3.

10301 FOUNDATION
ECONOMICS
PART I :

PRINCIPLES OF
MICROECONOMICS
TOPIC 3 Cont : BASICS OF
SUPPLY

Supply
Economists use the concept of supply to describe
the quantity of a good or service that a household or
firm would like to sell at a particular price.
Supply is different from stocks, Stocks refers to the
volume of goods that the producer has produced
and kept in the warehouses ready for sale.
Supply is that part of the total stock or production
which is actually made available on the market for
sale.
The supply curves show the quantity of a good a
firm is willing to produce at each price. Normally a
firm is willing to produce more as the price
increases which is why the supply curve slopes
upwards, holding all other factors constant

Supply and Price

This graph illustrates
that there is a direct
relation between price
and quantity supplied at
each price level.
As price increases from
P1 to P2, the quantity
supplied increases from
Q1 to Q2, vice versa if
price is decreased.

Extension and Contractions in Supply

The extension/expansion or
contraction in supply is
caused by changes in price,
holding
other
factors
constant. In this graph the
equilibrium
price
and
quantity are at P0 and Q0
respectively. When price
decreases from P0 to P1, there
is a contraction in supply and
the
quantity
supplied
decreases from Q0 to Q1.
When price increases from P0
to P2, there is an extension in
supply and the quantity
supplied increases from Q0 to
Q2.

Increase and Decrease in Supply

0
1

An increase or decrease in supply is

caused by other factors such as increase
or
decrease
in
the
cost
of
production( may be due to changes in
tax, govt subsidy, improve labor),
holding price constant. The equilibrium
price and quantity is at P0 and Q0
respectively. A leftward (inward) shift
from S0 to S2 may be caused by increase
govt sales tax, no production subsidy,
fall in labor productvity.This is a
decrease in supply. A rightward
(outward) shift from S0 to S1 is caused
by fall in government sales increase
government subsidy , if labor
productivity improves. This is an
increase in supply.

Price Elasticity of Supply

Supply is elastic with respect to price, and
the price elasticity of supply is a measure
of this responsiveness of supply to
changes in price. The formula of
calculating the price elasticity of supply
would be:
% change in quantity supplied
% change in price

Ed =
change in quantity supplied change in price

original quantity supplied

original price

Ed =

Perfectly Inelastic Supply

The supply curve is
vertically parallel to the yaxis or the price axis. In this
case, whether the price is
high (P1) or low (P2) this will
have no effect on producers'
supply.
That is, the changes in price
have absolutely no effect on
the quantity sold or
supplied. Supply is totally
insensitive to the change in
price.

Perfectly Elastic Supply

The supply curve is
horizontally parallel to
the x-axis. At a given
price of P0, producers
sold all goods. That
is, the supply
response to price
change is infinite.

More Inelastic or Less Elastic Supply

The supply curve is steep.
This indicates that a
relatively large decrease in
price (from P1 to P2) is
required to produce small
fall in quantity supplied
(from Q1 to Q2) or
conversely big increase in
price (from P2 to P1) will
increase quantity supplied
by small amount (from Q2 to
Q1).
Quantity supplied is less
sensitive to price changes.

More Elastic or Less Inelastic Supply

The supply curve is relatively
flat- this suggest that the
quantity supply is more
elastic. A small decrease in
price (from P1 to P2) gives
rise to a very large
contraction in quantity
supplied (from Q1 to Q2) or
conversely small increase in
price (from P2 to P1) will
increase quantity supplied by
big amount (from Q2 to Q1).
Quantity supplied is more
sensitive to price changes.

UNITARY ELASTIC SUPPLY

The supply curve is neither
steep nor flat, suggesting
that the quantity supply is
neither elastic nor inelastic.
A small decrease in price
(from P2 to P1) gives rise to
a same contraction in
supply (from Q2 to Q1) or
conversely small increase in
price (from P1 to P2) will
increase quantity supplied
by same amount (from Q1
to Q2). Supply is just
sensitive to price changes

The Determination of Price

The price of a particular product
is determined by the intersection
of supply and demand curves,
functions or schedules. This can
be illustrated by this graph.
The equilibrium point E
determines the equilibrium price
(P0) and output (Q0) in the
market. Point E can also be
referred to as the market-clearing
point. If price is above the
equilibrium price (P0), say at P2,
then there will be a surplus in the
market because supply exceeds
demand. On the other hand, if
price is set below equilibrium
price, say at P3, then there will be
shortage in the market because
demand exceeds supply.

Consumer and Producer Surplus

Consumer surplus describes the difference
between the amount that a consumer pays for
goods and, the maximum amount he would be
prepared to pay if he/she were charged a
different price for each unit.
Producer Surplus is the difference between the
producers total revenue and its total cost. In
other words, it represents profits of producers

Consumer Surplus
Demand curves also represent marginal utility curves. This is
because, it can be shown from the demand curves that
consumers get extra value for money whenever they buy
quantity of goods.
Consider this demand schedule for cigarettes Suppose that
the market price is K1.50 per packet and that John normally
purchases 5 packets per week which will cost him K7.50.

Price of a Packet of Cigarette Quantity Demanded Per

(Kina = K)
Week
2.60

2.30

2.00

1.70

1.50

Producer Surplus
The area A0CD represents
total expenditure to
consumers in purchasing the
product at equilibrium price
0A and consuming 0C
amounts. That expenditure
becomes the revenue to
producers because the
consumer pays the producer
to consume the product.
Therefore, total
expenditure of consumer
is equivalent to total
revenue of producer, which
is equivalent to area A0CD.

Producer Surplus
The area D0C (the area
under the supply curve) is
the cost of supplying the
product. The difference
between area A0CD and
D0C is the producer
surplus or profit which is
equivalent to area A0D.
The difference between
area B0CD and area
A0CD is the consumer
surplus which is
equivalent to area BAD.