VII. SUPPLY

Just as we did in our look at Demand, we begin our look at what producers are willing to produce, the supply side of the market, by defining quantity supplied. We then will take a look at the factors that affect the quantity supplied. After that, we will examine supply. D. Quantity supplied

Now our discussion of quantity supplied and supply will be simple, as it follows path parallel to that of quantity demanded and demand. We begin by defining quantity supplied as the amount that the sellers of a good plan to offer for sell in a particular time period. Again, this is a flow variable. Quantity supplied is affected by several factors, which can be expressed using functional notation as

6) QS_a = F(P_a, P_i, P_cp, P_sp, TECH),

where:

QS_a is the quantity supplied of good "a;"

P_a is the price of good "a;"

P_i are the prices of inputs into a's production process;

P_cp are the prices of goods that are complements in production, that is goods that are produced with good "a," in other words, the prices of by­products of "a;"

P_sp are prices of goods that are substitutes in production with "a," that is, goods that can be made with the inputs owned by the firm, other things that the firm can make with its assets.

TECH is the technology, or the knowledge that we have about the ways we can in change inputs into the output of the firm.

FIG IV

Just as the price paid for a good represents a punishment for using that good, the price received by the producers represents a reward for producing that good. Producers respond according to elementary psychology, increases in rewards increases the amount of the rewarded behavior, in this case, the rewarded behavior is output. The higher the price that consumers are willing to pay for a good, the more of that good producers are willing to produce and offer for sell. Holding other factors constant, price of the good and the quantity supplied of that good are positively or directly related.

The price of inputs into the production process, however, represents a cost of production, or a punishment for producing, and so, the higher the price of any input, the less of that good will be offered for sell on the market. Think of it this way, the real reward is profit, if the price of the good stays the same, but the prices of the things that must be used in order to produce the good increase, then the margin of profit will decrease and the reward of producing the good then falls, reducing the enticement to produce the good, and so less of the good is offered for sell. Price of inputs and quantity supplied are inversely or negatively related, holding other factors constant, particularly price of the good and technology.

Complements in production, better known as by­products, give the producer something else that can be sold, in addition to the initial good. If the price of a by­product increases, then there will be more dollars in revenues that can be made with the same amount of production, at the same costs, again increasing profits and raising rewards and increasing the enticement to produce. The price of a by­product and quantity supplied are directly or positively related, holding other factors constant.

If there is an increase in the price of a good that is an alternative product that the firm can produce, a substitute in production, it is clear that the opportunity cost of producing what the firm has been producing will increase. And, just as with higher production costs from higher input prices, higher opportunity costs of production because of higher priced alternative products leads to less output of the original good, as the firm will switch its resources from making what it had been making to production of the good which has the increased price­­the opportunity cost of what it had been making increases and so the firm makes less of what it used to make. Prices of substitutes in production and quantity supplied are inversely or negatively related, holding other factors constant.

Technology is the knowledge of methods of changing inputs into outputs. An improvement in technology is said to take place when we discover new methods of producing some good at a lower cost than was previously possible, new and helpful knowledge. Technology that reduces the production costs of a given good will make producing that good more profitable, and will lead to an increase in the quantity supplied of that good. That is, technology and quantity supplied are positively or directly related, holding other factors constant. The direction of the impacts of these various factors on quantity supplied can be summarized using the "+" and "­" signs we used in equation 2) for quantity supplied:

		+	-	+	-	+
7) QSa=	f(	Pa,	Pi,	Pcp,	Psp,	TECH)

E. Supply

Supply can now be defined as the relationship between price of a good and the quantity supplied of that good, holding other factors constant. From our discussion above and from equation 7), we can see that this is relationship is a positive or direct relationship. Changes in price of a good "a" do not affect supply of "a", the relationship, but do affect the quantity supplied of "a". Remember, "up" is to the right and "down" is to the left. All of the discussion above about changes in quantity demanded versus demand apply here with quantity supplied and supply.

F. Supply from a group

Summing the supplies of individual producers to get the supply of the group is done the same way as summing individual demands to get a group demand: add the quantities produced by each supplier at the same price and you get the quantity supplied at that price.