7.Supply
Transactions require both buyers and sellers. Unlike demand that describes the behavior of consumers supply refers to the behavior of sellers. Thus, demand is only one aspect of decisions about prices and the amounts of goods traded, the other is supply. So, supply is one of the two key determinants of price. The theory of supply explains the mechanisms by which prices and levels of production are set.
In economics, supply relates to the quantity of goods or services that a producer or a supplier is willing to bring into the market at a particular price in a given time period, all other things being equal.
The law of supply states that the quantity of a commodity supplied varies directly with its price, all other factors that may determine supply remaining the same. The law of supply expresses the relationship between prices and the quantity of goods and services that sellers would offer for sale at each and every price. In other words, the higher the price of a product, the higher the quantity supplied. As the price of a commodity increases relative to price of all other goods, business enterprises switch resources and production from other goods to production of this commodity, increasing the quantity supplied.
Clearly the law of supply is the opposite to the law of demand. Consumers want to pay as little as they can. They will buy more when there is a price decrease in the market. Sellers, on the other hand, want to charge as much as they can. They will be willing to make more and sell more as the price goes up. In this way they can maximize profits.
The relationship between price of a product and its quantity supplied is represented in a table called a supply schedule. The supply curve is a graphic representation of the market supply schedule and the law of supply. Each point along the supply curve represents a different price-quantity combination, showing a direct relationship between the quantities of products that firms are willing to produce and sell at various prices, all non-price factors being constant. Sloping upward from left to right the supply curve reflects that producers supply more at a higher price and less at a lower price.
The supply curve enables producers to anticipate what the supply would be for those prices falling in between the prices that are in the supply schedule.
People often confuse supply with the quantity supplied. The difference between supply and quantity supplied is that
Supply represents the amounts of items that suppliers are willing and able to offer for sale at different prices at a particular time and place, all non-price determinants being equal.
The quantity supplied refers to the amount of a certain product producers are willing to supply at a certain price. A change in the price of the product will cause a change in the quantity supplied.
Price is an important determinant of the quantities supplied. The law of supply states that the amount offered for sale rises, as the price is higher. The quantity of pairs of cut jeans producers are willing to offer for sale rises, since their price is higher primarily because they need to cover the increased costs of production.
However, there are things other than price which affect the amounts of goods and services suppliers are able to bring into the market. These things are called the non-price determinants of supply.
As it has been mentioned a change in the quantity supplied caused only by a change in the price of the product. A change in supply is caused by a change in the non-price determinants of supply. They are:
Changes in the cost of production. Production costs relate to the labour costs and other costs of doing business used in production process. The cost of production is probably one of the most important effects on production process. An increase in the costs of any input brings about the lower output. Regardless of the price that a firm can charge for its product, price must exceed costs to make a profit. Thus, the supply decision is a decision in response to changes in the cost of production.
Changes in technology. Changes in technology usually result in improved productivity. Improved technology decreases production costs and therefore increases supply.
Changes in the price of resources needed to produce goods and services. If the price of a resource used to produce the product increases, this will increase the production costs and the producer will no longer be willing to offer the same quantity at the same price. He will want to charge a higher price to cover the higher costs.
Changes in the expectations of future prices. Changes in producers' expectations about the future price can cause a change in the current supply of products. If producers anticipate a price rise in the future, they may prefer to store their products today and sell them later. As a result, the current supply of a particular product will decrease.
Changes in the profit opportunities. If a business firm produces more than one product, a change in the price of one product can change the supply of another product. For example, automobile manufacturers can produce both small and large cars. If the price of small cars rises, the producers will produce more small cars to earn higher profits. They will shift the resources of the plant from the production of large cars to the production of small ones. Therefore, the supply of small cars will increase and a supply curve will shift outward. So, profit opportunities encourage producers to produce those goods that have high prices.
Changes in the number of suppliers in the market. Potential producers are producers who can produce a product but don’t do it because of relatively low price. If price of a product rises potential suppliers will switch over production to that product to make more profit. If more producers enter a market, the supply will increase, shifting the supply curve to the right.
Making a summary it is necessary to emphasize that the understanding of concepts of supply and demand provides an explanation of how prices are determined in competitive markets.
An important concept in understanding supply and demand theories is elasticity. Comprehension of elasticity is useful to understand the response of supply to changes in consumer demand in order to achieve an expected result or avoid unforeseen consequences.
In economics, the price elasticity of supply is the degree of proportionality with which the amount of a commodity offered for sale changes in response to a given change in the going price. In other words elasticity of supply is a measure of how much the quantity supplied of a particular product responds to a change in the price of that product.
Elasticity of supply works similar to elasticity of demand. Supply is elastic if a change in price results in a large change in the quantity supplied. On the other hand, if a great change in price brings about a small change in the quantity supplied, supply is called inelastic. There are some factors that determine price elasticity of supply. The most important of them are the ability of producers to change the amount of goods they produce, time period needed to alter the output and others.
8. PRICE SYSTEM IN A MARKET ECONOMY
Prices are the key ingredients in a market economy because they make things happen. If buyers want to own some items badly, they will pay more for them. When sellers want to sell some items badly, they will lower their prices. Prices play such an important role in economic life that most democracies are often described as price-directed market economies.
The price system lies at the heart of any society. The price system is an economic system where prices are not set by government but by the interaction of supply and demand. Under such a system every commodity and every service has a price, i.e. the amount of money for which a unit of goods or services is sold and bought.
Price for a commodity is a reflection of supply of and demand for this commodity. The theory of supply and demand is the step toward understanding how market prices are determined and the way in which these prices help make production and consumption decisions - the decisions that make up not only the structure, but also the flesh and blood of the economic system*.
In economic theory, the interaction of supply and demand is known as equilibrium.
One of the functions of markets is to find equilibrium prices that balance the supply of and demand for goods and services. An equilibrium price (also known as a market price) is one at which each producer can sell all he wants to produce and each consumer can buy all he demands. Naturally, producers always would like to charge higher prices. But even if they have no competitors, they are limited by the law of demand: if producers insist on a higher price, consumers will buy fewer units. The law of supply puts a similar limit on consumers. They always prefer to pay a lower price than the current one. But if they insist on paying less suppliers will produce less and some consumers will go home empty handed.
In economics, economic equilibrium often refers to an equilibrium in a market that is the case where a market for a product has reached the price where the quantity supplied of a certain product exactly equals the quantity demanded. Thus, market clearing refers to an assumption that markets always go to where the quantity supplied is equal to the quantity demanded.
At prices above the equilibrium price, the quantity supplied exceeds the quantity demanded, so a surplus or excess supply develops.
What process occurs to bring the market back into equilibrium? Simple, the market price adjusts. When the quantity supplied by firms is greater than the quantity demanded by consumers there is more being produced than is being consumed. Unsold products start to accumulate. Firms respond by lowering prices to stimulate demand. Lower prices also means that firms will begin to produce less. In response to the lower prices the quantity demanded increases. This price response continues and the quantity supplied declines while the quantity demanded increases until the equilibrium is restored.
At prices below the equilibrium price, the quantity demanded is greater than the quantity supplied, and a shortage or excess demand develops.
It should be noted that a shortage is not the same thing as scarcity. Scarcity is an inevitable consequence of limited resources and unlimited wants. Scarcity cannot be eliminated. Shortage, however, can be eliminated by allowing prices to rise to the equilibrium level. Sellers see the goods and services are quickly bought up and realize they could have asked a higher price. The price goes up until the shortage disappears. The price continues to adjust until the quantities demanded and the quantities supplied are equal.
A decrease in demand leads to a decrease in both the equilibrium price and equilibrium quantity. An increase in supply produces a higher equilibrium quantity but a lower equilibrium price.
In a free market, prices are determined by the interaction of the forces of supply and demand.
To the economists, in most mixed economies prices ration scarce resources, motivate production and provide answers to the What, How and Who questions.
Since there is not enough of everything to go around goods and services are allocated, or distributed, based on their price. To put it another way, the more scarce something is, the higher the price will be and the fewer people will want to buy it. Economists describe this as the rationing effect of prices.
Price increases and decreases also send messages to suppliers and potential suppliers of goods and services. Price increases attract additional producers. Price decreases drive producers out of the market. Production-motivating function of prices refers to the way prices encourage producers to increase or decrease the level of output. By doing this prices help the economy maintain allocative efficiency and productive efficiency.
Prices act as signals to buyers and sellers. One of the things that prices do is carry information to buyers and sellers. Low prices are signals to buyers (consumers), who can now afford to purchase the things they want. When prices are high enough, they send a signal to sellers (producers), who can now earn a profit at the new price. Acting in accordance with the profit motive, business firms produce what the consumers desire. Producers can earn more revenues by responding to the consumer demand than by ignoring it. Those who sell goods at prices consumers are not willing to pay will suffer financial losses. In that way prices provide answer to the question of What to produce.
Prices encourage efficient production. Prices encourage business people to produce their goods at the lowest possible cost. The producers’ desire for profit leads them to introduce new production methods to lower production costs.
Firms that are efficient will produce more goods with fewer raw materials than firms that are inefficient. The quest for greater efficiency motivates producers to succeed in competitive activity. While these efforts are in the best interests of the sellers, all of consumers may benefit because they are provided with the things they want at lower costs. In such a way the price system carry out the task of determining how goods and services are produced.
How the price system determines how society’s output will be distributed among the people. Finally, prices help to determine who will receive the nation's output of goods and services. Under the price system, each person’s income is determined in the market place. Some people are endowed with talent, skill, intelligence, education or special training and earn more, on the average, than those who are not endowed with such qualities. What the worker can buy with his wage will depend, in turn, upon the prices of the goods and services the worker would like to own. Consumers who are willing and able to pay the equilibrium price (or more) buy a desired product, while those who are unwilling or unable to pay this price have to do without this product. Thus, by assigning values to the work people perform, the price system answers the Who question.