Supply and Equilibrium
Dr. Amy McCormick Diduch
Supply is the relationship between the possible prices of a product and the quantity that a business (or individual) is willing to offer for sale.
Quantity supplied is the quantity of the product that would be offered for sale at a particular price. In general, the quantity that a firm wants to supply increases as price increases. This relationship is known as the law of supply.
Worked example
This works just like the calculation for market demand: add up the quantity that each individual business wants to supply at each possible price. Suppose we’re calculating market supply for the coffee mug industry in which there are currently three producers of mugs:
Dr. Amy McCormick Diduch
Supply is the relationship between the possible prices of a product and the quantity that a business (or individual) is willing to offer for sale.
Quantity supplied is the quantity of the product that would be offered for sale at a particular price. In general, the quantity that a firm wants to supply increases as price increases. This relationship is known as the law of supply.
Worked example
- From individual firm supply to a market supply schedule.
This works just like the calculation for market demand: add up the quantity that each individual business wants to supply at each possible price. Suppose we’re calculating market supply for the coffee mug industry in which there are currently three producers of mugs:
2. From a market supply schedule to a supply curve:
The supply curve illustrates the positive relationship between the price of a product and the quantity that firms want to supply. (The higher the price, the more inducement a firm has to produce the product)!
Note that you can read from this supply curve the quantity supplied at any price. For example, at a price of $3, firms will supply 4000 mugs. At a price of $5, firms will supply 8000 mugs.
The supply curve illustrates the positive relationship between the price of a product and the quantity that firms want to supply. (The higher the price, the more inducement a firm has to produce the product)!
Note that you can read from this supply curve the quantity supplied at any price. For example, at a price of $3, firms will supply 4000 mugs. At a price of $5, firms will supply 8000 mugs.
3. Determinants of supply: illustrating a change in supply
The market supply curve illustrated above is based on an assumption of “ceteris paribus,” or “all other things held constant.” It freezes (for the moment) the level of technology used by firms, their costs of production, their other production options, and the number of competitors. However, supply conditions are not constant! We need to be able to predict when and why supply will change.
In general, the supply relationship for a product will shift if any of the following factors changes:
The market supply curve illustrated above is based on an assumption of “ceteris paribus,” or “all other things held constant.” It freezes (for the moment) the level of technology used by firms, their costs of production, their other production options, and the number of competitors. However, supply conditions are not constant! We need to be able to predict when and why supply will change.
In general, the supply relationship for a product will shift if any of the following factors changes:
- Input costs
- Inputs include raw materials, labor, electricity, and equipment. When a significant input becomes more costly, firms reduce their supply of output.
- Technology
- By adopting a new technology, a firm can produce more output with the same (or fewer) inputs. This allows the firm to increase its supply of output.
- Prices of related outputs
- Firms often produce more than one product. If the price of a different output is increasing, a firm will shift its production towards that product and away from products whose prices are not increasing.
- Taxes or subsidies
- Placing a tax on the supplier of a product will reduce the amount the firm supplies.
- Providing a subsidy for production of a good increases the supply.
- The number of sellers producing the good
- Weather conditions affect supply in many markets
What happens to the supply of coffee mugs if the technology for producing them improves? We expect that quantity supplied at any price will increase. This is shown in both the table and the graph (which shows the supply curve shifting to the right).
Important details for this graph:
As we saw with demand curves, you don’t need the entire numerical schedule of supply to show the relationship between price and quantity supplied or how that relationship changes when a determinant of supply changes. You already know that a supply curve is an upward sloping line. You can sketch a “representative” line that illustrates this positive relationship between price and quantity. (Note that it is labeled with an “S” to indicate supply):
- The new supply curve is labelled “S2” and an arrow shows the direction of the shift.
- After the increase in supply, firms now offer for sale more coffee mugs at any price. For example, at a price of $5, this graph shows that firms previously offered 8000 mugs for sale but now, after the technological change, they offer 9000 mugs for sale.
As we saw with demand curves, you don’t need the entire numerical schedule of supply to show the relationship between price and quantity supplied or how that relationship changes when a determinant of supply changes. You already know that a supply curve is an upward sloping line. You can sketch a “representative” line that illustrates this positive relationship between price and quantity. (Note that it is labeled with an “S” to indicate supply):
Suppose there is an increase in the wages that are paid to workers in the coffee mug factories. This increased input price leads to a decrease in the quantity of mugs supplied at any price. The supply curve shifts to the left:
Suppose there is an increase in the number of coffee mug manufacturers. The supply curve will shift to the right:
Practice problems with supply curves can be found at the end of this tutorial. Our next step: the interaction of supply and demand to determine market prices and quantity.
Equilibrium
Market equilibrium occurs when the quantity supplied of a good exactly equals the quantity demanded. There will be a unique price at which this occurs. Thus, searching for market equilibrium means we are searching for the unique price at which quantity supplied equals quantity demanded.
To work with equilibrium, you need to be able to do the following:
Worked example:
Suppose you have the following information about the quantities of Principles of Economics textbooks supplied and demanded at various possible prices:
Equilibrium
Market equilibrium occurs when the quantity supplied of a good exactly equals the quantity demanded. There will be a unique price at which this occurs. Thus, searching for market equilibrium means we are searching for the unique price at which quantity supplied equals quantity demanded.
To work with equilibrium, you need to be able to do the following:
- Identify the price at which quantity supplied equals quantity demanded.
- Identify the amount of excess demand (shortage) or excess supply (surplus) at non-equilibrium prices.
Worked example:
Suppose you have the following information about the quantities of Principles of Economics textbooks supplied and demanded at various possible prices:
- Find equilibrium price and quantity
When the current price is not at equilibrium, quantity supplied will not equal quantity demanded.
If the current price is below the market equilibrium, quantity demanded will exceed quantity supplied, a situation known as excess demand. If the current price is above the market equilibrium, quantity supplied will exceed quantity demanded, a situation known as excess supply.
- Find excess demand and excess supply at various prices.
At a price of $45, quantity demanded equals 2500 and quantity supplied equals 600. There is an excess demand of 1900 textbooks (2500-600).
At a price of $65, there is an excess demand of 800 textbooks (1600-800)
There will be “upward pressure” on price in the event of excess demand. There are people who are willing to pay more than the current price and will make higher offers. Prices will begin to rise, reducing the amount of excess demand.
At a price of $125, quantity demanded equals 100 and quantity supplied equals 1400. There is an excess supply of 1300 textbooks (1400-100).
At a price of $105, there is an excess supply of 800 textbooks (1200-400).
There will be “downward pressure” on price in the event of excess supply. Sellers find they have too many books and will start cutting prices. As prices fall, the amount of excess supply will get smaller.
- Plot the supply curve and demand curve, show equilibrium price and quantity
The equilibrium price and quantity are found by locating the point at which the supply and demand curves intersect. This occurs where P=$85 and Q=1000.
Note that you can sketch a general diagram of a market in equilibrium without reference to specific prices or quantities. The market diagram shows the downward-sloping demand curve, the upward-sloping supply curve, and the equilibrium price and quantity (where quantity supplied equals quantity demanded), market P* and Q*.
Note that you can sketch a general diagram of a market in equilibrium without reference to specific prices or quantities. The market diagram shows the downward-sloping demand curve, the upward-sloping supply curve, and the equilibrium price and quantity (where quantity supplied equals quantity demanded), market P* and Q*.
Try the practice problems on supply and equilibrium (below, with answers) before moving on to work with comparative statics.
practice_problems_on_supply_and_equilibrium.pdf |
Prefer to see these concepts demonstrated step-by-step? The videos below cover the same material.