Supply Analysis

Dr. Mukta Mukherjee

Reading
 3.1.4. S_N_Chapter03
 3.1.5. S_N_Chapter04
 3.2.3. P_R_Chapter02
 4.4.1. NGM_Chapter04
 4.4.2. NGM_Chapter05
 4.4.3. NGM_Chapter06
 4.4.4. NGM_Chapter07
 4.4.5. NGM_Chapter08

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Supply Curve
 Supply curve shows the relationship between quantity
demanded and price, ceteris paribus

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Law of Supply
“All other factors being equal, as the price of a good
increases, the quantity of goods that the suppliers offer
will increase and vice versa”

 As price of a good increases, suppliers will attempt to

increase their revenue (and potential their profits) by
increasing the quantity offered

 Supply curve is upward sloping

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Determinants of Supply

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Change in Quantity Supplied vs Change
in Supply
 Caused by change in price  Caused by change in factors
of the product under other than the price of the
discussion product under discussion

 Movement along the supply

 Shift of the supply curve
curve

Change in Quantity Supplied Change in Supply

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Supply Function
 Supply function is given by the equation below

 Supply curve vs Supply function

◦ Supply Curve: Q is independent and P is dependent
◦ Supply Function: Q is dependent and P is independent
◦ Supply curve is not obtained by plotting supply function
◦ Supply curve is obtained by plotting inverse supply function ceteris paribus

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 Price Elasticity of Supply
The sensitivity of quantity supply to price of the commodity
Elastic Supply ∆𝑄
When supply is elastic, the
quantity supplied is relatively 𝐸𝑠=
%∆𝑄
%∆𝑃
=
𝑄
∆𝑃
=
∆𝑄
∆𝑃 ( )( )
𝑃
𝑄
more responsive to changes in 𝑃
price (Es is greater than one).

Inelastic Supply Elasticity

When supply is inelastic, the
quantity demanded is >1 Relatively Elastic
relatively less responsive to =1 Unit Elastic
changes in price (i.e. Es is less

∞
than one).
<1 Relatively Inelastic
Perfectly Elastic
0 Perfectly Inelastic

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 Market Equilibrium
 The equilibrium price and
quantity occur when the
amount willingly supplied
equals the amount willingly
demanded

 In a competitive market, this

equilibrium is found at the
intersection of the supply
and demand curves

 There are no shortages or

surpluses at the equilibrium
price

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Changes in Market Equilibrium
 Three steps to analyzing changes in equilibrium
1. Decide whether the event shifts the supply curve, the
demand curve, or, in some cases, both curves
2. Decide whether the curve shifts to the right or to the left
3. Use the supply-and-demand diagram
 Compare the initial and the new equilibrium
 Effects on equilibrium price and quantity

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Changes in Market Equilibrium:
Hot weather and demand for Ice-Cream
• A change in market equilibrium due to a shift in demand
– One summer, very hot weather
– Effect on the market for ice cream?
1. Hot weather: shifts the demand curve (tastes )
2. Demand curve shifts to the right
3. Higher equilibrium price; higher equilibrium quantity

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Changes in Market Equilibrium:
Increase in price of sugar and supply of Ice-Cream
• A change in market equilibrium due to a shift in supply
– One summer, a hurricane destroys part of the sugarcane crop: higher price of
sugar
– Effect on the market for ice cream?
1. Change in price of sugar: supply curve
2. Supply curve: shifts to the left
3. Higher equilibrium price; lower equilibrium quantity

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Changes in Market Equilibrium:
Shifts in Both Demand and Supply Curves
 One summer: hurricane and heat wave
1. Heat wave shifts the demand curve; hurricane shifts the supply curve
2. Demand curve shifts to the right; Supply curve shifts to the left
3. Equilibrium price raises
 If demand increases substantially while supply falls just a little: equilibrium quantity rises
 If supply falls substantially while demand rises just a little: equilibrium quantity falls

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What Happens to Price and Quantity
When Supply or Demand Shifts?
No change in An increase in A decrease
supply supply in supply
No change in P same P down P up
Q same Q up Q down
demand
An increase in P up P ambiguous P up
Q up Q up Q ambiguous
demand
A decrease in P down P down P ambiguous
Q down Q ambiguous Q down
demand

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Assignment
Fill in the cells with appropriate impacts on price and quantity.
Support your answer with properly labelled diagrams.

An increase in A decrease
supply in supply
An increase in
demand
A decrease in
demand

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Applications of Elasticity:
Paradox of Bumper Crop
 Can Good News for Farming Be Bad News for Farmers?
◦ New hybrid of wheat – increase production per acre 20%
 Supply curve shifts to the right
 Higher quantity and lower price
 Demand is inelastic: total revenue falls

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Applications of Elasticity in Short- and Long-Run:
Why Did OPEC Fail to Keep the Price of Oil High?
 Short-run: supply and demand are inelastic
◦ Decrease in supply: large increase in price
 Long-run: supply and demand are elastic
◦ Decrease in supply: small increase in price

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Applications of Elasticity:
Does Drug Interdiction Increase or Decrease Drug-related
Crime?
 Policy of drug interdiction  Policy of drug education
◦ Reduce supply of illegal drugs ◦ Reduce demand for illegal drugs
◦ Leftward shift of supply curve ◦ Left shift of demand curve
◦ Lower quantity ◦ Lower quantity
◦ Higher price ◦ Lower price
◦ May increase drug related crime ◦ Reduce drug-related crime

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Applications:
Controls on Prices
 Price controls
◦ Usually enacted when policymakers believe that the market
price of a good or service is unfair to buyers or sellers
◦ Can generate inequities

 Price ceiling
◦ A legal maximum on the price at which a good can be sold

 Price floor
◦ A legal minimum on the price at which a good can be sold

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Applications:
Controls on Prices – Ceiling Price
 Not binding  Binding constraint
◦ Set above the equilibrium price ◦ Set below the equilibrium price
◦ No effect on the price or quantity sold ◦ Shortage
◦ Sellers must ration the scarce goods
 Long lines
 Discrimination according to sellers
bias

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Applications:
Controls on Prices – Floor Price
 Not binding  Binding constraint
◦ Set below the equilibrium price ◦ Set above the equilibrium price
◦ No effect on the market ◦ Surplus
◦ Some sellers are unable to sell what they
want
 The rationing mechanisms: not desirable

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Applications:
Evaluating Price Controls Policy
 Markets are usually a good way to organize economic activity
◦ Economists usually oppose price ceilings and price floors
◦ Prices are not the outcome of some haphazard process
◦ Prices have the crucial job of balancing supply and demand
 Coordinating economic activity

 Governments can sometimes improve market outcomes

◦ Want to use price controls
 Because of unfair market outcome
 Aimed at helping the poor
◦ Often hurt those they are trying to help
◦ Other ways of helping those in need
 Rent subsidies
 Wage subsidies

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Applications:
Imposition of Taxes
 Government use taxes
◦ To raise revenue for public projects
 Roads, schools, and national defense

 Tax incidence
◦ Manner in which the burden of a tax is shared among
participants in a market

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Applications:
Imposition of Taxes – On Seller
 Immediate impact on sellers: shift in
supply  Taxes discourage market activity
 Supply curve shifts left  Buyers and sellers share the burden of
 Higher equilibrium price tax
 Lower equilibrium quantity  Buyers pay more, are worse off
 The tax reduces the size of the market  Sellers receive less, are worse off
◦ Get the higher price but pay the tax
◦ Overall: effective price fall

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Applications:
Imposition of Taxes – On Buyer
 Initial impact on the demand  Buyers and sellers share the burden of
 Demand curve shifts left tax
 Lower equilibrium price  Sellers get a lower price, are worse off
 Lower equilibrium quantity  Buyers pay a higher market price, are
 The tax reduces the size of the market worse off
◦ Effective price (with tax) rises

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Applications:
Imposition of Taxes
 Taxes levied on sellers and taxes levied on buyers are
equivalent
◦ Wedge between the price that buyers pay and the price that
sellers receive
 The same, regardless of whether the tax is levied on buyers or
sellers
◦ Shifts the relative position of the supply and demand curves
 Buyers and sellers share the tax burden

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Applications:
Elasticity and Tax Incidence
 Elasticity and tax incidence
◦ Very elastic supply and relatively inelastic demand
 Sellers bear a small burden of tax
 Buyers bear most of the burden
◦ Relatively inelastic supply and very elastic demand
 Sellers bear most of the tax burden
 Buyers bear a small burden

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Applications:
Elasticity and Tax Incidence
 Tax burden
◦ Falls more heavily on the side of the market that is less elastic
◦ Small elasticity of demand
 Buyers do not have good alternatives to consuming this good
◦ Small elasticity of supply
 Sellers do not have good alternatives to producing this good

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 Application:
Willingness to Pay, Demand Curve and Consumer Surplus

 Consumer surplus possible buyers

◦ Measures the benefit buyers receive from  At any quantity, the price given by the
participating in a market demand curve
◦ Closely related to the demand curve ◦ Shows the willingness to pay of the
 Demand schedule marginal buyer
◦ Derived from the willingness to pay of the  The buyer who would leave the market
first if the price were any higher
Quantity
Price Buyers Demanded
More than $100 None 0

$80 to $100 John 1

$70 to $80 John, Paul 2

$50 to $70 John, Paul, 3

George
$50 or less John, Paul, 4
George, Ringo
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Application:
Willingness to Pay, Demand Curve and Consumer Surplus
 Consumer surplus in a market
◦ Area below the demand curve and above the price

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Application:
Consumer Surplus
 A lower price raises consumer surplus
1. Existing buyers: increase in consumer surplus
 Buyers who were already buying the good at the higher price are better off because
they now pay less
2. New buyers enter the market: increase in consumer surplus
 Willing to buy the good at the lower price

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Application:
Consumer Surplus
 Consumer surplus
◦ Benefit that buyers receive from a good
 As the buyers themselves perceive it
◦ Good measure of economic well-being
◦ Exception: illegal drugs
 Drug addicts are willing to pay a high price for heroin
 Society’s standpoint
 Drug addicts don’t get a large benefit from being able to buy heroin at
a low price

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 Application:
Willingness to sell, Supply Curve and Producer Surplus
 Cost  Supply schedule
◦ Value of everything a seller must give up to produce a ◦ Derived from the costs of the suppliers
good  At any quantity
◦ Measure of willingness to sell ◦ Price given by the supply curve shows the cost of the
 Producer surplus marginal seller
◦ Amount a seller is paid for a good minus the seller’s  Seller who would leave the market first if the price
cost of providing it were any lower
◦ Price received minus willingness to sell  Supply curve
◦ Closely related to the supply curve ◦ Reflects sellers’ costs
◦ Used to measure producer surplus
Quantity
Seller Cost Price Sellers Supplied
Mary $900 $900 or more Mary, 4
Frida,
Frida 800 Georgia,
Grandma
Georgia 600
$800 or $900 Frida, 3
Grandma 500 Georgia,
Grandma
$600 to $800 Georgia, 2
Grandma
$500 to $600 Grandma 1
Less than $500 None 0
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Application:
Willingness to sell, Supply Curve and Producer Surplus

 Producer surplus in a market

◦ Area below the price and above the supply curve

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Application:
Producer Surplus
 A higher price raises producer surplus
1. Existing sellers: increase in producer surplus
 Sellers who were already selling the good at the lower price are better off because they now get more
for what they sell
2. New sellers enter the market: increase in producer surplus
 Willing to produce the good at the higher price

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Applications:
Market Efficiency
 Total surplus = Consumer surplus + sellers
Producer surplus  Market outcomes
 Consumer surplus = Value to buyers – Amount 1. Free markets allocate the supply of goods
paid by buyers to the buyers who value them most highly
 Producer surplus = Amount received by sellers  Measured by their willingness to pay
– Cost to sellers
 Amount paid by buyers = Amount received by
2. Free markets allocate the demand for
goods to the sellers who can produce them
sellers
at the least cost
 Total surplus = Value to buyers – Cost to

 At market equilibrium, social planner

◦ Cannot increase economic well-being by
 Changing the allocation of consumption
among buyers
 Changing the allocation of production
among sellers
◦ Cannot raise total economic well-being
by
 Increasing or decreasing the quantity of
the good

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 Applications:
Market Efficiency – Cost of Tax
A tax on a good reduces
consumer surplus (by the area
B + C) and producer surplus
(by the area D + E)

Because the fall in producer

and consumer surplus exceeds
tax revenue (area B + D), the
tax is said to impose a
deadweight loss (area C + E)

Without Tax With Tax Change

Consumer Surplus A+B+C A -(B + C)

Producer Surplus D +E + F F -(D + E)

Tax Revenue None B+D +(B + D)
Total Surplus A+B+C+D+ E+ F A+B+D+F -(C + E)
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