chapter theory of demand & supply 2 unit - 3 : (supply)chapter theory of demand & supply 2 unit - 3...

J. K. SHAH CLASSES CPT – GENERAL ECONOMICS

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CHAPTER Theory of Demand & Supply Unit - 3 : (Supply) 2

STEP - 1 : Meaning definition of supply, law of supply & factors of supply

The term supply refers the amount of a good or service that the producers are willing & able to offer to the market at various prices during a period of time. Supply definition is complete when it has the following elements:-

(i) Quantity of a commodity that the producer is willing to offer for sale; (ii) Price of the commodity; (iii)The quantity supplied is so much per unit of time per day, per week, or per year and there-

fore supply is flow concept e.g.: A supply statement is ―Firm A supplies 50 kg of wheat at the price of Rs. 10 per kg in a month‖.

Difference between supply & stock

Stock of a commodity is the total quantity that is available in a market at a certain time. Supply is that part of the stock which a seller is ready to sell at a certain price during a certain time. Thus, supply is that part of stock which is actually brought into the market.

e.g. a producer has produced 400 pencils. This is the stock of pencils with him. He may be willing to offer for sale 100 pen-cils at the rate of Re1 per pencil, 120 pencils at Rs2 each; 150 pencils at Rs3 each & so on. In this case, stock is 400 pencils, but the supply of pencils is different at different prices & there-fore, it is a flow concept.

Individual supply schedule

Table (1)

Combination Price Qty supplied

A 1 5

B 2 8

C 3 12

From table (1), we can observe that as price of the commodity increases; with other things re-

maining constant, quantity supplied also increases. Plotting these combinations in fig (1) a

supply curve is obtained, which is upward sloped i.e. positive relationship between price &

quantity supplied, known as law of supply.

Note: The main reasons behind an upward sloping supply curve are :-

(i) Law of diminishing marginal productivity:-

The Law states that as more units of variable factor are employed, the addition made to to-

tal production falls, i.e. cost of production rises. Thus, more quantity is supplied only at

higher prices so as to cover the rise in cost of production.


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(ii) Goal of profit maximisation:

The aim of producers is to maximise profits. The aim can be achieved by raising price of the goods. At higher price producers increase supply of goods.

Further market supply schedule can be obtained as follows:

Price of product x A’s supply B’s supply Market supply (A + B)

3 12 13 25 2 8 6 14 1 6 5 11

Market supply curve is the graphical representation of market supply schedule. It is the ag-gregation of individual supply curves.

Determinants or factors of supply are : Qsx = f (Px, py, SI, Cp, Tech, obj, GP).

(i) Px Price of commodity x : Explained in table 1.

(ii) Py Price of other related commodity

When price of related goods ‗y‘ changes, with other things remaining unchanged quantity supplied of concerned commodity ‗x‘ also changes. E.g., if price of wheat rises, to increase quantity supplied of wheat farmers may shift lands to wheat produc-tion instead of corn & soyabeans (supply of these will fall). Further, when price of Maruti Zen rises, to supply more of Zen, Maruti Udyog Ltd. shifts assembly line from Maruti 800 to Zen & supply of Maruti 800 diminishes.

(iii) SI (Supplies of input): There are four inputs — land, labour, capital,organization. As

supply of factors increases, producer is able to supply more & vice-versa. SS of input & production are directly related.

(iv) CP (Cost of production) : As per unit of cost of production increases, additional unit

of output adds more to cost than to revenue & amount of production decreases. The ss curve shifts towards left & vice versa.

(v) Technology : As state of technology improves, innovation takes place & producer is able to produce better goods with increase in supply, & per unit cost of production decreases. Therefore, additional unit of output will add more to revenue than to cost & as profit increases, supply also increases.

(vi) Objective or Goal of firm : Generally, the goal of any firm is maximization of profit. But there are other objectives also, like maximization of sales, maximization of output or maximization of employment. If the firm intends to maximize the other goals at the stake of maximize profit, supply will be more than maximization of profit. So supply depends on priority of firm.


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(vii) Govt Policy : It is one of the important determinants of

supply. As contractionary fiscal policy takes place (i.e. in-crease in tax), with ceteris paribus, supply of the commodity decreases & supply shifts towards vertical axis as S3. For

expansionary fiscal policy (decrease in tax or increase in subsidies), with certeris paribus, SS increases & the supply curve shifts, towards horizontal axis as S2,as shown in

above figure.

STEP - 2 : Change in quantity supplied & change in supply:

Change in quantity supplied implies changes along the same supply curve. In fig 1, we have supply curve ‗SS‘ - other things remaining constant, when with increase in price quantity sup-plied of a commodity increases, it is called ‘expansion of sup-ply’ (movement from a to b).

On the other hand, with ceteris paribus,decrease in price leads to decrease in quantity supplied - it is known as ‘contraction supply’ (movement from a to c). In these cases the responsible factor is price only.

Further change in supply implies shift in supply curves. In fig 2, we have shift in supply curve towards horizontal, axis i.e. in-crease in supply, the factors are other than price, like,

i) Improvement in technique of production.

ii) Fall in price of substitute goods. iii) Fall in cost of production. iv) Favourable changes in govt policy. v) Fall in the expected price of the good.

Further decrease in supply takes place due to unfavourable changes in factors other than its price. The factors are

i) Obsolete technique of production ii) Increase in price of substitute goods iii) Increase in the cost of production. iv) Increase in the expected price of the good. v) Unfavourable changes in govt policy.

As a whole, movement along a supply curve & shifts in the supply curve can be obtained as follows:


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Basis Movement along a supply curve Shifts in the Supply Curve

1. Meaning

&

Definition

A rise or fall in supply due to change in price is called extension or con-traction of supply respectively. When we show them graphically, it means movement along a supply curve

The shifts in supply curve reflects increase or decrease in supply.

2. Types of Movements/ Shifts

There are two types of movements : (i) upward movement (expansion of

supply). (ii) downward movement (contrac-

tion of supply). Thus, under movements along the same supply curve extension and contraction of supply are shown

There are also two types of shifts in supply curve (i) rightwards shift (increase in

supply curve). (ii) upward shift that indicates de-

crease in supply. Thus, under shifts in the supply curve, we study increase and de-crease of supply.

3. Influence or

Factor responsible

Here, the producer/seller is under the influence of change in price of the commodity only.

Here, the producer is under the in-fluence of factors other than price.

4. Diagrammatic representa-tion

STEP- 3 : Elasticity of Supply:

Law of supply states us only about the ‘direction of change’ in supply as a result of change in price. But the law remains silent over the degree of change in response to change in price. The concept of elasticity of supply answers this question. Elasticity of supply is the measure of the degree of responsiveness of supply due to change in price. It can be obtained by three ways :

a) Percentage method

b) Geometric method

c) Arc method


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(a) Percentage Method By percentage method, elasticity of supply is measured by taking ratio of percentage change in Quantity Supplied to the percentage change in price.

es = % Change in Quantity supplied

% Change in price

Change in Quantity supplied × 100

Original Quantity suppliedChange in Price

× 100Original Price

= s sΔQ / Q

ΔP / P

sS

s

ΔQ Pe = × ΔP Q

Es =

Different types of elasticity of supply

i) In fig (2) supply line is upward steeper & started from horizontal.

In this case Qs/Qs < P/P s sQ /Q

< 1P/P

i.e es < 1 (Inelastic supply as in fig 2)

ii) In fig (3) supply line starts from origin & upward linear.

Here, s s s

s

Q Q /QP = = 1Q P P/P

i.e, es = 1(Unit elastic supply as in fig 3)

iii) In fig (4) supply line is having intercept on

vertical axis & flatter in nature.

Here, s s s

s

Q Q /QP > > 1Q P P/P

i.e, es > 1 (More elastic supply as in fig 4)

Further considering two extreme cases of elasticity of supply : iv) For perfectly inelastic supply: v) For perfectly elastic supply:

Qs/Qs = 0 i.e., es = Qs/Qs / P/P = 0 P/P = 0 i.e. es = Qs/Qs / P/P =


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Supply curve is parallel to vertical axis as in Fig. 5 Supply curve is parallel to Qty axis is in Fig. 6

As a whole, we have five types of price elasticity of supply given in brief. Value of Elasticity of Supply

Coefficient of Es

Types of Es Definition Shape of Supply

Curve

1. Es = 0 Perfectly inelastic supply

This occurs when to a percentage change in price there is no change in quantity supplied

Parallel to price axis

2. 0 < Es < 1 Inelastic (or less than unitary elastic)

This occurs when to a percentage change in price there is lesser change in quantity supplied

Upward sloping origi-nating from x-axis (in-tercept on X axis

3. Es = 1 Unitary elastic supply This occurs when to a percentage change in price there is equal change in quantity supplied

Upward sloping origi-nating from origin

4. Es > 1 Elastic (or more than unitary elastic) supply

This occurs when to a percentage change in price there is more than proportionate change in quantity supplied.

Upward sloping origi-nating from negative of X axis.

5. Es = Perfectly elastic supply

This occurs when there is infinite change in quantity supplied at a price

Parallel to quantity ax-is.

ARC Method: Point elasticity relates to a situation where the two price & quantity situations are far very close to each other. ARC elasticity relates to a situation where the two Price & Quantity situations are far from each other, such that they relate to an arc over the supply curve.

Qs

Q + Q1 22

es = –––––––––––––––

1 2

P P + P

2


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s 1 2

s1 2

Q P + Pe = ×

P Q + Q

e.g. (i) Find out elasticity of supply if price of rice rises from ` 20 to ` 40 per kg & I creases from 10 kg to 15 kg in a month. Ans. Q1 = 10, Q2 = 15, P1 = 20, P2 = 40

s

510+ 15e = = 0.6

2060

e.g. (ii) Let the supply function be Q = – 40 + 10P. Calculate ARC elasticity between price of ` 10 & ` 12 Ans. When P = 10, Q1 = – 40 + 10.10 = 60

When P = 12, Q2 = -40 + 10(12) = 80

s

20140e = = 1.57

222

STEP – 4 : Factors affecting elasticity of supply:

Some important factors influencing elasticity of supply are giv-en below: (i) Nature of the commodity (ii) Cost of production (iii) Techniques of production (iv) Availability of resources & facilities (v) Time period : It is the very important determinant of elasticity of supply. In the very short period, time is not sufficient to make changes in out-put.Hence, supply will be inelastic as represented by the curve S1S1 in Fig 1; which is vertical.

In the short period, output can be changed to some extent by changing the amount of variable factors only. The supply here will be S2S2 which is inelastic indicating less than unity supply.

The supply here increases somewhat in response to an increase in price. The supply curve S3S3 represents the supply of the same commodity in the long period. The small change in

price here brings a larger change in supply because time is enough to enable the producers to make changes in the output.


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Multiple Choice Questions

Chapter- 2: Theory of Demand & Supply Unit – 3: Supply

(1) The supply of a good refers to (a) Amount of production of good. (b) Running stock of the good. (c) Amount of the good offered for sale at a particular price per unit of time. (d) Stock available for sale.

(2) Contraction of supply is the result of : (a) Decrease in the number of producers (b) Decrease in the price of the goods

(c) Increase in the price of other goods (d) Decrease in the outlay of sellers

(3) An increase in the supply of a good is caused by : (a) Improvements in its technology (b) Fall in the prices of other goods

(c) Fall in the prices of inputs (d) Both a & c

(4) Apple juice & orange juice are substitute in consumption & apple juice & apple sauce are substitute in production. If the price of orange juice _________ or the price of apple sauce __________, then the price of apple juice will ____________ (a) Decrease; decreases; increase. (b) Increases; increases; increase

(c) Decreases; increases; decrease. (d) Increases; decreases; increase

(5) The Quantity supplied of a good or service is the amount that : (a) Producers wish they could sell at a higher price. (b) Is actually bought during a given time period at a given price. (c) Producers plan to sell during a given time period at a given price. (d) People are willing to buy during a given time period at given price.

(6) Supply is the : (a) Cost of producing good. (b) Entire relationship between the quantity supplied & the price of good. (c) Willingness to produce a good if the technology to produce it becomes available. (d) Limited resources that are available with the seller.

(7) An increase in the number of seller of cars will increase the (a) Price of cars (b) Demand for cars

(c) Supply of cars (d) Demand for car accessories

(8) Supply is (a) Stock concept (b) Flow concept

(c) Both stock & flow (d) None

(9) When state of technology improves supply will : (a) Fall (b) Contract

(c) Increase (d) Not change


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(10) When the Govt. imposes taxes, supply will (a) Expand (b) Contract

(c) Increase (d) Decrease

(11) If the producer expects an increase in price of goods in the near future, then current supply will : (a) Fall (b) Rise

(c) Not changed (d) Become zero

(12) When supply price increases in the short-run, the profit of the producer –––––– (a) Increases (b) Decreases

(c) Remains constant (d) Decreases marginally

(13) In a very short period the supply : (a) Can be changed rapidly (b) Cannot be changed

(c) Can be increased (d) None

(14) A lower supply curve indicates : (a) Smaller supply (b) Larger supply

(c) Constant supply (d) None.

(15) When supply curve moves to right it means : (a) Supply increases (b) Supply decreases.

(c) Supply remains constant (d) none

(16) Which of the following statements is correct? (a) When the price falls the quantity demanded falls. (b) Seasonal changes do not affect the supply of a commodity. (c) Taxes & subsidies do not influence the supply of the commodity. (d) With lower cost, it is profitable to supply more of the commodity.

(17) Supply of a commodity rises with increase in price, if ………………….. remain same. (a) Cost of production (b) Technique of production.

(c) Price of other goods. (d) All of the above

(18) Consider supply function Qs = 50 + 2P. Find out amount of supply when price = 5.

(a) 40

(b) 60

(c) 50

(d) None

(19) If the supply curve of a product is Sx = 20 + 1.5Px. Find the supply corresponding to

market price of Rs.4 per unit:

(a) 16 (b) 26

(c) 18 (d) None

(20) When the supply curve of a product is Sx = 10 + 1.5Px. Find the aggregate market supply corresponding to market price of Rs.4 per unit if there are 1000 suppling in the market. (a) 10,000

(b) 18,000

(c) 16,000

(d) 15,000


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(Questions on Elasticity of supply)

(21) The elasticity of supply in defined as the :

(a) Responsiveness of the Quantity supplied of a good without change in its price.

(b) Responsiveness of the quantity supplied of a good to a change in its price.

(c) Responsiveness of the quantity demanded of good to change in price.

(d) None.

(22) Elasticity of supply is measured by dividing the percentage change in quantity

supplied of a good by _____________.

(a) Percentage change in income. (b) Percentage change in taxes

(c) Percentage change in price. (d) Percentage change in tastes.

(23) If the percentage change in supply is less than the percentage change in price it is called

(a) Unit elasticity of supply

(b) Less elastic supply

(c) More elastic supply

(d) Perfectly Inelastic supply

(24) Elasticity of supply as zero & infinite imply respectively :

(a) Perfectly elastic supply & es = 0

(b) Perfectly inelastic supply & es = ∞

(c) Imperfectly inelastic supply & es = 1

(d) None.

(25) A horizontal supply curve parallel to the quantity axis implies that the elasticity

of supply is:

(a) Zero

(b) Infinite

(c) Equal to one

(d) Greater than zero but less than one

(26) Commodities which are perishable in nature have …………………. Elastic supply.

(a) Less

(b) more

(c) Perfectly

(d) None

(27) The supply curve for perishable commodity is …………………………..

(a) Elastic

(b) Inelastic

(c) Perfectly elastic

(d) Perfectly inelastic

(28) Elasticity of supply for a positively sloping supply curve that starts from price

axis or origin is

(a) Zero (b) Greater than one


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(c) Lesser than one (d) Equal to one

(29) For a positively sloped straight line supply curve that intersects the price axis elas-

ticity is:

(a) Equal to zero

(b) Equal to one

(c) Greater than one

(d) Constant

(30) Any straight-line supply curve, which cuts the x-axis, will have:

(a) An elasticity greater than one.

(b) Unitary elasticity of supply

(c) An elasticity less than one.

(d) Zero elasticity of supply.

(31) If the quantity supplied is exactly equal to the relative change in price then the elas-

ticity of supply is:

(a) Less than one

(b) Greater than one

(c) one

(d) None

(32) Elasticity of supply is greater than one when :

(a) Proportionate change in quantity supplied is more than the proportionate change in price

(b) Proportionate change in price is more than the proportionate change in quantity supplied.

(c) Change in price & quantity supplied are equal.

(d) None.

(33) Which factor is not affecting the elasticity of supply

(a) Nature of the commodity

(b) Production line

(c) Estimates of future price

(d) Nature of after sales service

(34) As time period is more, the value of elasticity of supply is

(a) Less

(b) More

(c) No effect

(d) Both (a) and (b)

(35) For portraits & paintings of eminent artists the value of elasticity of supply is

(a) s

e 1

(b) s

e 1

(c) s

e 1

(d) None


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(Questions on Numerical Problems)

(36) If price of computers increases by 10% & supply increases by 25%. The elasticity of supply is (a) 2.5

(b) 0.4

(c) 3.5

(d) 0.4

(37) If the supply of a commodity falls by 20% due to decrease in price of the commodity

by 10%, then elasticity of supply will be:

(a) Elastic

(b) Unit elastic

(c) Perfectly elastic

(d) None

(38) The supply function is given as Qs = – 100 + 10 P. find the elasticity of supply, when

price is `15.

(a) 4

(b) – 3

(c) – 5

(d) 3

(39) The supply function is P = - 50 + 0.5Q. Find out elasticity of supply, When P = 10.

(a) 0.12

(b) 2

(c) 0.16

(d) None

(40) The supply function is given as Qs = - 500 + 20P. Find out elasticity of supply, When

P = 30.

(a) 3

(b) – 6

(c) 6

(d) None


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Five in one ENGEL’S CURVEY (ICC)

INCOME

Consumption curve

X

e=

0

e


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30 28 26 24 22 20 18 16 14 12 10 8 6 4 2

Y

0 1 2 3 4 5 6 7

MMU = P

X

Consumer Surplus P

rice &

MU

Quantity

In the above table and figure consumer is in equilibrium at the 6th unit because here MU = P i.e. ` 20 and in this way when he will consume 6 units then he is total ready to pay ` 150 (30+28+26+24+22+20) but total amount actually paid is ` 120 (20+20+20+20+20+20), So total consumer surplus will be 30 (150-120), which is maximum. Assumptions: The assumptions are same as mentioned in law of DMU. Limitations – 1. Consumer’s surplus cannot be measured because it is difficult to measure the MU. 2. In the cases of necessaries, the marginal utilities of the earlier units are highest. In such case the consumer’s surplus is always infinite. 3. CS is affected by the available of substitutes. 4. There is no simple rule of deriving the utility of articles of prestige value diamond [wa-ter-diamond paradox] 5. Mum does not remain constant and this assumption is unrealistic.

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