Supply: Study Guide (Microeconomics 2.2)

From buyers to sellers

In Topic 2.1 you studied buyers. Now look at the other side of the market: the sellers, or producers. Like buyers, sellers respond to incentives. A higher price rewards producing more. A tax per unit sold is a penalty. A subsidy per unit is a reward. Sellers also face constraints, above all the cost of the resources they use and the technology they have.

Throughout this guide we use Fenmoor Valley, a fictional farming area. Three farms grow strawberries and sell them by the crate:

• Hillside, a family farm on well-drained slopes;
• Riverside, a newer farm on heavier soil;
• Orchard End, a large farm with good, sheltered fields.

What supply means

Supply is the quantity of a good that sellers are willing and able to offer for sale at each possible price, during a given period, with all other influences held constant.

• Willing and able: a farm must want to sell at that price and be able to produce the crop.
• At each possible price: supply is a list of price-quantity pairs (a supply schedule) or a whole curve.
• Other influences held constant: we change only the good’s own price.

Quantity supplied is one number: the amount offered at one particular price.

The law of supply

The law of supply says that, other things equal, when the price of a good rises, the quantity supplied rises; when the price falls, the quantity supplied falls. Price and quantity supplied move in the same direction.

On a graph with price on the vertical axis and quantity on the horizontal axis, the supply curve slopes upward. A change in the good’s own price moves sellers along the curve.

Why the supply curve slopes upward

Marginal cost (MC) is the extra cost of producing one more unit. For most producers, MC rises as output rises. You met the reason in Topic 1.3: resources are not equally suited to every task. Hillside first picks the easy, sunny rows with its own family workers. To grow more, it must use shadier rows, pay overtime and hire pickers who are less experienced. Each extra crate costs more than the one before.

Each farm grows strawberries in blocks of 20 crates a week. The marginal cost per crate of each block is:

Block of 20 crates	1st	2nd	3rd	4th	5th	6th	7th
Hillside’s MC ($ per crate)	8	13	18	23	28	33	38
Riverside’s MC ($ per crate)	12	17	22	27	32	37	42
Orchard End’s MC ($ per crate)	6	10	15	20	25	30	35

A seller produces an extra block when the price covers its marginal cost (price ≥ MC), because then the extra block adds at least as much to revenue as to cost. So:

• at $10 per crate, Hillside produces only the 1st block (MC $8): 20 crates;
• at $15, it adds the 2nd block (MC $13): 40 crates;
• at $20, it adds the 3rd block (MC $18): 60 crates.

A higher price makes higher-cost output worth producing. That is the profit incentive behind the law of supply, and it is why the supply curve slopes upward. You can read a supply curve the other way too: its height at a quantity is the lowest price sellers would accept for that last unit, which is its marginal cost. You will study this link in detail in Unit 3.

Doing the same for every farm, using its own row of the table, gives the individual supply schedules (crates per week):

Price per crate	Hillside	Riverside	Orchard End
$10	20	0	40
$15	40	20	60
$20	60	40	80
$25	80	60	100
$30	100	80	120

Riverside supplies nothing at $10, because its lowest marginal cost is $12 per crate. A low price keeps high-cost sellers out of the market.

Worked example 1: market supply and a movement along the curve

Question. Use the three supply schedules. (a) Build the market supply schedule for Fenmoor Valley strawberries. (b) The price rises from $15 to $25 per crate. Find the change in quantity supplied and show it on a graph. (c) Explain Hillside’s response using marginal cost.

(a) Market supply is the sum of the individual quantities supplied at each price:

Price per crate	Hillside + Riverside + Orchard End	Market quantity supplied (crates per week)
$10	20 + 0 + 40	60
$15	40 + 20 + 60	120
$20	60 + 40 + 80	180
$25	80 + 60 + 100	240
$30	100 + 80 + 120	300

As with demand, this is horizontal summation: add quantities at the same price.

(b) At $15, quantity supplied is 120 crates. At $25, it is 240 crates. Change = 240 − 120 = +120 crates per week.

Only the own price changed, so the curve does not move. Sellers move along S from point a to point b. This is an increase in quantity supplied, not an increase in supply.

(c) At $15, Hillside produces the blocks whose MC is at most $15: the 1st ($8) and 2nd ($13), so 40 crates. At $25, the 3rd ($18) and 4th ($23) blocks are now worth producing, so it supplies 80 crates. The 5th block (MC $28) still costs more than the price, so Hillside stops there.

Check. The market schedule rises by 60 crates for every $5, so it is a straight line: quantity supplied = 12 × price − 60. At $25: 300 − 60 = 240. It reaches zero at $5, below every farm’s lowest marginal cost, so no strawberries are offered at or below that price.

Change in quantity supplied versus change in supply

	Change in quantity supplied	Change in supply
Caused by	the good’s own price	any determinant of supply (not own price)
On the graph	movement along the existing curve	the whole curve shifts
Words to use	“quantity supplied rises / falls”	“supply increases / decreases”

An increase in supply shifts the curve to the right: more is offered at every price, or, reading up, each quantity is offered at a lower price. A decrease in supply shifts it to the left (up).

The determinants of supply

These are the influences, other than own price, that shift supply. Most of them work by changing costs or the incentive to sell.

• Prices of inputs (resources). Higher wages, rent, fuel or raw-material prices raise costs and decrease supply. Cheaper inputs increase it.
• Technology and productivity. Better methods produce more from the same resources, lowering cost per unit, so supply increases.
• Prices of other goods the seller could produce. If the price of an alternative product rises, sellers move resources towards it, so supply of this good decreases. (If a Fenmoor farm can grow raspberries in the same fields, a rise in the raspberry price reduces strawberry supply.)
• Taxes and subsidies. A tax per unit sold acts like an extra cost and decreases supply. A subsidy per unit lowers the effective cost and increases supply. Costly regulations also decrease supply.
• Expectations. If sellers of a good that can be stored expect its price to rise soon, they may hold some back now, so current supply decreases.
• Number of sellers. More firms in the market increase market supply.
• Natural conditions. For farm goods especially, good weather increases supply; floods, drought or disease decrease it.

Worked example 2: shifting the supply curve

Question. Start from the market schedule in Worked example 1 (call it S₁). Treat each event separately. (a) A new picking machine lowers every farm’s marginal cost of every block by $5 per crate. Find the new schedule S₂. (b) Pickers’ wages rise, raising every farm’s marginal cost of every block by $5 per crate. Find the new schedule S₃. (c) Compare quantity supplied at $20 on S₁, S₂ and S₃, and the price sellers need for 180 crates on each curve.

(a) With MC $5 lower, each farm now supplies at any price what it used to supply at a price $5 higher. For example, Hillside’s blocks now cost $3, $8, $13, $18…, so at $20 it produces 4 blocks (80 crates) instead of 3. Adding the farms gives the S₂ column. (At $30, S₂ equals S₁ at $35: Hillside 120 + Riverside 100 + Orchard End 140 = 360 crates.)

Price	S₁	S₂ (new machine)	S₃ (higher wages)
$10	60	120	0
$15	120	180	60
$20	180	240	120
$25	240	300	180
$30	300	360	240

(b) With MC $5 higher, each farm supplies at any price what it used to supply at a price $5 lower. At $10, every farm’s lowest marginal cost is now above $10 (Hillside $13, Riverside $17, Orchard End $11), so nothing is offered. The S₃ column is S₁ moved one row down.

(c) At $20: S₁ gives 180 crates, S₂ gives 240 (60 more) and S₃ gives 120 (60 fewer). Reading up instead, 180 crates need a price of $20 on S₁, only $15 on S₂ and $25 on S₃. Technology increased supply (shift right, or down by $5). Higher wages decreased supply (shift left, or up by $5).

Quick classification. Use Fenmoor Valley:

Event	Effect	Graph
The price of strawberries rises	quantity supplied rises	movement up along S
A fourth farm starts growing strawberries	supply increases	shift right
The government pays farms $2 per crate grown	supply increases (subsidy)	shift right
A late frost damages the plants	supply decreases	shift left
The price of raspberries, grown in the same fields, rises	supply of strawberries decreases	shift left
Fertiliser becomes more expensive	supply decreases	shift left
More shoppers want strawberries	no change in supply (this is demand)	supply curve does not move

Common misconceptions

• “A higher price increases supply.” A higher own price increases quantity supplied: a movement along the curve. Supply itself does not change.
• “A decrease in supply shifts the curve down.” It shifts it left, which is also up: sellers need a higher price for each quantity.
• “Firms supply more at a higher price because buyers want more.” The reason is cost: a higher price covers the rising marginal cost of extra output. Buyers want less at a higher price.
• “A tax on sellers shifts demand.” A per-unit tax on sellers raises their costs, so it decreases supply.
• “Higher demand increases supply.” A change in demand shifts the demand curve only. Sellers may then sell more, but that is a movement along the supply curve (Topic 2.7).
• “Market supply is the average of the firms’ supply.” It is the sum of quantities supplied at each price.
• “Better technology for another product increases supply of this one.” If the other product becomes more profitable, resources move towards it, so supply of this good may decrease.

Where this leads

You now have both sides of the market. Next, Topic 2.3, Price Elasticity of Demand, measures how strongly buyers respond to price, and Topic 2.4 does the same for sellers. In Topic 2.6 supply and demand meet at equilibrium. Test yourself with the practice questions, then use the revision notes and the checklist to consolidate. To review the buyers’ side first, see the demand study guide.