UNIT-3

3.Supply & Market Equilibrium:

Introduction, Meaning of Supply and
Law of Supply, Exceptions to the Law of
Supply, Changes or Shifts in Supply.
Elasticity of supply, Factors Determining
Elasticity of Supply, Practical Importance,
Market Equilibrium and Changes in Market
Equilibrium.

8-1
 SUPPLY
How business owners adapt to
meet changes in price

8-2
2
 Why do people start businesses?
• Supplier’s Motive:
PROFIT
Def. The difference between the cost to
produce a good or service and the amount it
is sold for.
Ex. It costs 80 to make a pizza (human, natural
and capital resources), I sell it for 100, my
profit is…
20!!
8-3
 Supply

Willing to Offer to Able to Offer to

the Market at the Market at
Various Prices Various Prices
during Period of during Period of
Time Time
8-4
 Supply

What Firms Offer Is a Flow i.e. as per

for Sale, Not unit of time, per
Necessarily to day, per week, or
What they per year
Succeed in Selling
8-5
 Definitions of Supply
• The Supply of Goods is the Quantity offered
for Sale in a given Market at a given Time
at various Prices.
By : Thomas
• Supply refers to the Amounts of a Good
that Producer in a given Market Desire to
Sell, during a given Time Period at Various
Prices, Ceteris Paribus.
By : Samuelson
8-6
 Determinants of Supply
• Price of the Good
• Price of Related Goods
• Price of the Factors of
Production
• State of Technology
• Government Policy
8-7

•
 Determinants of Supply
• Price of the Commodity
Ceteris Paribus i.e. Other Things
Being Equal,
Relative Price of the Good ↑
Quantity Supplied ↑
This Happens Because Goods are Produced by
the Firm to Gain Profits. Profit rises when
rises.
Price 8-8
 Determinants of Supply
• Price of the Related Good
Price of Related Good (Y)
Quantity Supplied of Other Good (X)

Rise in Price of Related Good makes it more

Profitable for the Firm to Produce & Sell.
8-9
7
 Determinants of Supply
• Prices of the Factors of
Change in Price of Factors of Production
Production

Changes in Relative Profitability of Different

Lines of Production
Producers Shift from one Line to Another

Supplies of Different Commodities Change 8-10

8
 Determinants of Supply
• Government Policy
–Imposition of Commodities Taxes
Increase the Cost of Production.
–Subsidies Reduce the Cost of
Production which Increases Firm’s
Supply.
8-11 1
1
 Determinants of Supply
• State of Technology
• Other Factors
–Govt. Industrial & Foreign Policies
–Goals of the Firm
–Market Structure, etc.

8-12
Law of Supply

8-13
 Law of Supply
• There is a Direct Relationship Between Price &
Quantity Supplied:
– Quantity Supplied Rises as
PriceRises, Other things Constant.
– Quantity Supplied Falls as
PriceFalls, Other things Constant.
• The Law of Supply is accounted for by 2 Factors:
– When Prices Rise, Firms Substitute Production of One
Good for Another.
– Assuming firms’ Costs are
Constant, a Higher Price means Higher
8-14
Profits.
 Law of Supply

• Behaviour of Supply Depends upon:

–Phenomenon Considered.

–Degree of Possible Adjustment in

Supply.

–Time taken into Consideration i.e.

Short- Run & Long Run. 8-15
 Assumption to Law of Supply
• Law of Supply holds Good when “Other Things
Remain the Same” meaning thereby, the
Factors affecting Supply ,other than Price, are
Assumed to be Constant.

• Supply Function: Qx= f(PX, Cx, Tx)

where, Qx = Supply of Commodity X Px = Price
of Commodity X
Cx = Cost of Production of Commodity X
Tx = Technology of its Production 8-16
 Assumptions of Law of Supply
While stating law of supply the phrase ‘keeping
other factors constant or ceteris paribus’ are
used. This phrase is used to cover the following
assumptions on which the law is based:
1. Price of other goods are constant;
2. There is no change in the state of technology;
3. Prices of factors of production remain the same;
4. There is no change in the taxation policy;
5. Goals of the producer remain the same.

8-17
 Important Points about Law of Supply:

1. It states the positive relationship between

price and quantity supplied, assuming no
changes in other factors.
2. It is a qualitative statement, as it indicates
the direction of change in the quantity
supplied, but it does not indicate the
magnitude of change.

8-18
 Important Points about Law of Supply:

3. It does not establish any proportional

relationship between change in price
and the resultant change in quantity
supplied.
4. Law is one sided as it explains only the
effect of change in price on the supply,
and not the effect of change in supply
on the price.
8-19
 Reasons for Law of Supply:
1. Profit Motive: The basic aim of producers,
while supplying a commodity, is to secure
maximum profits. When price of a commodity
increases, without any change in costs, it
raises their profits. So, producers increase
the supply of the commodity by increasing
the production. On the other hand, with fall in
prices, supply also decreases as profit
margin decreases at low prices.

8-20
 Reasons for Law of Supply:
2. Change in Number of Firms: A rise in price
induces the prospective producers to enter into
the market to produce the given commodity so
as to earn higher profits. Increase in number of
firms raises the market supply. However, as the
price starts falling, some firms which do not
expect to earn any profits at a low price either
stop the production or reduce it. It reduces the
supply of the given commodity as the number
of firms in the market decreases.

8-21
 Reasons for Law of Supply:
3. Change in Stock:
When the price of a good increases, the
sellers are ready to supply more goods
from their stocks. However, at a
relatively lower price, the producers do
not release big quantities from their
stocks. They start increasing their
inventories with a view that price may
rise in near future.
8-22
 Supply Schedule
• Supply Schedule is a Series of Quantities
which Producer would like to Sell per unit
of Time at Different Prices.
• Two Aspects of Supply Schedule
–Individual Supply Schedule
–Market Supply Schedule

8-23 2
3
 Individual Supply Schedule
• It is defined as a Price (Rs.) Quantity
Table which shows (per kg) Supplied (kg)
Quantities of a 1 10
Given Commodity 2 30
which an Individual 3 50
Producer will Sell 4 70
at all Possible
5 80
Prices at a given
Time.
8-24
 Market Supply Schedule
• It is defined as the Quantities of a Given
Commodity which all Producers will Sell at
all Possible Prices at a given Moment of
Time. In Market there are many Producers
of a Single Commodity. By Aggregating
the Individual Supply, the Market Supply
Schedule is Constructed.

8-25
 Price of Supply by Supply by Market
Commodity ‘X’ A B Supply
(in Rs.) (Units)
100 40 50 40+50=90
200 60 70 60+70=130
300 65 80 65+80=145
400 80 100 80+100=180

It indicates that when Price of ‘X’ is Rs 100 per unit, A’s Supply
is of 40 units and that of ‘B’ is of 50 units. Thus the Market
Supply is 90units.
As the Price Increases, Quantity Supplied Increase
8-26
 Supply Curve
• A Supply Curve is a Locus of Points
showing various Price-Quantity
Combinations of a Seller.
• It shows the Direct Relationship
between Price & Quantity Supplied.
• It Slopes Upwards to the Right.

8-27
 Individual Supply Curve
X The Supply Curve
S
Slopes Upwards from
5
Left to Right,
4 meaning
thereby that when
3 Price is High Quantity
Supplied is also High
2
and vice versa.
S
1

0
10 30 50 70
80 Y
Quantity Supplied (KGegn) 8-28
Market Supply Curve
Y

400 S

300

200

100
S
X
0 100 120 140 160 180
8-29
 Exceptions to Law of Supply
• Supply of Labour: If we take the Supply
of Labour at very High Wages, we may
find that the Supply of Labour has
decreased instead of Increasing.
• Agricultural Products: Since the Production of
Agricultural Products cannot be Increased
beyond a certain Limit, the Supply cannot be
Increased beyond this Limit even on an
Increase in their Prices.
8-30
 Exceptions to Law of Supply
• Artistic Goods : Supply of Artistic Goods cannot
be Increased or Decreased easily.
• Goods of Auction: Supply of Goods of Auction
is Limited as such cannot neither be Increased
nor Decreased.
• Hope of Change in the Prices of Commodities
in Near Future: If the Price of Commodity is on
Rising Pace, then the Supply of such
Commodity Decreases as Producers and Sellers
will like to Store this Commodity & Vice-Versa.
8-31
Expansion & Contraction in Supply

• QS ↑ Price ↑
Expansion • Upward Movement
Along the Supply Curve

• QD ↓ Price ↓
Contraction • Downward
Movement
Along the Supply Curve 8-32
Extension & Contraction in Supply
Y

P`

Extension of Supply
P
Contraction of Supply
P``
S
O X
L Q N
Quantity
Supplied 8-33
 Increase & Decrease in Supply

• Q Supplied ↑ (at all prices)

due to Change in Other
Increase
Factors
• Rightward Shift

• Q Supplied ↓ (at all prices)

due to Change in Other
Decrease
Factors
• Leftward Shift
8-34
Causes for the Increase in
Supply:
(i) Fall in the price of
substitute goods.
(ii) Fall in the price of
factors of production.
(iii) Improvements in
technology.
(iv) Increase in the number
of firms in the market.
(v) Reduction in factor price.
(vi) Decrease in taxation.
Causes for the Decrease in
Supply
(i) Rise in the price of
substitute goods.
(ii) Rise in the price of factors
of production.
(iii) Outdated technology.
(iv) Decrease in the number of
firms in the market.
(v) Increase in factor price.
(vi) Increase in taxation.
8-35
 Increase & Decrease in
Supply
Increase in Supply Decrease in Supply
S S` S
S`

S S`
S` S
Quantity Supplied Quantity Supplied

8-36
 Elasticity of Supply
• Elasticity of Supply is defined as the
Responsiveness of the Quantity Supplied of a
Good to Change in its Price.

ES = % Change in Q.
% Change in
Supplied
Price
ES Change in Q. Supplied Original
= 
Price Change in Price Q. Supplied 8-37
 Elasticity of Supply

E = Q P
S 
P Q
Where, ES
∆Q Price Elasticity of Supply
Q Change in Quantity Supplied
∆P Original Quantity Supplied
P Change in Price
8-38
Original Price
Degrees of Price Elasticity of Supply

More Less than

Perfectly Perfectly Unit than Unit Unit
Elastic Inelastic Elastic Elastic Elastic
E=∞ E=0 E=1 (Elastic) (Inelastic)
E>1 E<1

8-39
 Perfectly Elastic Supply
Y • A Perfectly Elastic Supply is
6
one in which there is a
Significant Change in the
S
E = infinite
S
Supply of the Commodity
4 without any Change or
Little Change in its price.
•It is an Imaginary Concept.
In Practical Life, there is no
Commodity, the Supply of
0 10 20 30 X
which is Perfectly
Elastic.
Quantity
8-40
 Perfectly Inelastic Supply
Y • Perfectly Inelastic
E=0 S Supply is one in which
a Change in Price
6
Produces No Change in
the Quantity Supplied.
4 • It is an Imaginary
Concept. In Practical
2
S
Life, there is no
Commodity, the Supply
0 2 4 6
X of which is Perfectly
Quantity
Inelastic. 8-41
 Unitary Elastic Supply
• Unitary Elastic
Y S
is one in
E=1 which a % Change in
P Price Produces an
Equal % Change in
T
Quantity Supplied.

S
O M N X

Quantity 8-42
(%)
 Greater than Unitary Elastic (Elastic)
Supply
Y

• Greater than Unitary

S
Elastic Supply is one in
E>1
T
which a Given %
Change in Price
P
S Produces Relatively
more % Change in
Supply.
X
O M N

Quantity (%) 8-43

 Less than Unitary Elastic
(Inelastic) Supply
Y
• Less than Unitary
S
Elastic Demand is one
in which a given %
E< 1
Change in Price
T Produces Relatively
P Less % Change in
Quantity Supplied.
S

X
M N
O

Quantity (%) 8-44

 Point Elasticity of Supply
• Refers to Measuring the Elasticity at a Particular
Point on Supply Curve.
• Makes Use of Derivative Changes
Rather than Finite Changes in Price &
Quantity Supplied.
• Defined As: dq p

dp q
dq
Where, dp is the Differentiation of Supply
Function w.r.t. Price at a point on Supply
8-45
Curve.
 Arc Elasticity of Supply
• When Elasticity is to be found between 2
Points, we use Arc Elasticity.

q1  q2  p1  p2
Elasticity = q  q p1  p2
1 2
Where,
p1 = Original Price
q1 = Original Quantity Supplied
p2 = New Price
8-46
 Arc Elasticity of Supply
For Example, Find Elasticity of Supply Between:
p1 = Rs. 12 p2 = Rs. q1 = 20
15 q2 = 50
q1  q2 p1  p2
Elasticity = q1  q 2  p 1  p 2

E S = 30  27
70 3
ES = 8-47
Determinants of Price Elasticity of Supply

• Nature of Commodity:

•Inelastic
Perishable
Supply

•Elastic
Durable

Supply 8-48
Determinants of Price Elasticity of Supply

• Time
Very Short
Period
•Inelastic

Short Period •Elastic

Long Period •Highly Elastic

8-49
Determinants of Price Elasticity of Supply

• Production
Technique
•Inelastic
Complicated
Supply

Not
•Elastic
Complicated
Supply 8-50
Determinants of Price Elasticity of Supply

• Stages of Law of
Returns
•Inelastic
Law of Returns
Diminishing

Law of
Constant
•Elastic
Returns
Law of Increasing
Returns
•Highly Elastic
8-51
If there are lots of apples in the market
and little demand for apples, market
disequilibrium occurs. 8-52
 Let’s Review Equilibrium!
• Equilibrium occurs when quantity
supplied equals quantity demanded.

• Economists state that a market will tend

toward equilibrium.

• This means that price and quantity will

gradually move towards their
equilibrium levels. 8-53
 Market Equilibrium
Market
p
demand

q=D(p)

D(p)

8-54
 Market Equilibrium
p Market
supply
q=S(p)

S(p)

8-55
 Market Equilibrium
Market Market
p
demand supply
q=S(p)

q=D(p)

D(p), S(p)

8-56
 Market Equilibrium
Market Market
p
demand supply
q=S(p)

p*
q=D(p)

q* D(p), S(p)

8-57
Equilibrium is the point where the supply
curve intersects the demand curve. 8-58
 Let’s Review Disequilibrium!

• Disequilibrium occurs when the

quantity supplied does not equal the
quantity demanded.
• Disequilibrium occurs when the price is
not right.
• If the price is too high or too low for
that particular market, disequilibrium
occurs.
8-59
The original equilibrium price does not
work when the supply curve shifts.
8-60
 Surplus
• A surplus occurs when quantity supplied is
greater than quantity demanded.

• Another term for surplus is excess supply.

• When a surplus occurs, the price must be

lowered to restore the market to
equilibrium.
8-61
Too many cookies and not enough
consumers creates a surplus. 8-62
 Shortage
• A shortage is a situation in which quantity
demanded is greater than quantity
supplied.

• Another term for shortage is excess

demand.

• When a shortage occurs, prices must be

raised to restore the market to equilibrium.
8-63
When quantity demanded is created than
quantity supplied, a shortage occurs. 8-64
 Prices
• Market disequilibrium occurs when the
price is not right for that particular market.

• If the price is too low for that particular

market, demand is encouraged and
shortage occurs.

• If the price is too high for that particular

market, demand is discouraged and
surplus occurs. 8-65
The beautiful thing about price is that
it can easily be changed to restore
equilibrium to the market.
Fortunately, price is flexible and
market equilibrium can be restored.
8-66
Market Equilibrium
Equilibrium is where quantity
supplied equals quantity
demanded:
Specifically, it is the price where
QD = Q S
(not where demand = supply)

• At any price level other than P0,

the wishes of buyers and sellers
do not coincide 
disequilibirum

8-67
 Market Disequilibria
Excess demand, or shortage, is
the condition that exists when
quantity demanded exceeds
quantity supplied at the current
price:
At P1, Q1D > Q1S

Price rationing: “as long as there is a way for buyers and sellers
to Interact, those who are willing and able to pay more will
make that fact known”
8-68
Market Disequilibria
Excess supply, or surplus, is the
condition that exists when
quantity supplied exceeds
quantity demanded at the
current price:
At P1, Q1S > Q1D

8-69
Changes in Equilibrium: Increases in
Demand and Supply

An increase in demand leads to An increase in supply leads to

higher equilibrium price and lower equilibrium price and
higher equilibrium quantity. higher equilibrium quantity.

8-70
 Changes in Equilibrium: Decreases
in Demand and Supply

A decrease in demand leads to A decrease in supply leads to

lower price and lower quantity higher price and lower quantity
exchanged. exchanged.

8-71
Relative Magnitudes of Change

The relative magnitudes of change in supply and demand determine the

outcome of market equilibrium.
8-72
Relative Magnitudes of Change

When supply and demand both increase, quantity will increase, but
price may go up or down. 8-73
8-74