Producers exist to meet consumer demand. If the individual motive is satisfaction from the consumption of goods, then the motivation of the producer in providing goods is the maximum profit. Therefore, when the price of goods rises, the quantity supplied will go up because all producers try to maximize profits. Conversely, when prices fall, the quantity supplied is also reduced. The positive relationship (price and quantity supplied) is what we call the law of supply.
However, on the other hand, when prices rise, consumers ask less for products, and when prices fall, consumers ask for more. It is because the price of goods is inversely related to the quantity demanded by consumers.
And, the interaction between demand and supply takes place in the market. When at a certain price, the quantity supplied is equal to the quantity demanded, the market reaches equilibrium. In a graph, equilibrium occurs at the point of intersection between the supply curve and the demand curve. At this point, the equilibrium price and the equilibrium quantity are formed.
Market supply vs. individual supply
Market supply refers to the sum of the production of each producer. For example, there are 10 companies and each of them produces 10 units. Then the market supply is 100 units.
Whereas, individual supply represents the quantity produced by a producer. In this example, the individual supply is 10 units.
Factors affecting supply
Several factors affect supply. And, when we present the relationship between supply and its determinants in a graph or mathematical function, it will be very complicated. Therefore, economists isolate some of those factors and choose prices as explanatory variables. The aim is to facilitate understanding and present it in a graph more simple.
Why is the price the primary determinant? Prices signal producers to change the output to maximize profits. It also signals the value consumers give to a product. Therefore, in the supply curve or function, economists use prices to explain changes in the quantity supplied.
When prices change, the quantity supplied will move along the curve. Conversely, when non-price determinants change, quantity will also change but shift the curve to the right or left.
Non-price determinants, we mean, are factors outside the price of the item itself. They include:
- Number of producers in the market
- Input price
- Production subsidy
- Prices of related goods
- Producers’ expectations
- Weather conditions
Number of producers
The more producers, the more output offered in the market. Say, in the market, there are 10 producers, each with 10 units of output. So in total, the market supply is 100 units. Then, because it is interested in the profits of the market, the new company enters and produced 5 units. So in total, market supply increased to 105 units.
More reliable technology leads to increased productivity, and thus output. With more advanced technology, employees can produce more output using the same input as before.
However, technology can also disrupt the market. It can make items obsolete or not in demand. As a result, instead of increasing supply, technology can also accelerate the decline in output and shut down an industry. You can see with the daily newspaper production that continues to shrink.
Examples of production inputs are energy, raw materials, and labor. Higher input prices increase production costs. It reduces profits and causes a decrease in supply.
Conversely, if input prices fall, the cost of producing goods decreases. And therefore, producers should increase production to get more money. So the decline in input prices causes an increase in supply.
Subsidies are a sum of money from the government to encourage production and consumption. Payment of production subsidies contributes to reducing production costs, giving producers incentives to increase supply.
Lower taxes reduce operating costs. In a sense, a reduction in taxation will increase the production of goods or services.
Prices of related goods
Related goods include substitute goods and complementary goods. If the price of substitute goods increases, producers will produce more because there is potential for increased demand. An increase in the price of substitution encourages consumers to turn to alternatives. For example, when palm oil prices rise, some consumers switch to soybean oil. Thus, soybean oil demand increases and spur producers to increase their output.
Meanwhile, when prices of complementary goods increase, the potential demand for goods decreases, so producers tend to reduce production. For example, printer ink is a complement to the printer. When the price of the printer rises, its demand decreases and causes the demand for printer ink also falls. That encourages printer ink manufacturers to reduce production.
Producer expectations of future prices. If producers expect future prices to be higher, they tend to produce less intensively at the moment. Instead, they will be more intensive in using their productive resources in the future to maximize the potential for higher income and profits.
Good weather is favorable for supply. Conversely, storms, floods, other natural disasters, and man-made disasters can cause supply shortages and have a significant impact on the amount of supply on the market.
Profit-maximizing output occurs when marginal revenue equals marginal cost. Producers are willing to supply their output as long as marginal costs are lower than marginal revenue. The higher the positive difference between marginal revenue and marginal cost, the higher the willingness of producers to supply goods.
Supply function and its curve
The supply function is a mathematical equation that links the quantity of supply of an item with its determinants. Because many factors affect supply, economists often focus on the price of the goods. So, in a simple function, the quantity supplied is a function of the price of goods (P). For example, the supply of goods X is as follows:
Qs = 10 + 5P
From the above equation, we know that when the price rises by 1 rupiah, the quantity supplied increases by 15 units. Conversely, when the price drops by 1 rupiah, the quantity supplied decreases by 15 units.
Remember, in the supply curve, the x-axis is the quantity, and the y-axis is the price. Therefore, to illustrate the above function in a graph, we need to find an inverse supply function. To do, we state the price as a function of the quantity supplied. In the case above, the inverse function is:
P = (Qs – 10) / 5 = 0.2Qs – 2
From the inverse function, we know the curve has a slope of 0.2. Let’s prove it with the data from the supply curve below.
We calculate the slope with the following formula:
Slope = (y1-y2) / (x1-x2)
Where y is the price, and x is the quantity. Take the price data of 4 and 5, then the slope of the curve is (5-4) / (35-30) = 0.2.
Because it is a linear curve, the value of the slope will always be the same, regardless of the price point we take. Let’s take prices 8 and 2. The curve slope will be equal to = (8-2) / (50-20) = 6/30 = 0.2.