MODULE 4: Supply Basics

Learning Outcomes:

At the end of the course, the student is able to:

define the concepts of supply, supply schedule, supply curve and law of supply;
draw the supply curves given hypothetical cases;
identify the different factors affecting supply; and
differentiate change in supply from change in quantity supplied.

Teaching-Learning Activity:

In this module, you will get lectures on the definition of supply; determine the
factors of supply and law of supply. Compute for supply function and determine the
relationship of price and quantity supplied through problem sets and case analysis.

The Concept of SUPPLY

Supply refers to the various quantities of a good or service that producers are
willing to sell at a given price, ceteris paribus. Obviously, firms are motivated to produce
and sell more at higher prices, since the objective of the firm is to maximize profit.
Emphasizes the relationship between quantity sold of a commodity and its price.

The Law of Supply

States that the quantity sold of a good or service is positively or directly related to
its own price.

When the price increases, more of the good or service will be sold
When the price decreases, less of the good or service will be sold

Or when price increases quantity supplied increases; on the other hand when price
decreases quantity supplied also decreases.

3 Ways of presenting the supply relationship

The relationship between quantity supplied and prices may be presented in 3 ways:

Supply schedule –in tabular form.

The supply schedule shows various quantities of the good or service that is
offered to the market at various possible prices. A supply schedule may reflect an
individual schedule for one seller or producer of a good. The schedule depicts also the
relationship of price and quantity supplied which is a positive or direct relationship.

Example:
Price Quantity supplied
20 100
40 200
60 300
80 400
100 500

Supply curve – in graphical form

The supply curve is the graphical representation of the supply schedule.In
graphing the supply curve, price is measured at the vertical or y axis while quantity
supplied is measured in the horizontal or x axis. Each pair of price and quantity supplied
is plotted on a point and then the points are connected to come up with the supply
curve. The curve slopes upwards which implies that price and quantity supplied are
directly or positively related.
Price

Quantity supplied

Supply function – in equation form

This is the functional relationship of price and quantity supplied shown in an
equation form. Quantity supplied (Qs) is expressed as a mathematical function of price
(P). The supply function may thus be written as:
Qs = a + bp

Where: Qs= quantity supplied

a= the minimum quantity supplied when price is equal zero
b= the slope of the line
p= price

Factors affecting supply

There are other factors aside from price that affect the supply schedule. These are:

Resource prices
The prices of resources used in producing goods or providing services help
determine the costs of production incurred by firms. Assuming a given product price,
higher resource prices raise the cost of good or service. This squeezes the profits of firms
which discourages production and therefore decreases supply. On the hand , lower
resource prices would make producer to buy more of resources, thereby enabling the
firm to produce more. The resource prices are inversely related to supply.

Prices of related goods in production

The prices of alternative goods or services which a firm can produce or provide
given its production process may affect supply. An increase in the price of an
alternative good or service becomes more attractive to firm because this would mean
higher profits. Thus, firms are more willing to produce the product or service resulting to
more supply.

Technology
Technological advances which consist of changes that lower the amount of
resources needed to produce the same quantity and quality of the product or service,
increase supply.

Expectations
Changes in the expectations of sellers about the future price of the product will
affect the willingness of sellers to supply the product. If sellers expect the future price to
increase, they will hold on to their stock, thus, decreasing current supply and vice versa.
Number of sellers
The more sellers there are in a specific market, the greater the market supply,
ceteris paribus. As more sellers enters the industry, more goods and services are
produced resulting to an increase in supply.

Taxes and subsidies

Taxes are considered as costs by businesses, therefore higher taxes reduces
supply. Subsidies on the other hand are grants given to businesses, thus increasing
supply.

Changes in Supply versus Changes in Quantity Supplied

Change in quantity supplied is a movement along the same supply curve, due
solely to a change in price, i.e., all other factors held constant.

Change in supply is a shift in the entire supply curve (either to the left or to the
right) as a result of changes in other factors affecting supply. A shift to the right is an
increase in supply, and a shift to the left is a decrease in supply.

Change in Supply or Shift of the Supply curve

price

Quantity supplied

Change in Quantity Supplied

Price

p1

p2

Quantity supplied
Q2 Q Q1

Method to compute for Supply Function

Least Square Method

Na + ∑xb = ∑y
2
∑xa + ∑x b = ∑xy

Q(Na + ∑xb = ∑y)

Where:
N= total number of items
Q= ∑x ÷ N

1. Step 1: complete the variables needed in the 3 equations starting with representing
price= x and quantity demanded = y. Then formulate the table showing the needed
2
variables ∑x ;∑y ;∑ x ; ∑xy

Price(x) Quantity 2
xy
Supplied (y)
x
20 100 400 2,000
40 200 1,600 8,000
60 300 3,600 18,000
80 400 6,400 32,000
100 500 10,000 50,000
∑x= 300 ∑y= 1,500 2 ∑xy = 110,000
∑ x =22,000

2. Step 2: formulate the 3 equations

Na + ∑xb = ∑y

5a + 300b =1,500 equation 1

2
∑xa + ∑x b = ∑xy

300a + 22,000b = 110,000 equation 2

Q(Na + ∑xb = ∑y)

60(5a + 300b =1,500)

300a + 18,000b= 90,000 equation 3

Where N= total pairs of price and quantity demanded

Q= 300 ÷ 5 = 60

3. Formulate the Supply Function by

solving for the value of b using equation 2 and equation 3

300a + 22,000b = 110,000

300a + 18,000b = 90,000
4,000b = 20,000
b=5
solve for the value of a using equation 1

5a + 300b = 1,500
5a + 300 (5) = 1,500
5a +1,500 = 1,500
5a= 1,500-1,500
5a= 0
5
a= 0

4. Substitute the value of a and b to the supply function

 Therefore the demand function is

Qs = 0+ 5p

5. Interpretation
For every 5 units increase in quantity supplied there is a peso increase in price, for
every 5 units decrease in quantity supplied there is a peso decrease in price.

References:

Managerial Economics by Villegas

Introductory to Macroeconomics by Pagoso et al

Introductory to Microeconomics by Pagoso et al

Economics by Fajardo

Basic Economics with Taxation and Agrarian Reform by Lucas et al