CHAPTER-2

UNIT 3: THEORY OF SUPPLY

(BY- Dr. JATIN KUMAR LAMBA)

 SUPPLY ANALYSIS

 The term ‘supply’ refers the amount of a good or service that the
producers are willing and able to offer to the market at various prices
during a period of time. Two important points apply to supply:

1) The supply refers to what firms offer for sale, not necessarily to what
they succeed in selling.

2) Supply is a flow. The quantity supplied is so much per unit of time, per
day, per week, or per year.
 DETERMINANTS OF SUPPLY
 Price of the good: Other things being equal, the higher the relative price of a
good the greater the quantity of it that will be supplied. This is because the firm
produces goods and services in order to earn profits and ceteris paribus, profits
rise if the price of its product rises.

 Price of the related goods: If the prices of other goods rise, they become
relatively more profitable to the firm to produce and sell than the good in
question. For example, if price of wheat rises, the farmers may shift lands to
wheat production and away from corn and soyabeans.

 Price of the factors of production: A rise in the price of a particular factor of

production will cause an increase in the cost of making those goods that use a
great deal of that factor than in the costs of producing those that use relatively
small amount of the factor.

 Expectation of Price: If sellers have expectation of increase in price in future,

the suppliers reduce the supply today and vice versa.
 State of technology: The supply of a particular product depends upon the
state of technology also. Inventions and innovations tend to make it possible to
produce more or better goods with the same resources, and thus they tend to
increase the quantity supplied of some products.

 Government Policy: the production of a good may be subject to the

imposition of commodity taxes such as excise duty, sales tax and important
duties. These raise the cost of production and so the quantity supplied of a
good would increase only when its price in the market rises.

 Nature of Competition: Under competitive condition, supply will be more than

that under monopolized condition.

 Number of Sellers: If there are large number of firms in the market, supply
will be more.

 Other Factors: The quantity supplied of a good also depends upon

government’s industrial and foreign policies, goals of the firm, infrastructural.
 LAW OF SUPPLY
The law of supply can be stated as: Other things remaining constant, the
quantity of a good produced and offered for sale will increase as the price of
the good rises and decrease as the price falls.
This law is based upon common sense, for the higher the price of the good, the
greater the profits and can be earned and thus greater the incentives to
produce the good and offer it for sale. There is an exception however. If we take
the supply of labour at very high wages, we may find that the supply of labour
has decreased instead of increasing.
Supply Schedule of Good ‘X

PRICE (Rs./KG) Quantity Supplied (KG)

1 5
2 35
3 45
4 55
5 65
 C
S1
5

PRICE 4

3
C
2

1
S
O
10 20 30 40 50 60 70 X
QUANTITY

Supply Curve
When we draw a smooth curve through the plotted points, what we get is the
supply curve for good X. The curve shows the quantity of X that will be offered
for sale at each price of X. It slopes upwards towards right showing that as price
increases, the supply of X increases and vice-versa.
 Law of Supply can be Expressed Through

Supply Supply Supply

Supply Curve
Function Schedule Equation

Individual
Individual
Supply
Supply Curve
Schedule

Market Supply Market Supply

Schedule Curve
 CHANGE IN QUANTITY CHANGE IN SUPPLY/SHIFT IN SUPPLY
SUPPLIED/MOVEMENT ALONG THE CURVE
SUPPLY CURVE
 Ceteris Paribus  Price of the commodity
 Supply changes due to remains constant
change in price of the  Demand changes due to
commodity change in any other factor
 There is upward or downward  There is rightward or leftward
movement on supply curve shift in supply curve
 It has two forms:  It has two forms:
(i) Expansion in Supply (i) Increase in Supply
(ii) Contraction in Supply (ii) Decrease in Supply
Y S Y Y
S1 S1
S2 S2
PRICE

PRICE
C C C

S
O O
X X
X
QUANTITY QUANTITY
QUANTITY
 ELASTICITY OF SUPPLY
The elasticity of supply is defined as the degree of responsiveness of the
quantity supplied of a good to a change in its price. Elasticity of supply is
measured by dividing the percentage change in quantity supplied of a good by
the percentage change in its price i.e.

Percentage change in quantity supplied

EP 
Percentage change in price
Change in quantity sup p lied
 100
quantity sup p lied
Or
change in p rice
 100
p rice
 q
q q p
Or  
p p q
p
Where q denotes original quantity supplied
q denotes change in quantity supplied
p denotes original price
p denotes change in price
 TYPES/DEGREES OF PRICE ELASTICITY OF
SUPPLY

Perfectly Inelastic Inelastic Unit Elastic Elastic Supply

Supply (Es=0) Supply (Es<1) Supply (Es=1) (Es>1)
Perfectly Elastic
Supply (Es= )
(i) Perfectly Inelastic supply: If as a result of a change in price, the quantity
supplied of a good remains unchanged, we say that the elasticity of supply is
zero or the good has perfectly inelastic supply.

Y S

PRICE
C

C X
QU A N T I T Y

(ii) Relatively less-elastic supply: It is a result of a change in the price of a good

its supply changes less than proportionately, we say that the good is relatively less
elastic or elasticity of supply is less than one.
Y
S

P2
PRICE

P
P1 C

O q
X
Q1 Q2
QU A N T I T Y
(iii) Relatively greater-elastic supply: If elasticity of supply is greater than one
i.e., when the quantity supplied of a good changes substantially in response
to a small change in the price of the good we say that supply is greatly
elastic, shows that the relative change in the quantity supplied is greater
than the relative change in the price.
Y
S

P2

PRIC E P1
P
C

q
X
O Q1 Q2
QUANTITY

(iv) Unit-elastic: If the relative change in the quantity supplied is exactly equal to
the relative change in the price, the supply is said to be unitary elastic. Here
coefficient of elasticity of supply is equal to one. The relative change in the
quantity supplied (q) is equal to the relative change in the price (p).
 Y
S

P2

PRICE
P
P1 C

q
X
O Q1 Q2
QUANTI TY

(v) Perfectly elastic supply: The supply elasticity is infinite when

nothing is supplied at a lower price but a small increase in price causes
supply to rise from zero to an indefinitely large amount indicating that
producers will supply any quantity demanded at that price.
 Y

PRIC E P
C
S

X
C
QUANTITY

The elasticity of supply can be considered with reference to a given

point on the supply curve or between two points on the supply curve.
Arc-Elasticity: Arc-elasticity i.e. elasticity of supply between two prices can be
found out with the help of the following formula:

q1  q 2 p1  p 2
Es  
q1  q 2 p1  p 2

q1  q 2 p1  p 2
Es  
q1  q 2 p1  p 2

p1  p 2 q

q1  q 2 p
 FACTORS AFFECTING ELASTICITY OF SUPPLY
(i) Nature of the commodity
Elasticity of supply depends upon the nature of the commodity. The supply of
perishable commodities is generally less elastic because their supply cannot be
increased even when their price changes. On the other hand, the supply of
durable commodities is generally elastic because when price changes their
supply can also be changes.

(ii) Cost of Production

Elasticity of supply depends upon the fact as to whether per unit cost of a
commodity increases or decrease when output is increased. The supply of such
commodities is generally inelastic whose per unit cost increases when output is
increased. This is so because if price increases due to increase in the cost of
production, supply cannot be easily increased. On the other hand, supply of
such commodities is generally elastic whose per unit cost decreases when
output is increased. The supply of such commodities can be increased if price
increases.
(iii) Time period
Longer is the period higher is the elasticity of supply. On the other hand, lesser
is the period lesser is the elasticity of supply. In short, supply is more elastic
during long period lesser is the elasticity during short period. This is so because
in the short period supply cannot be increased even when price increases. On
the other hand, in the long period supply can be changed in accordance.

(iv) Production technology

The supply of commodities whose technology is simple is generally elastic.
Output of such commodities can be easily increases when their price
increases. On the other hand, the supply of such commodities whose
production technology is complex and where more capital is used is generally
less elastic. Output of such commodities cannot be easily increased when their
prices increase.

(v) Natural factors

Supply of these commodities whose production depends on natural factors
such as rain, climate, etc. is generally inelastic. Generally, elasticity of supply
manufactured goods is greater than one.
(vi) Nature of inputs used
Nature of inputs used for producing a commodity also affects its elasticity of
supply. If the inputs such as raw materials etc. are general in nature, then
elasticity of supply of the commodity will be elastic. On the other hand, if inputs
(both factor and non-factor) are of specific nature, then the elasticity of supply
of the commodity will be inelastic.
 EQUILIBRIUM PRICE
The equilibrium price in the market is determined by the interaction
between demand and supply that tends to determine price and quantity. It is
also called Market Equilibrium.

Price (Rs./Unit) Demand (Units) Supply (Units)

1 60 5

2 35 35

3 20 45

4 15 55

5 10 65
When we plot the above points on a single graph with price on Y – axis
and quantity demanded and supplied on X-axis, we get a figure like
this:
Y D

5
S

4
PRICE

E
2

1 S
D

10 20 30 40 50 60 70 X

It is easy to see which will be the market price of the article. It cannot be
Re. 1, for at that price there would be 60 units in demand, but only 5
units on offer. At Rs.2 demand and supply are equal (35 units) and the
market price will tend to settle at this figure. This is equilibrium price and
quantity – the point at which price and output will tend to stay.
 MARKET EQUILIBRIUM & SOCIAL EFFICIENCY

Social Efficiency represents the net gains to society from all exchanges
that are made in a particular market. It has two components i.e.,
Consumer Surplus and Producer Surplus. Consumer surplus is a measure
of consumer welfare. Producer surplus is the benefit derived by the
producers from the sale of a unit above and beyond their cost of
producing that unit. This occurs when the price they receive in the market
is more than the minimum price at which they would be prepared to
supply.
For all quantities below OQ, we have find that there is the difference
between the price that producer are willing to get for supplying the good
and the market price. Producer surplus disappears when market price is at
equilibrium.
THANK YOU