ECONOMICS CHAPTER 5: LAW OF SUPPLY AND ELASTICITY OF SUPPLY Class: XII(ISC) Q1. Define Supply.

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1 ECONOMICS CHAPTER 5: LAW OF SUPPLY AND ELASTICITY OF SUPPLY Class: XII(ISC) Q1. Define Supply. Supply is defined as the quantity of a commodity which a producer or sellers are willing to produce and offer for sale at a particular price during a particular period of time. Ex. A farmer may not be prepared to sell his produce at Rs.400 per quintal but he may be ready to sell it, if the prices rises to Rs.500 per quintal. Individual Supply: It refers to the quantity of a commodity which a firm or producer is willing to produce and offer for sale at a particular price during a particular period of time. Market supply/industry supply : It refers to the quantity of a commodity which all firms or producers are willing to produce and offer for sale at a particular price during a particular period of time. Difference between stock and supply:- SUPPLY It refers to the actual quantity that the seller is willing to bring into the market and offer for sale at a particular price and time. Supply is related to a period of time Supply is that part of the stock which is offered for sale in the market. In case of durables supply consists only a part of total stocks Supply depends on market price STOCK /Intended supply It is the total quantity of a commodity that can be brought into the market for sale at a short notice. Stock is related to a point of time. Stock of a commodity is the total amount with the producer. In case of perishables the stock and supply would be the same. Stock depends on production, procurement price of good. 1

2 DETERMINANTS OF SUPPLY a. Price of the commodity- Other thing being constant, Higher the price of the commodity, larger will be the supply and smaller quantity will be supplied at a lower price. At higher price the producer/firm now expects to earn larger profit and will thereby get motivated to increase the supply of the commodity. b. Input prices- The price of inputs or factors used in production, such as raw materials, labor, machines etc affect supply. If producers have to pay high prices to secure FOP needed foe production, its cost of production rises which in turn reduces the profit margin. Thus, lower amount of output will be produced by the firm and would be offered for sale at a given price and vice versa. c. Price of related goods Supply of related goods also depend upon the prices of substitute goods.if price of other commodities are rising, while the price of the commodity under question remains constant, producers will find it more profitable to produce the other commodities. As a result the supply of the commodity reduces Ex A farmer can grow various vegetables on a given piece of land. If market price of peas rises, farmer will produce and supply more peas at the cost of cabbage and other vegetables by diverting resources from the production of other vegetables to the production of peas in order to earn more profit. d. Techniques of Production An improvement in the technique of production, the invention of new machines and advanced techniques reduce the code of production and increase the profit margin. Increased profitability induces the producers to produce more and increase the supply e. Nature of the commodity In case of monopoly, one firm produces the entire commodity. A monopolist firm will like to restrict the output so as to raise the market price. If there is competition among firms, there will be no tendency to restrict the output. Thus, the competitive firms are likely to produce and sell more as compared to monopolized industry. f. The policy of Taxation and Subsidies : Indirect taxes like sales tax, excise duty etc., are likely to increase the prices of the commodities and increase in its cost of production and, therefore, it will generally lead to a decrease in supply. Subsidies also affect the supply of a commodity. The government pays subsidies to firms to produce certain goods. Subsidies will reduce the cost and induce the procedures to increase supply. g. Expectations of Future Prices: If the producer expect an increase in the price of a commodity in future, then they will supply less today and hoard it so as to offer a large quantity of the commodity in future at higher prices. Conversely, expectations of fall in future prices tend to increase supply h. Natural Factories : Natural factors are particularly important for the supply of agricultural products. Natural factors like drought, flood, unfavourable, climatic conditions, etc. adversely 2

3 affect the supply of commodities. Heavy rains, flood and drought conditions will lead to decrease in supply of agricultural commodities. Adequate rain and favourable climatic conditions may help in increasing the supply of agricultural commodities. i. Agreement among producers : Sometimes producers may form a pool and enter into some agreement to restrict the supply of a commodity to earn large profits. They will create artificial scarcity of the commodities and, as a consequences, supply will decrease. j. Availability of Transport and communication facilities: An improvement in the transport and communication facilities will expand the size of the market. This will motivate the producers to produce and supply more. k. Goal of the Firm The goal of the firms may be 1. Profit Maximization Higher the profit from the sale of a commodity, higher will be the amount supplied by the firms and vice versa. 2. Sales Maximization The firms may aim to maximize the sales or revenue rather than profits. They may like to maximize the sales or revenue rather than profits. They may like to maximize the sales in order to acquire status and prestige in the society or to dominate the market. 3. Risk Minimization If the firms aim at minimization the risk, they will play safe and produce and supply a smaller quantity of the commodity. Supply function The supply function is a statement which states the relationship between the quantity supplied of a commodity and its determinants. Sn=f (Pn) Where, Sn is the quantity supplied of the commodity. Pn is the price of the commodity. Sn =f (Pn, P1,.Pn-1, Gf, Fi Fm, T, E, Gt, N, Mt ) Where Sn is the quantity supplied of a commodity n ; f is a symbol showing the relationship between supply of a commodity n and all its determinants; Pn is the price of commodity n ; P1 Pn-1 are the prices of commodities other than n ; Gf is the goal of the firms; Fi Fm is expression for prices of different factors of production; T is the technique of production; E is a symbol for expectation of future prices; Gt is the taxation policy of the government; N is the natural factors; and Mt stands for means of transportation. 3

4 Law of Supply The law of supply states that, other things remaining same, the quantity of any commodity that the firms will produce and offer for sale rises with the rise in price and falls with eth fall in price. Following are the assumptions of the law of supply or other things being equal Prices of other related goods remain constant Producers do not expect changes in the prices of the commodity in near future. Taxation policy of the government should not change. Technology of production should not change. Cost of factors of production should not change. Goals of the firm should not change Why does the supply curve slope upwards? / The law of supply indicates a positive slope/ explanation of law of supply: Positive slope of a supply curve can be explained in terms of three factors. 1. First reason is that the level of price determines the amount of profits. Higher is the price of the commodity, the larger is the profit that can be earned, ceteris paribus. This gives incentives to producers to produce and offer for sale a larger amount of the commodity. 2. The positive slope of the supply curve is also caused by the rise in the marginal cost of production. Marginal cost of production increases with increase in the amount of production. This implies that the producer would be prepared to produce and supply a larger quantity of a commodity only at a higher price, so as to cover higher cost of production. 3. A rise in price would give incentive not only to the existing producers of a commodity, but it would also motivate the other prospective producers to produce this commodity so as to earn higher profits. For example, a rise in price of rice would motivate the farmers to produce more of rice in place of other products, like wheat. Thus, at higher prices more firms are willing to enter the market to produce the good. Individual Supply schedule- A supply schedule is a tabular statement showing various quantities which producers are willing to produce and sell at various alternative prices during a given period of time. It is a tabular presentation of the law of supply. Price Quantity supplied

5 An individual supply schedule is defined as a table which shows various quantities of a commodity that an individual producer or a firm would offer for sale at different prices during a given period. Market Supply schedule-a market supply schedule is defined as a table which shows various quantities of a commodity that all firms are willing to supply at each market price during a specified time period, assuming that factors other than the price of the goods are given A supply curve is a graphical depiction of the law of supply. Individual Supply curve: It is defined as the curve that shows various quantities of a commodity which an individual producer is willing to supply at different prices during a given period of time, assuming no change in all other factors affecting supply. The quantity that all the producers are willing to produce and offer for sale at a particular price during a specified period is known as market supply or industry s supply. Market supply curve: 5

6 It is defined as the curve that shows various quantities of a commodity which all the producer are willing to produce and supply at different prices during a given period of time, assuming no change in all other factors affecting supply Derivation of market supply curve from individual supply curve Market supply curve can be graphically drawn as the horizontal summation of individual supply curve. A market supply curve is sometimes called as industry s supply curve. EXCEPTIONAL SUPPLY CURVE: A. Vertical supply curve. Supply for some commodities cannot be increased or decreased at all. Ex. Rare goods, classical paintings, old coins etc. Whereas, in some other cases supply may be fixed in the short run, and it be increased in the long run only. Ex. Agricultural product. 6

7 In such cases the supply curve will be vertical line parallel to Y axis. B. Backward bending supply curve. In certain cases a part of the supply curve may have a backward slope. This would mean that a smaller quantity would be offered at a higher price than at a lower price. This type of backward sloping supply curve might occur in case of labour supply. Workers may be willing to work for shorter hours if wages are higher so as to enjoy more leisure. Change in quantity supplied/movement along the same supply curve( change in its own price)- when the quantity supplied of a commodity changes(rises or falls) as a result of changes in its own price, while other determinants of supply remain constant, it is known as change in quantity supplied Extension in supply When the quantity supplied of a commodity rises due to rise in its price, other things remaining the same. It is called rise in quantity supplied or extension of supply. Contraction in supply When the quantity supplied of a commodity decreases due to fall in its price, other things remaining the same. It is called fall in quantity supplied or contraction of demand. Change in supply/shifts in supply( due to change in other factors) 7

8 When the amount supplied of the commodity rises or falls because of change in factors other than the own price of the commodity, it is called change in Supply. Increase in supply It refers to a situation when the producers are willing to supply a larger amount of a commodity at the same price or same quantity at a lower price. Decreases in demand. - It refers to a situation when the producers are willing to supply a smaller amount of a commodity at the same price or same quantity at a higher price. Extension of supply Increase in supply Other things being equal, when price increases supply of that commodity also increases. When at the same price, more is supplied due to change in other factors. Price(Rs) Qt supplied (kgs) Price(Rs) Qt supplied (kgs) Upward movement along the same supply curve. It occurs due to rise in price of a commodity Supply curve shifts downward to the right. i. Improvement in technology. ii. Fall in input prices iii. Fall in prices of other goods iv. Increase in the number of firms v. Expected fall in prices of goods in future. vi. Government raising subsidy and lowers taxes on production 8

9 Contraction in supply Other things being equal, when price decreases supply of that commodity also decreases Decrease in supply When at the same price, less is supplied due to change in other factors. Price(Rs) Qt supplied (kgs) Price(Rs) Qt supplied (kgs) Downward movement along the same supply curve. It occurs due to fall in price of a commodity. Supply curve shifts upwards to the left. i. Use of less efficient production techniques. ii. Rise in input prices iii. Rise in prices of other goods iv. Decrease in the number of firms v. Expected rise in prices of goods in future. vi. Government lowering subsidy and raising taxes on production Time period and Supply a. Market period Supply/Instant period Supply- It refers to the current supply of a commodity. It is very short period in which the supply is fixed. Thus in the market period firms cannot adjust their output to any change in price. As a result, the supply curve of such firms remains vertical. (S1) b. Short period Supply- Short-run period is the period in which supply can be adjusted to some extent. Supply may be changed by changing the variable factors like raw materials, labour etc. i.e., using them intensively by running the existing plant for longer hours like two-shifts instead of one. Short- period is not long enough for the firms to set up new plants or new machines (fixed factors) (S2) c. Long period supply/normal period supply: It is the period during which the firms can build new pants or close down the old plants. Moreover, the new firms can enter the industry by setting up new plants. Thus, it is possible to bring about a large change in quantity supplied.(s3) 9

10 S1 S2 Price S3 Quantity supplied PRICE ELASTICITY OF SUPPLY. Price elasticity of supply measures the degree of responsiveness of the quantity supplied of a commodity to a change in its price. Proportionate change in quantity supplied Es= Proportionate change in Price Degrees of Elasticity of Supply Ans. The five different types/magnitudes are 1. Perfectly Elastic supply : It represents a case in which the quantity supplied is responded by an infinite amount to a very small change in price. This supply curve runs parallel to X axis. This is an extreme case of supply curve, rarely exists in actual life. The supply curve is a horizontal line parallel to the X axis Es= 10

11 2. Perfectly Inelastic Supply : When there is no change in supply response, no matter how large a price change takes place Ex. There is only one Mona Lisa painting. A higher price cannot bring even one more Mona Lisa Es=0 3. Relatively Elastic Supply: Supply is said to be elastic when the percentage change in the quantity supplied is greater than the percentage change in its price. Es > 1 4. Unit elastic supply Unitary elasticity of supply occurs when the percentage change in the quantity supplied is exactly equal to the percentage change in price. Any straight line supply curve drawn through the origin has an elasticity of unitary over its whole length, no matter what its slope is. Es=1 5. Relatively inelastic supply Supply is said to be elastic when the percentage change in the quantity supplied is less than the percentage change in its price. Any straight line supply curve that cuts the X-axis has inelastic supply all through. Es <1 11

12 MEASUREMENT OF ELASTICITY OF SUPPLY. a. Percentage method. The ratio of percentage change in quantity supplied of a commodity to a given proportionate change in its price es=percentage Change in Quantity Supplied Percentage Change in Price In terms of symbols, we can write Where es stands for elasticity of supply Q =stands for initial quantity Q=Stands for change in quantity supplied P stands for initial price, P= Stands for change in price b. Geometric or point method. Geometric method is used to measure the elasticity of supply at a point on the supply curve. That is why it is also known as the point method of measuring elasticity of supply. Suppose we want to measure price elasticity of suppy at point K on the supply curve SS in Panel (i). Point K indicates that at OP price the quantity supplied is OB. Extend supply curve SS downward so that it meets X-axis at A. The elasticity of supply at point K is measuredby the formula AB /OB It is ratio of horizontal segment AB divided by quantity supplied OB In the given diagram AB is smaller than OB, therefore the supply elasticity AB is less than unity. OB 12

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