SUPPLY THEORY

Supply is the amount of a good or service that a firm is willing and able to offer for sale at a given price per period of time.

Market supply refers to the quantity of a good that all firms are willing to make available for sale at different prices in a given market during a given time.

TYPES OF SUPPLY

1.     Complementary (Joint) supply.

Joint supply refers to the supply of two or more commodities from the same process of production/ same source/ same resources such that an increase in the supply of one commodity leads to increase in the supply of the other.

Examples of joint supply include;

·        Supply of meat and skin from slaughtered animals/ beef and hides from slaughtered animals

·        Supply of petrol, diesel and paraffin from crude oil (through factional distillation)

·        Supply of mutton and wool

·        Supply of maize flour and maize bran

2.     Competitive supply

This refers to the supply of two or more commodities that use the same resources for their production such that an increase in the supply of one product leads to decline in the supply/ production of the other.

Examples of competitive supply include;

·        Supply of eggs and meat from chicken

·        Supply of milk and meat from cows

·        Crop and animal production from a piece of land.

·        Supply of jerry cans and basins from plastics.

THE LAW OF SUPPLY

The law of supply states that the higher the price, the higher the quantity supplied and the lower the price, the lower the quantity supplied ceteris paribus.

THE SUPPLY SCHEDULE

This is a table showing the number of units of a commodity sellers are willing to offer at alternative prices during a given period of time all other things being equal.

ILLUSTRATION

From the table above, it can be seen that as the price increases, quantity supplied also increases.

THE SUPPLY CURVE

The supply curve is the graphical representation of the supply schedule.

The supply curve is a locus of points showing the quantities supplied of a commodity at various prices in a given period of time.

From the above table, we derive the supply curve by plotting price against quantity supplied as shown below.

A normal supply curve is upward sloping from left to right, that is it has a positive slope meaning that there is a direct relationship between price and quantity supplied. (As price increases, quantity supplied increases and vice versa).

ABNORMAL/ REGRESSIVE/ EXCEPTIONAL SUPPLY CURVES

These are curves which do not obey the law of supply which states that the higher the price, the higher quantity supplied and the lower the price, the lower the quantity supplied ceteris paribus.

The following are the factors that violet the law of supply.

1.     Supply of labour.

The supply curve for labour is as shown below.

From the curve, when the wage increases from OW₁to OW₂, labour supply increases from Oh₁ to Oh₂. Further increase in wages from OW₂to OW₃leads to a reduction in labour supply from Oh₂to Oh_3. This is due to the following factors;

     Presence of target workers

     Preference of leisure to work

     Existence of a progressive tax system/ increased rate of taxation

     Cultural and political factors which influence reduction in labour supply (Discrimination in the employment sector)

     Declining working conditions

     Effect of old age

     Decline in the real wage of workers due to high levels of inflation

2.     Supply rigidities.

At times the producers may not supply more even if the price of the commodity increases due to supply rigidities such as drought, political instabilities, etc. this causes a fixed supply.

From the diagram above, same quantity is supplied at different prices until when the supply rigidities are removed.

3.     Supply of land.

The supply of land cannot be increased. It is a fixed resource.

From the diagram, supply remains constant in spite of price changes.

4.     Expectation of future price changes (speculation)

If producers expect the prices to increase in future, they put less on the market even if prices are slightly increasing. This is because they expect to get a lot of profits in future by selling at high prices. On the other hand, if the prices are expected to fall in the future, producers supply more even if the prices are slightly decreasing. This causes an abnormal supply curve.

5.     Supply of perishable goods

For perishable goods, more is supplied immediately after harvest whether prices are high or low hence violating the law of supply.

6.     Exhaustion of raw materials.

In this case, even if there is an increase in price, quantity supplied may not increase because the producers have no requirements to produce final goods.

7.     Existence of commodities supplied by the government.

The government may decide to supply certain essential commodities to consumers at lower prices to improve peoples’ standards of living. This creates a regressive supply curve.

FACTORS THAT INFLUENCE SUPPLY

1.     Price of the commodity.

A high price for the commodity in question leads to high supply because it attracts many producers to produce and maximise profits. However, a low price leads to low amount supplied because it discourages some producers from engaging in production.

2.     The price of a jointly supplied commodity.

A high price for the jointly supplied product leads to high supply of the commodity in question because it becomes profitable to produce both goods while low price for a jointly supplied product leads to low supply of the commodity in question because it becomes unprofitable to supply both goods.

3.     The price of a competitively supplied product.

A high price for competitively supplied good leads to low supply of the commodity in question because producers divert resources to production of other goods while a low price for competitively supplied good leads to high supply of the commodity in question because production of the commodity becomes profitable.

4.     The cost of production.

At a high cost, the supply is low because the producer is only able to mobilise few factors of production or few raw materials. However at a low cost of production, supply is high because the producer is able to acquire many factors of production.

5.     The level of demand for the commodity/ market size.

High demand for a product leads to high supply because it encourages production and therefore leads to high output produced. However, low demand leads to low supply of the commodity because it discourages production and therefore leads to low output produced.

6.     Level of technology used in the production of the commodity.

The use of efficient and modern technology leads to high supply since such technology improves the speed at which goods and services are produced. However, poor methods of production lead to low supply since the production process is made slow.

7.     Length of gestation period.

The longer the gestation period, the longer it takes the producer to make a good hence leading to low supply. However, a short gestation period creates high supply because the producer is able to produce a lot of output in a limited period of time.

8.     The objective of the firm.

A producer whose main objective is to maximize sales produces high output so as to lower the average cost leading to high supply. However, a producer whose main objective is to maximise profits limits output in order to charge a high price hence leading to low supply.

9.     The level of supply of factor inputs/ availability of factors of production.

Availability of factors of production encourages production leading to high output and high supply. However, scarcity of factors of production discourages production leading to low output and low supply.

10. Political climate in the area.

Political stability encourages production of goods and services due to assured security of life and property hence leading to high supply while political instability scares away producers due to fear of loss of their lives and property hence resulting into low supply.

11. Natural factors/ climatic conditions.

This is especially with respect to agricultural products. Favourable climatic conditions like reliable rainfall lead to high agricultural production leading to high supply. However, unfavourable climatic conditions like long droughts lead to low agricultural production leading to low supply.

12. Level of development of infrastructure.

Availability of adequate and well developed means of transport and communication facilities makes it possible to move commodities from one place to another hence high supply. However, under developed infrastructures lead to low supply because they make transportation of raw materials to production centres and finished goods to market centres difficult.

13. Degree of freedom of entry of firms into the industry/ Number of producers

Free entry of new firms into the industry leads to high supply because it is possible for many firms to join in the production of a good. However, restricted entry of new firms into the industry leads to low supply because there are few firms that produce the product.

14. Government policy of taxation and subsidisation.

A favourable government policy of giving producers subsidies leads to low production costs hence encouraging production leading to high supply while unfavourable government policy of imposing high indirect taxes results into high production costs thereby discouraging production hence leading to low supply.

15. Working conditions.

Favourable working conditions encourage hard work among the workers which leads to high output produced and high supply. However, poor working conditions make the workers’ morale to be low hence limiting output levels thus leading to low supply.

16. Future price expectations.

If the producers expect the prices to increase in future, current supply is low because they store the goods so as to sell them in the future at high prices and make a lot of profits. However, if the producers expect a fall in prices, current supply is high because they want dispose of the commodities before prices fall to avoid making losses.

CHANGE IN SUPPLY AND CHANGE IN QUANTITY SUPPLIED

CHANGE IN SUPPLY

A change in supply is where more or less units of a commodity are supplied due to changes in other factors that determine supply keeping price of the commodity constant.

It is illustrated by the total shift of the supply curve either inwards to the left of outwards to the right at a constant price.

Illustration

From the diagram above, SoSo is the original supply curve.

S₁S₁shows a shift of the supply curve inwards from SoSo representing a decrease in supply

S₂S₂shows a shift of the supply curve outwards from SoSo representing an increase in supply.

FACTORS THAT CAUSE A CHANGE IN SUPPLY OF A COMMODITY

1.     Change in the cost of production.

2.     Change in the number of firms in the industry.

3.     Change in the level of demand for the commodity/ market size.

4.     Change in the level of technology used in the production of the commodity.

5.     Change in the objective of the firm.

6.     Change in the gestation period of the commodity

7.     Change in the level of supply of factor inputs/ availability of factors of production.

8.     Change in the price of a jointly supplied commodity.

9.     Change in the price of a competitively supplied product.

10. Change in the political climate in the area.

11. Change in natural factors/ climatic conditions.

12. Change in the level of development of infrastructures.

13. Change in the degree of freedom of entry of firms into the industry.

14. Change in government policy of taxation and subsidization.

15. Change in working conditions.

16. Expectation of future price changes.

INCREASE IN SUPPLY

This is an economic situation where more units of a commodity are supplied at a constant price due to other factors affecting supply of that particular commodity becoming (more) favourable.

Illustration

CAUSES OF AN INCREASE IN SUPPLY

1.     Decrease in the cost of production.

2.     Increase in the number of firms in the industry.

3.     Increase in the level of demand for the commodity/ market size.

4.     Improvement in technology used in the production of the commodity/ shift from inferior/ poor/ labour intensive technology to capital intensive/ superior technology.

5.     Change in the objective of the firm from profit maximization to sales maximization

6.     Reduction in the gestation period of the commodity

7.     Increase in the level of supply of factor inputs/ availability of factors of production.

8.     A fall in the price of a jointly supplied commodity.

9.     Increase in the price of a competitively supplied product.

10. Political climate in the area becoming favourable

11. Natural factors/ climatic conditions becoming favourable

12. An improvement in infrastructures.

13. Increased freedom of entry of firms into the industry.

14. Government policy on production of a commodity becoming favourable.

15. Working conditions becoming favourable.

16. Expectation of future price fall

DECREASE IN SUPPLY

This is an economic situation where less units of a commodity are supplied at a constant price due to other factors affecting supply of that particular commodity becoming unfavourable.

ASSIGNMENT

Account for a decrease in commodity supply in an economy                             (20 marks)

CHANGE IN QUANITY SUPPLIED

This is an economic situation where more or less units of a commodity are supplied due to changes in the price of the commodity keeping other factors determining supply constant.

it is illustrated by movement along the supply curve either upward due to price increase or downward due to price fall.

A fall in the price from OPo to OP₁leads to a decrease in the quantity supplied from OQo to OQ₁as illustrated by the movement along the supply curve from point a to b and this is known as a contraction in supply.

A rise in the price from OPo to OP₂leads to an increase in quantity supplied from OQo to OQ₂as illustrated by the movement along the supply curve from point a to c and this is known as an expansion in supply.

INCREASE IN QUANTITY SUPPLIED

This is an economic situation where more units of a commodity are supplied due to an increase in its price when other factors that affect supply of that particular commodity have not changed.

Illustration

DECREASE IN QUANTITY SUPPLIED

This is an economic situation where less units of a commodity are supplied due to a decrease in its price when other factors that affect supply of that particular commodity have not changed.

Illustration

RELATIONSHIP BETWEEEN DEMAND AND SUPPLY

Demand and supply also looked at separately in the previous chapters do not operate in isolation. Forces of demand and supply are constantly operating in every market and in so doing affecting the level of prices. As forces of demand and supply operate, there comes a price at which the quantity that is demanded is equal to the quantity that is supplied. This gives rise to the equilibrium concept

The term equilibrium here is used to imply a state of balance where what is put on the market by the sellers is all bought off by the buyers without creating any shortages or surpluses.

ILLUSTRATION OF THE EQUILIBRIUM CONCEPT

(THE MARKET EQUILIBRIUM)

Where  E = equilibrium point

Pe = Equilibrium price

Qe = Equilibrium quantity

An increase in price to OP2 leads to a fall in quantity demanded to OQ1 and an increase in Quantity supplied to OQ2. This creates a surplus of Q1Q2 on the market. As a result, producers are forced to reduce the price to OPe so as to dispose of the surplus.

A fall in price to OP1 leads to an increase in quantity demanded to OQ2 and a fall in quantity supplied to OQ1. This creates a shortage of Q1Q2 on the market. As a result, buyers are forced to offer a higher price of OPe so as to encourage producers to supply more and remove the shortage.

In case such a situation happens in the market, then OPe would be referred to as the normal price.

NOTE

1.     Stable equilibrium is a situation whereby divergence from the equilibrium point can be restored through the interaction of market forces of demand and supply.

2.     Unstable equilibrium is a situation whereby divergence form the equilibrium point can never be restored through the interaction of market forces of demand and supply.