing technique. At the same time, the cost of high-quality timber increases significantly. Analyse the likely overall effect on the supply of its chairs.5 marks
  10. Compare the likely Price Elasticity of Supply for hotel rooms in a popular tourist city versus the PES for building new hotels in that city. Justify your answer.6 marks

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