The demand side of a market represents the interests of buyers who, naturally, want to spend as little money as possible to purchase goods. The supply side of a market represents the interests of producers. Producers are businesses that make or distribute products to buyers. Producers, it is assumed, strive to earn maximum profits. Businesses earn a profit when the price they charge for a product is greater than the average cost of producing the item. Business profits are used to reward investors and to finance business modernization or expansion. Hence, businesses and consumers see markets through a very different lens.
Supply is the amount of a good, service, or resource that producers are willing and able to sell at a series of prices at a moment in time. The supply of a product or resource is
Figure 2.5 Illustrating the Supply of Product X
illustrated in tabular form by a supply schedule, or with a supply curve, as shown in Figure
2.5. The supply curve slopes upward, reflecting the law of supply. According to the law of supply, there is a direct relationship between the price of a good and the quantity supplied. That is, if the price of a good increases, the quantity supplied will also increase. Conversely, if the price of a good decreases, the quantity supplied will also decrease.
The ceteris paribus assumption is used to construct an initial supply curve, just as it was used when charting an original demand curve. In the product market, the supply curve typically represents the viewpoint of businesses, which produce or sell final goods or services to households. In the resource market, the supply curve represents the viewpoint of households, which sell their labor and other resources to businesses.
The supply curve shown in Figure 2.5 represents the initial supply of product X at a moment in time. A change in the price of product X causes a change in the quantity supplied, not a change in the overall supply of the product. Economists say that a change in price causes a movement along an existing supply curve. In Figure 2.5, if the price of product X increases from $2 to $4, there is an upward movement along the existing supply curve. In this situation, the $2 increase in price causes the quantity supplied to increase from 2,000 items to 4,000 items. This change in price had no impact on the overall supply of product X, however. Note that a change in price does not cause the supply curve to shift to the right or to the left.
Changes in Supply
The overall supply of a product changes when the ceteris paribus assumption is lifted and one or more of the determinants of supply changes. A change in a determinant of supply causes the producer to supply more or less of a good or resource at each and every price. There are five main determinants of supply: resource prices, technological advance, number of firms in an industry, taxes, and expectations.
Suppose there was a decrease in the price of natural resources used in the production of product X. Lower costs of production would likely cause producers to supply more of product X at each and every price. At a price of $2, for example, producers would be willing to supply 4,000 items; at $4 they would supply 6,000 items; at $6 they would supply 8,000 items; at $8 they would supply 10,000 items; and at $10 they would supply 12,000 items. Thus, a change in the price of a key resource, a determinant of supply, causes the entire supply curve to shift to the right (a positive shift). The new supply curve represents the new reality of the marketplace, so the original supply curve disappears. Conversely, an increase in the price of key resources used in the production of product X would raise the costs of production, which would cause producers to supply less at each and every price (a negative shift). In addition to resource prices, the four other determinants of supply are:
• Technological advance. Improvements in technology allow businesses to improve efficiency and cut production costs, thus encouraging firms to increase the supply of the product. Technological advances in one industry can also negatively affect production in a related industry. For example, technological advances in the computer industry made the typewriter obsolete.
• Number of firms in an industry. When additional firms enter an industry, the supply of the product tends to increase. Conversely, when firms exit an industry, the overall supply of the product tends to fall.
• Taxes. Lower taxes reduce production costs and encourage businesses to increase the supply of goods. Higher business taxes tend to increase business costs and thus cause businesses to reduce the supply of goods and services.
• Expectations. Optimistic expectations about future prosperity in the economy or about the prospects for high prices and healthy profits within an industry, cause businesses to increase the supply of goods. Pessimistic economic forecasts cause businesses to reduce the supply of goods.