Market Equilibrium

UNIT 4
Structure

4.1 Introduction
Objectives
4.2 Meaning of Supply and law of Supply
4.3 Exceptions to the Law of Supply
4.4 Changes or Shifts in Supply
4.5 Determinants of supply
4.6 Supply Function
4.7 Elasticity of supply
4.8 Factors determining elasticity of supply
4.9 Practical importance

Supply Analysis

4.1 Introduction
The supply analysis is related to the behavior of producers or manufactures.
Supply is made by producers. Each firm has to make a careful calculation
about its total supply in the market. Supply analysis deals with mainly the
different factors which bring about changes in the supply of a product in the
market. Supply of a product basically depends on cost of production and the
management decision. Hence it covers such problems like whereto sell, when
to sell, to whom to sell, and how much to sell and at what price to sell etc.

Demand and supply are two important concepts in economics, the essential to
a manufacturing firm for taking numerous decisions almost everyday. These
two concepts link the market behavior of consumers, producers and sellers
and with that of price. The behavior of supply is just opposite of demand. Both
demand supply are influenced by the price.

Learning Objectives:

After studying this unit, you should be able to understand the following
1. The law of supply and its exceptions
2. The factors that affect supply
3. How demand and supply curves determine the market equilibrium
4. How changes in the price level establish equilibrium in the market
correcting the shortage and surplus conditions.
5. How changes in demand, supply remaining constant, influence
equilibrium price.
6. Similarly how changes in supply, demand remaining constant, influence
equilibrium price.
7. How changes in both demand and supply effect equilibrium price.

4.2 Meaning of Supply and Law of Supply

Supply is one of the two forces that determine the price of a commodity in the
market. The study of supply, therefore, is important as the study of demand.
Supply means the amount offered for sale at a given price. According to
Thomas, "The supply of goods is the quantity offered for sale in a given
market at a given time at various prices. "According to Prof. Macconnel -
"supply may be defined as a schedule which shows the various amounts of a
product which a producer is willing to and able to produce and make available
for sale in the market at each specific price in a set of possible prices during
some given period." " To quote Meyers - "We may define supply as a
schedule of the amount of a good that would be offered for sale at all possible
prices at anyone instant of time, or during anyone period of time, for example,
a day, a week and so on, in which the condition of supply remain the same."
Thus supply of a product refers to various amounts which are offered
for sale at a particular price during a given period of time.

Supply is different from production and stock. Often we assume that the
volume of supply is equal to the volume of production. This, however, is not
necessary. Supply can be equal, more or less, than the current production
depending upon the nature of the commodity, price and the requirements of
the procedures

Supply is also different from stock. Stock is the total volume of a

commodity which can be brought into the market for sale at a short
notice and supply means the quantity which is actually brought in the
market. For perishable commodities, like fish and fruits, supply and stock
are the same because they cannot be stored. The commodities which are
not perishable can be held back, if prices are not favorable and released in
large quantities when prices are favorable. In short, stock is potential supply.

Supply Schedule

Supply schedule is a tabular representation of different quantities of a

commodity supplied at varying prices. It represents the functional
relationship between quantity supplied and price. It is strictly prepared with
reference to the price of a given commodity.

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The following imaginary supply schedule shows that as price rises, supply
extends and as price falls, supply contracts. Supply schedule is never
absolute. It varies with different prices and at different times. For instance 0.75
paisa is the minimum price to be charged per unit because it equals cost of
production. No producer would like to charge cost price to customers. Hence,
supply is zero at this price. It is called reserve price.

Price in Rs Quantity Supplied in

Units
5-00 500
4-00 400
3-00 300
2-00 200
1-00 100
0-75 00

Market supply Schedule

The total quantity of commodity supplied at different prices in a market

by the whole body of sellers is called market supply schedule. It refers to
the aggregate behavior of the market rather than mere totaling of all individual
supply schedules.

Quantity Supplied in Units

Price in Rs. Total (A+B+C)
A B C
5.00 500 600 700 1800
4.00 400 500 600 1500
3,00 300 400 500 1200
2.00 200 300 400 900
1.00 100 - 200 300 600

The market supply schedule helps a firm to formulate its sales policy by
manipulating the prices. It helps the management to know how much sales
can be increased by raising the price without losing the demand for the
product.

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 Y

S
5

1
S

O X
100 200 300 400 500
Quantity Supplied
Supply Curve
The supply curve is a geometrical representation of the supply
schedule. The upward sloping curve clearly indicates that as price rises,
quantity supplied expands and vice-versa.

The Law of Supply

The law of supply is just the opposite of the law of demand. Normally, a
seller supplies more units of a commodity at a higher price and vice-versa.
Given the cost of production, profits are likely to be high at higher prices.
Higher the price, the greater is the inducement to the producers to produce
and sell more and appropriate more profits. Hence more quantity is supplied
at higher prices and less is supplied at lower prices. This relationship between
the price and the quantity supplied is popularly known as the law of supply. It
states that "Other things remaining constant, the quantity supplied
varies directly with the price i.e. when the price falls, supply will contract
and when price rises, supply will extend". According to S.E.Thomas, "a
rise in price tends to increase supply and a fall in price tends to reduce it."
There is a functional relationship between supply and price. Mathematically
S= F (P). The law of supply is based on a number of assumptions.

The other things which should remain constant for the law to operate are:
1. Number of firms, the scale of production and the speed of production.
2. Availability of other inputs.
3. Techniques of production.
4. Cost of production.
5. Market prices of other related goods.
6. Climate and weather conditions.

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Special features of law of supply
1. There is a direct relationship between price and supply l.e., higher the
prices higher will be the supply and vice-versa.
2. Price is an independent variable and supply is a dependent variable.
3. The applicability of the law is conditioned by the phrase "Other things
being constant". Thus the law is not universal in nature.
4. The supply curve normally rises from left to right.
5. It is only qualitative statement.

4.3 Exceptions of the Law of Supply

Generally supply expands with the rise in price and contracts with the fall in
price. But under certain exceptional circumstances, in spite of rise in price,
supply may not expand or at a lower rate more quantity may be sold. This will
happen under exceptional situations. In this case, the supply curve slopes
backward.
Y S

6
PRICE
5
S
O X
10 20 30
SUPPLY
In the diagram when price is Rs. 5.00, 10 units are sold and when price is
Rs.6.00, 30 units are sold. But, when price rises to Rs. 8.00 quantity supplied
falls from 30 units to 20 units.

The following are some of the exceptions to the law of supply.

1. If the seller is badly in need of money, he will sell more even at lower
prices.
2. If the seller wants to get rid of his products, then also he will sell more
at reduced rates.
3. When further heavy fall in price is anticipated the seller may become
panicky and sell more at a current lower price.
4. In case of auction, the auctioneer is not interested in maximizing profits

by selling more units at a higher price. Here, the price is determined by

the bidder while selling an item in an auction, the auctioneer may have

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 some other motives to sell the product. Thus, an auction sale is an
exception to the law of supply.
4.4 Changes or Shifts in Supply

When supply of a product changes only due to a change in the price of

that product alone, it is called as either expansion or contraction in
supply. Expansion in supply means, more quantity is supplied at a higher
price and contraction in supply means, less quantity is supplied at a lower
price.

This tendency can be represented through a single supply curve. In this

case, the seller will be moving either in the upward or downward direction
along with the same supply curve. It is clear from the following diagram.
Y
S

PRICE

S
O X
20 40
QUANTITY

In the diagram, we can notice that when price is Rs. 2.00, 20 units are sold
and when the price rises to Rs. 4.00, 40 units are sold (extension). On the
other hand, when price falls from Rs. 4.00 to Rs. 2.00 quantity supplied also
falls from 40 to 20 units.

Supply of a product may change due to changes in other factors. If supply

changes not because of changes in price, but because of changes in other
determinants, then it will be a case of either increase or decrease in supply .

Increase in Supply

It implies more supply at the same price or same quantity of supply at a

lower price. In this case, we have to draw a new supply curve. In the
diagram, Original price = Rs 6.00;

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Original supply = 10 units; Original supply Curve = SS

Y
S

S1

6 P P’

PRICE

4 P”
S
S1
O X
10 20
QUANTITY
Now the seller sells 20 units at the same price of Rs. 6. Hence, we get a P'. or
same quantity of 10 units are sold at a lower price of Rs. 4=00. Hence, we get
another new point P". If we join these two new points P’ & P” we get a new
supply curve S'S'. There is forward shift in the position of supply curve.
Forward shift indicates increase in supply.

Decrease in supply
It implies that less quantity is supplied at the same price or same
quantity is supplied at a higher price. In this case also, we have to draw a
new supply curve.

In the diagram,
Original price = Rs. 4
Original supply = 20 units
Original supply Curve = SS
Y

S1

6 P” S
PRICE
P’
4 P

X S1

7
 O S X
10 20
SUPPLY

When less quantity of 10 units are supplied at the same price of Rs.4.00, we
get new point P'. Similarly, when same quantity of 20 units are supplied at
a higher price of RS.6 -00, we get a new point P". If we join these new points
P’ & P” then we get a new supply curve S'S', which is located to the left of
the original supply curve. There is backward shift in the position of supply
curve backward shift in the curve indicates decrease in supply.

Managerial uses of the Law of supply

* Helps a producer to take decisions with respect to:-

1. What product he has to produce and sell.
i) What quantity he has to sell.
ii) At what price he has to sell.
iii) When he has to produce.
iv) Where he has to sell.
v) For whom he has to sell etc.
2. Helps him to maintain a balance between stock & supply.
3. Helps him in preparing the sales budget policy.
4. Helps in estimating the present and future expected revenue and profit
levels.
5. Helps to analyze the effects of taxes on total sales in the market.
6. Helps to analyze the impact of various govt. policies on the supply of a
product.
7. Helps in identifying the factors which affect supply of a product.

4.5 Determinants of Supply

Apart from price, many factors bring about changes in supply. Among them
the important factors are:

1. Natural factors: Favorable natural factors like good climatic

conditions, timely, adequate, well distributed rainfall results in higher
production and expansion in supply. On the other hand, adverse
factors like bad weather conditions, earthquakes, droughts, untimely,
ill-distributed, inadequate rainfall, pests etc., may cause decline in
production and contraction in supply.
2. Change in techniques of production: An improvement in techniques
of production and use of modern, highly sophisticated machines and
equipments will go a long way in raising the output and expansion in

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 supply. On the contrary, primitive techniques are responsible for lower
output and hence lower supply.
3. Cost of production: Given the market price of a product, if the cost of
production rises due to higher wages, interest and price of inputs,
supply decreases. If the cost of production falls, on account of lower
wages, interest and price of inputs, supply rises.
4. Prices of related goods: If prices of related goods fall, the seller of a
given commodity offer more units in the market even though, the price
of his product has not gone up. Opposite will be the case when the
price of related goods rises.
5. Government policy: When the government follows a positive policy, it
encourages production in the private sector. Consequently, supply
expands. For example granting of subsidies, development rebates, tax
concession, etc,. On the other hand, output and supply cripples when
the government adopts a negative policy. For example withdrawal of
all concessions and incentives, imposition of high taxes, introduction of
controls and quota system etc.
6. Monopoly power: Supply tends to be low, when the market is
controlled by monopolists, or a few sellers as in the case of oligopoly.
Generally supply would be more under competitive conditions.
7. Number of sellers or firms: Supply would be more when there are a
large number of sellers. Similarly production and supply tends to be
more when production is organized on large scale basis. If rate or
speed of production is high, supply expands. Opposite will be the case
when number of sellers is less, small scale production and low rate of
production.
8. Complementary goods: In case of joint demand, the production &
sale of one product may lead to production and sale of other product
also
9. Discovery of new source of inputs: Discovery of new sources of
inputs helps the producers to supply more at the same price & vice-
versa.
10. Improvements in transport and communication: This will facilitate
free and quick movements of goods and services from production
centers to marketing centers.
11. Future rise in prices: When sellers anticipate a further rise in price, in
that case current supply tends to fall. Opposite will be the case when,
The seller expect a fall in price.

Thus, many factors influence the supply of a product in the market. A firm
should have a thorough knowledge of all these factors because it helps in
preparing its production plan and sales strategy.

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4.6 Supply Function
The law of supply and supply schedule explains only the direct relationship
between price and supply. Mathematically S = f (P). Both analyses the impact
of change in price on quantity supplied. Supply of a product, apart from price
changes also depends upon many factors. When we analyze the influence of
these factors on supply, supply schedule will be converted into a supply
function.

Supply function is a comprehensive one as it analyses the causes for

changes in supply in a detailed manner. Mathematically a supply function can
be represented in the following manner.

Sx = f (Pf, T, Cp, Gp, N …… etc)

Where
Sx = supply of a given product x
Pf = price of factor input
T = Technology
Cp = cost of production
Gp = Government policy
N = Number of firms etc

Supply function is also described as shifts in supply.

4.7 Elasticity of Supply

It is a parallel concept to elasticity of demand. It refers to the sensitiveness

or responsiveness of supply to a given change in price. In short, it
measures the degree of adjustability of supply to a given chance in price of a
product.

The formula to calculate elasticity of supply is as follows:

ES = % change in supply 8% = 4
% change in Pr ice 2%

It implies that at the present level with every change in price one time, there
will be a change in supply four times directly. Usually elasticity of supply is
positive.

Types of elasticity of supply

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Just like elasticity of demand, elasticity of supply is also equal to infinity,
zero, greater than one, lower than one and equal to one.
1. Perfectly elastic supply.
Supply is said to be perfectly elastic when a slight change in price leads
to immeasurable changes in supply: Hence supply curve would be a
horizontal or parallel line to OX axis.
Y

Price ES = ∞
S S

X
Supply

2. Perfectly inelastic supply

When supply of a commodity remains constant and does not change
whatever may be the change in price, it is said to be absolutely or perfectly
inelastic supply. Here the supply curve tends to be a vertical straight line.
ES = 0 (zero).
Y S

Price ES = 0

O X
S
Supply

3. Relatively Elastic supply

If change in the supply is more than proportionate to the change in
price, elasticity of supply is greater than one. In that case, the supply
curve is flatter and is more inclined to x axis.
Y
S

Price

ES >1
S

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 O X
Supply

4. Relatively inelastic supply

If the change in supply is less than proportionate to a given change in
price, then, elasticity of supply is said to be less than one. Here the
supply curve is a steeply rising one.
Y
S

Price

ES <1
S

O X
Supply
5. Unitary elastic supply
If proportionate change in supply is exactly equal and proportionate to the
change in price, then elasticity of supply is equal to one.
Y
S

Price

ES =1
S

O X
Supply

4.8 Factors Determining Elasticity of Supply (Determinants)

1. Time Period
Time has a grater influence on elasticity of supply than on demand. Generally
supply tends to be inelastic in the short run because time available to
organize and adjust supply to demand is insufficient. Supply would be more
elastic in the long run.
2. Availability and mobility of factors of production
When factors of production are available in plenty and freely mobile from one
occupant to another, supply tends to be elastic and vice versa.
3. Technological Improvements

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Modern methods of production expands output and hence supply tends to be
elastic. Old methods reduce output and supply tends to be inelastic.
4. Cost of Production
If cost of production rises rapidly as output expands, then there will not be
much incentive to increase output as the extra benefit will be choked off by
the increase in cost. Hence supply tends to be inelastic and vice-versa.
5. Kinds and nature of markets
If the seller is selling his product in different markets, supply tends to be
elastic in any one of the market because, a fall in the price in one market will
induce him to sell in another market. Again, if he is producing several types of
goods and can switch over easily from one to another, then each of his
products will be elastic in supply.
6. Political conditions
Political conditions may disrupt production of a product. In that case, supply
tends to become inelastic.
7. Number of sellers
Supply tends to become more elastic if there are more sellers freely selling
their products and vice-versa.
8. Prices of related goods
A firm can charge a higher price for its products, if prices of other products are
higher and vice-versa.
9. Goals of the firm
If the seller is happy with small output, supply tends to be inelastic and vice-
versa.
Thus, several factors influence the elasticity of supply.

4.9 Practical Importance

1. The concept of elasticity of supply is of great importance to the finance
minister while formulating the taxation policy of the country. If the
supply is inelastic, the imposition of tax may not bring about any
change in the supply. If supply is elastic, reasonable taxes are to be
levied.
2. The price of a commodity depends upon the degree of elasticity of
demand and supply.
3. It is used in the theory of incidence of taxation. The money burden of
taxation is shared by the tax payers and the sellers in the ratio of
elasticity of supply and demand.

Thus, it has both theoretical as well as practical application in our study.

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