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The law of supply

Now, we’ll define the law of supply, which states that there is a direct and positive relationship between price and quantity supplied (Mas-Colell et al., 1995, p. 138).

Put another way, quantity supplied is the amount of some goods that sellers are willing and able to sell. If a seller or producer notices that more of their goods are being sold, they will make more. This makes the supply line slope in the opposite direction to demand.

The supply graph compares quantity and price, with quantity on the x-axis and price on the y-axis. The line points diagonally up to the right, indicating that as quantity increases so does price, so it's a positive correlation.

Why does the line slope upwards? This is due to opportunity cost, because as price rises there is an incentive to produce more goods. A supplier wants to make more profit, so focuses their resources on the most profitable activities. As the quantity supplied increases, resources will become more expensive because they become more scarce. This then increases costs, which are passed onto the buyers.

The opposite is true when price falls, which leads to the supplier supplying less as there’s no profit to be made.

Determinants of supply

Just as there are determinants in demand, there are determinants in supply.

This graph is the same as the supply graph above, but with two additional lines, identical in shape but in a different position. The first line is to the left of the original supply line, while the second line is to the right. These lines indicate that a change in determinants of supply move the supply curve to the left or right. Shifts along the supply line occur because of changes in price. A tax that raises the price of transport would therefore result in a movement along the supply line.

Determinants of supply (ie things that can cause the supply curve to shift left or right) include:

  • Input and raw material prices
  • Government policy
  • Technology
  • Expectations
  • Prices of related substitutes or complementary goods
  • Number of competing producers in the same market

You might think these are the same as the determinants of demand, but the main differences are raw material costs, government policy and the number of suppliers. All of these can shift the supply line to the left or right.

Government policies can have a large effect on suppliers. Transport infrastructure is often dependent on government policy and funding. The three common tools used by governments include:

  • Direct provision of transport services, eg bus services
  • Indirectly encouraging transport services with taxes and subsidies
  • Regulatory and legislative measures allowing or disallowing certain market behaviours

Supply elasticity

As with demand, elasticity affects the slope of the line and changes in price move along the supply line.

Supply elasticity is the same as demand elasticity and can be represented on a graph as a horizontal line because it’s infinite. Supply inelasticity on a graph is a vertical line. The factors that affect changes in price of supply are time to produce, stock, spare capacity and mobility of factors of production.

If these factors are flexible, then supply is elastic. Goods with a short shelf life, like fresh fruit, are inelastic, as time moving them to consumers is short, and stock and spare capacity is low. Goods with a long shelf life, such as a can of baked beans, are more elastic.

Your task

Elasticity of price is all about how sensitive price is to changes in demand or supply.

Read about price elasticity of demand and price elasticity of supply.

Discuss in the comments how CV1Logistics is affected by price elasticity and other determinants that could move the position of the supply or demand lines.


References

Mas-Colell, A., Whinston, M. D., & Green, J. R. (1995). Microeconomic theory. Oxford University Press.

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This article is from the free online course:

What is Economics in Global Logistics?

Coventry University