Relationship with price

The supply curve, produced below, shows the supply of a good by firms at given price levels over a period of time. As noted in the previous article, we are making a number of assumptions when modelling this - including that, apart from price, all other factors remain equal unless otherwise stated (the ceteris paribus assumption).

The relationship between price and quantity supplied is direct; as prices go up, quantity supplied goes up. This is shown by the upward sloping nature of the supply curve below.

There are two main reasons that supply is upward sloping:

1. ‍Higher prices mean a good is more profitable - firms may be encouraged to produce more of it rather than less profitable goods;‍
2. As firms produce beyond a certain level, goods may cost more per unit to produce - producers may therefore require a higher price incentive. For example, assuming a firm has a fixed number of workers, it may have to pay them more per hour for overtime to produce extra goods; the marginal costs (cost per extra unit) of producing those goods goes up, and producers may require a higher price to produce at those levels.

Other determinants of supply

The quantity of a good supplied at given prices is determined by a number of (non-exhaustive) factors listed below. Each of these will determine the shape of the supply curve, and where it sits on the Price and Quantity axes:

1. ‍Availability and costs of factors of production - there may be a number of inputs for the supply of a good, such as labour, raw materials, premises, machinery, energy etc. The availability and cost of these factors may impact how much of a good can be supplied at a particular price. The more available and lower the costs of inputs, the more a producer will be able to supply a good at a particular price. The inverse is also true. Reasons why the availability or cost of these factors might change include (non-exhaustively) global demand for these inputs, government policy, shortages due to shocks in the economy etc;‍
2. Profitability of alternative products - as the profitability of alternative products goes up, producers are more likely to switch to producing those, therefore causing a reduction in supply for the product in question;‍
3. Profitability of goods in joint supply - sometimes, when one good is produced another is produced at the same time e.g. when you refine crude oil to produce petrol, diesel is produced at the same time. If the supply of good A goes up, the production of goods in joint supply will also increase;‍
4. Acts of God and random shocks - weather issues, disease, wars etc may affect the supply of goods e.g. disease affecting a farm's output, a war stopping the supply of oil thereby decreasing supply of fossil fuels but (perhaps) increasing the supply of renewable electricity;‍
5. Expectations of future price changes - if a price is expected to rise, producers may reduce the amount of goods they sell and stockpile it (if the good is non-perishable).

As noted above, when we look at a supply curve, we assume that all the determinants of supply are constant at given price levels. This is the ceteris paribus assumption.

However, if these determinants of supply change, this would result in a movement of the supply curve.

If the change results in supply increasing, the supply curve will shift outwards and producers will supply more at a given price; movement from S1 to S2 below. For example, if the availability of oil increases (i.e. oil cost decreases), this will result in an increase in the supply of petrol, causing the supply curve to move outwards.

If the change results in supply decreasing, the supply curve will shift inwards, and producers will supply less at a given price; movement from S1 to S3 below. For example, if overall labour costs increase, this will result in a decrease in the supply of a good or service, causing the supply curve to move inwards.

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