- Introduction to Economics
- The Four Types of Economies
- Opportunity Cost
- Introduction to Demand
- Elasticity of Demand
- Competition (or Lack of It)
- The Economic Structure of The United States
- Business Cycles 1: Four Stages of the Business Cycle
- Business Cycles 2: Inflation, Deflation and Poverty
- The Role of the Government in the Economy
GED Social Studies Practice Test: Supply
Supply is the flip side of demand. It is the quantity of goods or services that a producer is willing to sell (at different price points).
The law of supply states that more goods and services are offered by producers when they can command higher prices. When people aren’t willing to pay as much, suppliers must either (a) be willing to see their businesses hurt (not likely); or (b) lower their prices.
Producers in a capitalist system are in business for one reason: the profit motive.
Profit = revenues (how much money a producer takes in) — costs of production.
Company X charges $100 for a car part. But it costs the company $80 to manufacture the part (this reflects the human, capital, and natural resources used). So $100 — $80 = $20 (put another way, that’s 20% of the manufacturing cost). That’s the profit per unit for Company X. But — and this is a big but — a producer must be sensitive to the market: how much are consumers willing and able to pay. Company X might be able to make an even better car part, but it would cost double the current amount to manufacture ($160), and it would have to charge $200 to make the same profit: (20% of the manufacturing cost here would be $40). Company X may do some research and discover that people simply don’t want to pay that much for a basic car part; it’s just not worth the cost to them. Thus, producing the more expensive good is a bad idea.
Here’s a graphic that shows the relationship between the price of a good or service and the quantity that a producer will supply. Naturally, producers want to charge as much as possible for their goods or services.
Let’s say this supply curve applies to the maker of high-end motorcycles. The company is willing to make 100,000 of the motorcycles that sell for $30,000. It can make a large profit. Conversely, the company is only willing to make 20,000 units of its low-priced ($5000) cycles.
Each point on this graph is a particular combination of price and quantity supplied. As you may have noticed, the upward slope of this graph is the opposite of the downward slope of the demand graph shown previously.
Just as factors can affect demand, supply can be affected. In particular, there can be non-price factors or events that change supply. We are used to thinking of supply being dependent mostly on demand — and that’s often true — but there are other determinants.
The price of resources. A jewelry maker will have to charge more when the price of gold goes up. That’s a change in the price of natural resources. Or, suppose, a manufacturer reaches a new contract with its unions and workers get a raise. That’s a change in the cost of human resources. Or, finally, a company needs to build a new factory or renovate an existing one (capital resources). All of these events will affect supply, and prices will rise.
You have experienced price increases due to scarcity of natural resources. Almost every time there’s a frost in Florida, the price of orange juice rises, because a portion of the crop is destroyed. On the flip side, when there is a crop surplus (let’s say coffee beans), the price of coffee might come down.
The role of government in supply. Business organizations, like people, pay taxes. And taxes must be added to production costs, and this may drive up the price. Since a company may not be able to sell as many units at a higher price, may throttle back supply.
In agriculture, the U.S. government helps farmers stay in business by paying them to not grow too many crops. If farmers grew as much as they could, the price of the natural resources would fall because the supply increases. This is great for the consumer, but bad for the producer (the farmer). So, for example, if Farmer Jane has a 100-acre apple orchard, it’s possible that the federal government will pay her to plant only 80 of the 100 acres. This will give her more profit, but it will keep the price of apples higher than they might ordinarily be. Simply put, this is manipulation of supply.
Manufacturers, in particular, must add into the prices they charge the cost of complying with extensive government regulations. A car without seat belts, anti-skid brakes, and airbags would be cheaper to produce — but this would be illegal. Manufacturers, for instance, must comply with worker safety rules, emissions controls, and product safety regulations (remember the meat industry before the introduction of federal inspection). All of these factors may increase the cost of production and decrease supply.
Technology and Innovation. Supply can be increased when costs drop. For example, the computer industry has made unimaginable strides in the power of computers since the 1970s, and the price of computers — which were once the province of large companies and scientific laboratories — has come down dramatically. New technology allows computer makers to produce more computers. While the profit margin on an individual unit may be smaller, the manufacturers sell so many more units that their revenues rise dramatically.
Competition. When demand for a good or service rises, suppliers will be quick to try to fulfill consumers’ desires. There may be an increase in supply at different price levels (think of “high-end” and “low-end” products). Look around you — today, there are more smart phones — at every price and with every bell and whistle you can imagine. Where one or two companies might have dominated the market just a few years ago, there are today many manufacturers of this product.
A perfect inelasticity of supply (sometimes called zero inelasticity) exists when producers cannot increase the quantity supplied, no matter what the price. Look at the graph below. Let’s say, for example, a drug is made from a very rare mineral. It costs a great deal of money to produce the drug, and the cost of production is always climbing because the amount of the rare mineral present in the Earth’s crust is finite (the price axis). At the same time, there is a population of desperately sick people who need this medication (the quantity axis). No matter what the cost, the people who take the drug will pay the price because the company cannot produce more. The quantity produced does not change, no matter what the price.