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BASIC CONCEPT
3.1
SUPPLY
OF
INTRODUCTION (CONCEPT OF SUPPLY)
Supply is one of the forces that determine the price in the market. Supply of a commodity
refers to the quantity of a product which a seller is willing and able to sell at a given price
per unit of time. In words of Anatol Mirad, “The quantity supplied is defined as the quantity
of a commodity offered for sale at a given price in a given market at a given time. Supply
may also be defined as that part of stock that the seller offers for sale at a given price and
at a given time. Thus, supply means the quantity of a commodity offered for sales at a
particular price during a given period of time.
3.1.1 Definition of Supply
(1) According to Meyers: Supply may be defined as a schedule of the amount of a
product that would be offered for sale at all possible prices at any one instant of time, or
during any one period of time, for example, a day, a week, a month, a year and so on, in
which the conditions of supply remain the same.
(2) According to Anatol Mirad: The quantity supplied is defined as the quantity of a
commodity offered for sale at a given price in a given market at a given time.
Supply is always expressed with reference to a particular price and a particular time
period.
LAW OF SUPPLY
The law of supply states that “Other things being
equal, quantity supplied of a commodity is directly related
to the price of commodity.”
Normally, at a higher price suppliers will be ready
to supply more units of a commodity and vice versa.
“The law of supply follows, “The quantity supplied
varies directly with price, when price falls supply will
contract and when price rises, supply will extended.”
According to S.E. Thomas, “A rise in price tends to
increase supply and a fall in price tends to reduce it.” If
the price of a X increases, sellers will supply more X, on
the contrary, if the price of X falls, sellers will offer lower
quantity of X for sale.
15
Y
S
P
P¢
Price
3.2
P²
S
O
M²
M¢
Quantity
M
Fig. 3.1. Supply curve
X
16
3.3
INDUSTRIAL ECONOMICS AND PRINCIPLES OF MANAGEMENT
CLASSIFICATION OF SUPPLY
(i) Individual supply and
(ii) Market supply.
(i) Individual supply: Individual supply can be defined as supply of a commodity
offered by individual firm in the market.
(ii) Market supply: Market supply can be defined as supply of a commodity offered
by all the firms dealing with or producing selling that commodity.
3.3.1 Supply Function
Supply function explains the relationship between the supply and the factors determining
supply of the commodity. In other words, supply function reflects the functional relationship
between supply and determinants of supply such as price of the commodity, price of other
goods, price of factors of production, goals or objectives of the firm. They explain variations
in the quantity of good supplied. The supply function can be stated as follows:
Qs = f (Pa, Pb, Pc, T, Tp)
where Qs = Supply
Pa = Price of that good of which supply is made
Pb = Price of other goods
Pc = Price of factor input
T = Technology
Tp = Time period.
The supply function states that the quantity supplied of any good (Qs) varies with price
of that good (Pa), the price of other goods (Pb), the price of factor Input (Pc), Technology T
and Time period Tp.
ELASTICITY OF SUPPLY
When a small fall in price leads to great contraction
in supply, the supply is comparatively elastic but a big fall
in price leads to a very small contraction in supply, the
supply is said to be comparatively inelastic. Conversely, a
small rise in price leading to a big extension in supply
shows elastic supply, and a big rise in price leading to a
small extension in supply indicates inelastic supply. It has
two types: (i) Perfectly Elastic Supply and (ii) Perfectly
Inelastic Supply.
(i) Perfectly elastic supply: When a small rise in
price leads to infinitely large supply, supply is said to be
elastic. Supply is said to be perfectly elastic when any
amount of units are supplied at the same price. The supply
curve will be straight line (ss′) parallel to OX-axis as shown
in Fig. 3.2 (i).
Y
Price
3.4
S
O
S¢
Quantity of Supplied
X
Fig. 3.2 (i). Perfectly elastic supply
curve
17
BASIC CONCEPT OF SUPPLY
(ii) Perfectly inelastic supply: When a change in price does not lead to any change
in quantity supplied, supply is said to be perfectly inelastic. The supply curve is a straight
line perpendicular to the x-axis shown in Fig. 3.2 (ii) ss′ is the perfectly inelastic supply
curve.
S¢
Price
Y
O
S
Quantity of Supply
X
Fig. 3.2 (ii). Perfectly inelastic supply curve
3.5
MEASUREMENT OF ELASTICITY OF SUPPLY
Prof. Marshall suggested a mathematical method for measuring elasticity of supply. The
formula for this method is given as follows:
Elasticity of supply (Es) =
Percentage change in supply
Percentage change in price
⇒
Change in supply
× 100
Original supply
Es =
Change in price
× 100
Original price
⇒
Es =
Change in supply
Original price
×
Original supply
Change in price
⇒
Es =
∆Q
P
×
∆P
Q
⇒
Es =
∆Q P
×
∆P Q
where:
Es = Elasticity of supply
Q = Original supply
∆Q = Change in supply
P = Original price
∆P = Change in price.
Elasticity of supply will, therefore, be equal to the change in supply over change in price
multiplied by original price over original supply.
18
INDUSTRIAL ECONOMICS AND PRINCIPLES OF MANAGEMENT
Q. 1. When price of a plastic toy is Rs. 2, its supply is 1000. But when price rises to
Rs. 3 per unit, supply of plastic toys also goes upto 2000 units. Calculate the Elasticity of
Supply.
Solution:
∆P = Rs. 3 – Rs. 2
∆P = Rs. 1
∆Q = 2000 units – 1000 units
= 1000 units
P = 2
Q = 1000
Elasticity of Supply (Es) =
∆Q P
×
∆P Q
1000
2
×
=2
1
1000
E = 2
Elasticity of Supply = 2. Ans.
=
Q. 2. For the Supply Function q = 5 + 2P2 , find the elasticity of supply at p = 2.
Solution:
Given q = 5 + 2p2
⇒
dq
= 4p
dp
At
p = 2,
dq
= 4× 2
dp
dq
= 8
dp
⇒
At
p = 2;
q = 5 + 2p2
= 5 + 2 × (2)2
= 5 + 8 = 13
Es =
⇒
∆Q P
dq p
×
×
=
∆P Q
dp q
Es =
dq p
×
dp q
= 8×
Es =
Elasticity of supply is equal to
2
13
16
.
13
16
. Ans.
13
19
BASIC CONCEPT OF SUPPLY
3.6
INDIFFERENCE CURVE ANALYSIS
Bananas
An indifference curve is a curve which represents different combinations of goods which
give same satisfaction to the consumer.
The aim of indifference curve analysis is to analyse how a rational consumer choosen
between two goods. In other words, how the change in the wage rate will affect the choice
between leisure time and work time.
The term utility is something subjective. According to Hicks and Allen. Cardinal utility
measurement is not essential for constructing a theory of demand. In view of them, a consumer
makes comparisons of the satisfaction obtainable from different combinations of different
commodities.
1. According to Edgeworth: Indifference curve is that path on which a substitution of
a particular commodity by another in any manner or quantity gives the consumer the same
satisfaction in any position.
2. According to W. J. Boumol: An indifference curve as the locus of points each of
which represents a collection of commodities such that the consumer is indifferent any of
these combinations.
An indifference curve is a geometrical representation of the preference of a consumer’s
scale. For this any number of combinations of two products A and B which are located on an
indifference curve will show the same level of satisfaction to the consumer.
Y
Example: A consumer has one apple and
10 bananas. Now he is prepared to give 4 bananas
to get 1 more apple. Thus, we can have four
10
A
combinations of apples and bananas which give the
8
same amount of satisfaction. Each combination
ABCD gives equal amount of satisfaction.
B
6
Indifference Table
Combination
Apples
Bananas
A
1
10
B
2
6
C
3
4
D
4
2
3.7
C
4
D
2
O
1
2
Apples
3
4
X
Fig. 3.3. An indifference curve
INDIFFERENCE MAP
An indifference map depicts a complete picture of consumer’s scale of preference for
Apples and Bananas. In Figure 3.4, an indifference map of a consumer is shown which
consists of five indifference map. Each indifference curve reflects a different level of total
utility. A higher indifference curve shown a greater amount of satisfaction. While the consumer
is indifferent among the combinations lying on the same indifference curve. Thus higher level
of satisfaction to a consumer is due to the higher curve in this way. In figure, we are showing
similar indifference curves having combinations of Apples and Bananas which refer greater
20
INDUSTRIAL ECONOMICS AND PRINCIPLES OF MANAGEMENT
Y
IC 5
IC4
Apples
and lesser satisfaction than that shown on indifference
curve IC. Thus, in the figure IC, refers a lower level
of satisfaction than IC2, IC3, IC4 and IC5. It is conducted
that the aggregate utilities are remarkable but not
measurable as the increase in utility cannot be ranked
as we cannot say how much greater utility does IC2
has than IC1.
IC3
IC 2
3.7.1 Income Effect:
IC
1
A change in quantity demanded as a result of
X
change in real income caused by change in price of a
O
Bananas
commodity is called income effect. The change in
Fig. 3.4. An indifference map
consumer’s income will change the consumer’s
equilibrium when the relative prices of goods remains the same. When price of a commodity
falls, less has to be spent on purchase of same quantity of the commodity. In short, a fall
in price increase the real income (Purchasing power) of a consumer with the result that he
buys more quantity with the same money income. Income effect is related to change in
income caused due to change in price and not due to change in money income.
3.7.2 Price Effect:
The consumer equilibrium shifts due to change in the price of one commodity when his
income and the price of the other commodity remains the same. It is known as “Price effect”.
Price effect denotes changes in demand of a commodity caused by change in its price. It is
the combined effect of income effect and substitution effect. Thus,
Price effect = Income effect + Substitution effect.
When the price of a commodity falls, real income of the consumer goes up leading to rise
in demand (Income effect). When price of a commodity falls, it becomes relatively cheaper
than its substitute goods leading to rise in demand (Substitution effect). Clearly, rise in
demand due to fall in price is the result of income effect and substitution effect. Thus change
in demand of a commodity caused by change in its price is known as price effect.
3.7.3 Substitution Effect:
Substitute goods are those goods which can be used in place of each other to satisfy a
given want e.g., coffee and tea or ghee and oil. They are also called competitive goods.
Between substitute goods, use of one in place of other when the former becomes relatively
cheaper is called a substitution effect. It refers to substitution of one commodity in place of
other commodity when it becomes relatively cheaper. A rise in the price of a commodity, say
coffee, also means that price of its substitute, say tea, has fallen in relation to that of coffee
even though price of tea remains unchanged. So people will buy more of tea and less of coffee
when price of coffee rises. In other words, consumers will substitute tea for coffee. This is
called substitution effect.
EXERCISE
1. Define elasticity of supply and examine its significance in the theory of supply.
2. What is law of supply ? Explain it with the help of supply schedule.
3. Briefly explain: Price effect, Income effect and Substitution effect.
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