Cambridge O Level2281

Supply

Economics 2281 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. 2Movements Along the Supply Curve
  3. 3Shifts in the Supply Curve
  4. 4Price Elasticity of Supply (PES)
  5. 5Determinants of 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 offer for sale at various prices over a specific period. The fundamental principle is the 'Law of Supply', which states that, ceteris paribus (all other things being equal), as the price of a product rises, the quantity supplied of that product will also rise. This positive relationship exists because higher prices provide a greater profit incentive for firms to produce more. The supply curve is a graphical representation of this relationship, showing quantity supplied on the x-axis and price on the y-axis. It slopes upwards from left to right, visually demonstrating that producers will supply more at higher prices.

Key term

Supply: The quantity of a good or service that producers are willing and able to sell at a given price in a given time period.

Examiner insight

Examiners award marks for accurately drawn and labelled diagrams. Ensure your supply curve slopes upwards and that axes are correctly labelled as 'Price' and 'Quantity'.

Common pitfall

Confusing 'supply' (the entire relationship shown by the curve) with 'quantity supplied' (a specific amount at a specific price).

Worked example 14 marks

The table shows the market supply schedule for silver-plated tankards. Plot the market supply curve on a graph. Label the axes and the curve correctly.

  1. 1

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

  2. 2

    Step 2: Choose a suitable scale for both axes. The price axis should go up to at least $20, and the quantity axis up to at least 1,600.

  3. 3

    Step 3: Plot the points from the supply schedule. For example, the first point is at a price of $20 and a quantity of 1,600. The second is at $16 and 1,100, and so on.

  4. 4

    Step 4: Join the plotted points with a line or a smooth curve.

  5. 5

    Step 5: Label the resulting curve 'SS' to represent the market supply curve.

Recap

  • Supply is the willingness and ability of producers to sell a product.
  • The Law of Supply states that price and quantity supplied have a positive relationship.
  • Higher prices increase the potential for profit, encouraging firms to supply more.
  • The supply curve is a graph that slopes upwards from left to right.
  • A supply schedule is a table showing the quantity supplied at different prices.

Quick check

  1. State the Law of Supply.1 mark
  2. Why does the supply curve typically slope upwards?2 marks

2. Movements Along the Supply Curve

A change in the price of the product itself, while all other factors remain constant, causes a movement along the existing supply curve. This is not a change in the overall conditions of supply. There are two types of movement: an 'extension' and a 'contraction'. An extension of supply occurs when a higher price leads to a higher quantity supplied (a movement up and to the right along the curve). A contraction of supply occurs when a lower price leads to a lower quantity supplied (a movement down and to the left along the curve).

Key term

Extension of Supply: An increase in the quantity supplied of a product following a rise in its price, shown as a movement up along the existing supply curve.

Examiner insight

You must use the precise terms 'extension' and 'contraction' when describing movements along the supply curve to gain full marks.

Common pitfall

Incorrectly describing a price change as causing 'supply to increase' instead of 'quantity supplied to increase' (an extension).

Worked example 13 marks

Using the supply schedule for silver-plated tankards, describe the effect of the price falling from $16 to $8, assuming no other factors change.

  1. 1

    Step 1: Identify the initial quantity supplied at $16, which is 1,100 tankards.

  2. 2

    Step 2: Identify the new quantity supplied at $8, which is 300 tankards.

  3. 3

    Step 3: Describe the change. This is a 'contraction of supply' because the price has fallen.

  4. 4

    Step 4: Quantify the change. The quantity supplied has decreased by 800 tankards (1,100 - 300). On a diagram, this would be shown as a movement down along the supply curve.

Recap

  • A change in the product's own price causes a movement along the supply curve.
  • An increase in price causes an extension of supply (more is supplied).
  • A decrease in price causes a contraction of supply (less is supplied).
  • Movements along the curve are different from shifts of the entire curve.

Quick check

  1. What single factor causes a movement along a supply curve?1 mark
  2. What is the term for a decrease in quantity supplied due to a fall in price?1 mark

3. Shifts in the Supply Curve

A shift in the supply curve occurs when a factor other than the product's own price changes, causing producers to supply more or less at every price level. An 'increase in supply' is a shift of the entire curve to the right (e.g., from S to S1), meaning more is supplied at each price. A 'decrease in supply' is a shift to the left, meaning less is supplied at each price. Key factors causing shifts include: changes in the costs of production (e.g., wages, raw materials), new technology (improves productivity), government subsidies (increase supply), indirect taxes (decrease supply), weather conditions (especially for agriculture), and the number of firms in the market.

Key term

Shift in Supply: A change in the conditions of supply causing the entire supply curve to move to the left (decrease) or right (increase).

Common pitfall

Stating that a fall in production costs causes price to fall. The cost change shifts the supply curve; the interaction with demand then determines the new market price.

Fun fact

The invention of the 'float glass' process by Pilkington in the 1950s dramatically lowered the cost of producing high-quality flat glass, causing a massive and permanent rightward shift in the global supply curve for windows.

Worked example 14 marks

The original supply of potatoes is shown in the table. A new disease affects the crop, causing supply to fall by 10,000 kg at every price. Draw a diagram showing the original and new supply curves.

  1. 1

    Step 1: Draw and label the axes for Price and Quantity.

  2. 2

    Step 2: Plot the original supply curve (SS) using points like (10,000 kg, 20 cents) and (50,000 kg, 100 cents).

  3. 3

    Step 3: Calculate the new quantities supplied. At 100 cents, it's 50,000 - 10,000 = 40,000 kg. At 80 cents, it's 40,000 - 10,000 = 30,000 kg, and so on.

  4. 4

    Step 4: Plot the new supply curve (S1S1) using these new points.

  5. 5

    Step 5: The new curve S1S1 will be parallel to and to the left of the original curve SS, indicating a decrease in supply.

Worked example 23 marks

Explain how a fall in the cost of leather would affect the supply of leather shoes.

  1. 1

    Step 1: Identify leather as a factor of production (a cost) for making shoes.

  2. 2

    Step 2: A fall in the cost of leather lowers the total cost of producing each pair of shoes.

  3. 3

    Step 3: This makes production more profitable at any given selling price.

  4. 4

    Step 4: Firms are now incentivised to produce and sell more shoes at every price level.

  5. 5

    Step 5: This causes an increase in supply, shown as a shift of the supply curve to the right.

Recap

  • A shift in supply is caused by a change in 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 causes of shifts include costs, technology, subsidies, taxes, and weather.

Quick check

  1. Name two factors that could cause the supply curve for coffee to shift to the left.2 marks
  2. Does a successful advertising campaign for a product shift its supply curve?1 mark

4. 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 extent of an extension or contraction. The value is calculated by dividing the percentage change in quantity supplied by the percentage change in price. The result tells us if supply is elastic or inelastic.

  • If PES > 1, supply is 'price elastic'. A change in price leads to a proportionally larger change in quantity supplied. The supply curve is relatively shallow.
  • If PES < 1, supply is 'price inelastic'. A change in price leads to a proportionally smaller change in quantity supplied. The supply curve is relatively steep.
  • If PES = 1, supply has 'unitary elasticity'. The percentage change in quantity supplied is equal to the percentage change in price.
  • If PES = 0, supply is 'perfectly inelastic'. Quantity supplied does not change at all when price changes (e.g., seats in a stadium). The supply curve is vertical.
  • If PES = ∞, supply is 'perfectly elastic'. Producers will supply any amount at a specific price, but nothing above or below it. The supply curve is horizontal.

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 product to a change in its price.

Examiner insight

Show your full working when calculating PES. Marks are awarded for calculating the percentage changes correctly, as well as for the final PES value and its interpretation.

Fun fact

The global supply of genuine Stradivarius violins is perfectly inelastic. There are a fixed number (around 650) in existence, and no matter how high the price goes, no more can be made.

Worked example 14 marks

The price of a bunch of carnations rises from 100 cents to 200 cents. In response, suppliers increase the quantity offered from 10,000 to 12,000 bunches per month. Calculate the PES and interpret the result.

  1. 1

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

  2. 2

    Step 2: Calculate the percentage change in price. %ΔP = [(200 - 100) / 100] × 100 = (100 / 100) × 100 = 100%.

  3. 3

    Step 3: Calculate PES. PES = %ΔQS / %ΔP = 20% / 100% = 0.2.

  4. 4

    Step 4: Interpret the result. Since the PES value (0.2) is less than 1, the supply of carnations is price inelastic. This means the quantity supplied is not very responsive to the change in price.

Recap

  • PES measures the responsiveness of quantity supplied to a price change.
  • The formula for PES is %ΔQS / %ΔP.
  • A PES value less than 1 means supply is price inelastic.
  • A PES value greater than 1 means supply is price elastic.
  • Perfectly inelastic supply (PES=0) is a vertical line; perfectly elastic (PES=∞) is a horizontal line.

Quick check

  1. If a 10% rise in price leads to a 5% rise in quantity supplied, what is the PES?1 mark
  2. Is a PES value of 1.8 considered elastic or inelastic?1 mark

5. Determinants of Price Elasticity of Supply

Several factors determine whether the supply of a good is price elastic or inelastic. The most important determinant is the time period. In the short run, it's difficult for firms to change production levels, so supply is often inelastic. In the long run, firms can build new factories, hire more workers, and acquire more resources, making supply more elastic. Other key factors include:

  1. Availability of Spare Capacity: If a firm has idle machinery or underemployed staff, it can quickly increase output in response to a price rise, making supply more elastic.
  2. Level of Stocks/Inventories: Firms with large stockpiles of finished goods can respond quickly to a price rise by releasing stock onto the market, leading to elastic supply.
  3. Mobility of Factors of Production: If labour and capital can be easily switched from producing one good to another, supply will be more elastic.
  4. Complexity and Length of Production: Goods that are complex and take a long time to produce (e.g., aircraft, agricultural crops) tend to have inelastic supply. Simple manufactured goods (e.g., pencils) have more elastic supply.

Key term

Spare Capacity: The extent to which a firm or economy is operating below the maximum potential level of output.

Examiner insight

Examiners appreciate comparative analysis. When asked to compare the PES of two goods, explain the relevant determinant for each good and then make a clear conclusion.

Common pitfall

Simply stating 'time' as a determinant of PES without explaining *why* the long run allows for greater flexibility in production.

Worked example 14 marks

Explain why the PES for natural rubber might be lower than the PES for man-made rubber.

  1. 1

    Step 1: Consider the production process for natural rubber. It comes from rubber trees, which take many years to grow to maturity.

  2. 2

    Step 2: In the short run, if the price of natural rubber rises, producers cannot instantly grow more trees. They can only increase supply slightly by tapping existing trees more intensively. This makes supply price inelastic.

  3. 3

    Step 3: Now consider man-made (synthetic) rubber. It is produced in factories using chemical processes.

  4. 4

    Step 4: If the price of man-made rubber rises, producers with spare capacity can increase output relatively quickly by running more shifts or turning on idle production lines. This makes supply more price elastic than for natural rubber.

Recap

  • The time period is the most important determinant of PES; supply is more elastic in the long run.
  • Firms with spare capacity can respond more quickly to price changes, making supply elastic.
  • The ability to store goods (inventories) increases price elasticity of supply.
  • Complex or lengthy production processes lead to inelastic supply.
  • Easy mobility of factors of production increases the elasticity of supply.

Quick check

  1. Name two factors that would make the supply of a product price elastic.2 marks
  2. Is supply likely to be more elastic in the short run or the long run? Explain why.2 marks

End-of-chapter exercise

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

  1. Define the law of supply and explain one reason why the supply curve for most goods is upward sloping.3 marks
  2. Using a diagram, distinguish between a contraction of supply and a decrease in supply.5 marks
  3. The price of a smartphone rises from $400 to $440. As a result, the quantity supplied increases from 50,000 to 57,500 units per month. Calculate the price elasticity of supply (PES) and state whether supply is elastic or inelastic.4 marks
  4. Explain two factors that could cause the supply curve for bicycles to shift to the right.4 marks
  5. Analyse why the price elasticity of supply for beachfront holiday homes is likely to be very low.4 marks
  6. A firm has a PES of 0.8. If the market price for its product increases by 15%, calculate the expected percentage change in the quantity supplied.2 marks
  7. Analyse the likely effects of a new, highly efficient production technology on the supply of a manufactured good. In your answer, refer to the supply curve and price elasticity of supply.6 marks
  8. Discuss whether the supply of a highly skilled workforce, such as brain surgeons, is likely to be price elastic or price inelastic in the short run and long run.6 marks
  9. A government wants to discourage the consumption of sugary drinks and places a large indirect tax on producers. Using a supply and demand diagram, analyse the impact this tax will have on the supply curve, the market price, and the quantity sold.6 marks
  10. Evaluate the factors that determine the price elasticity of supply for a typical agricultural product like wheat compared to a manufactured product like a car.8 marks

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