Economics 101: Supply
Supply and Demand is the most fundamental concepts in economics. If you can fully grasp the concepts of supply and demand you will be able to understand many more “complex” economic theories.
In a previous story, I detailed the basics of demand. Here is a quick recap of what I covered in that story.
Factors that impact the demand for a product include;
- Peoples income
- Price of the product
- Government Intervention (think sugar taxes)
- Price of a competitor’s product
- Price of complementary product
- Price of substitute products
- Change in consumer preferences
Movements Along the Supply Curve
How do coffee companies decide how much coffee to produce? One of the driving factors is, of course, the market price coffee can be sold for. This can be best understood by looking at the supply curve below.
- On the vertical axis, we have the price of coffee
- On the horizontal axis, we have the quantity of coffee that coffee companies are willing to produce.
- The supply curve demonstrates the relationship between the price of coffee and the quantity of coffee supplied.
- When coffee is priced at $2 per unit, coffee producers are willing to produce 4 units of coffee. When Coffee rises to $6 per unit, producers are willing to provide 12 units of coffee.
- Holding other factors constant, the higher the price the more producers are willing to supply to the market.
- The reverse is also true, the lower the price the fewer producers are willing to supply to the market place.
- Changes in price will cause movements along the supply curve.
Shifts in The Supply Curve
It makes perfect sense why changes in price would impact the number of units’ producers are willing to supply to the marketplace. The higher the price, the more money they can make from selling more units.
Price is not the only factor that will determine the number of units’ producers are willing to supply to the market place. Other factors include;
- Cost of production
- Natural disasters
- Technology changes
These factors will change the number of units’ producers are willing to provide to the market place at ANY price. This is represented by a shift in the supply curve.
Going back to our coffee example, let’s assume the cost to produce coffee falls. What will that mean for the number of units’ coffee companies are willing to supply to the market?
Since it has become less expensive to produce coffee, companies will be willing to sell more coffee at every price point (if they can make a profit).
This is represented as a shift of the supply curve to the right from S1 to S2 as illustrated below.
- At the original cost of production (S1) when the market price of coffee was $6 coffee companies were willing to sell 12 units of coffee. When the price fell to $2, they were only willing to sell 4 units.
- When the cost to produce coffee falls (S2) coffee companies have a higher profit margin and are willing to sell more coffee at any price.
- When the price of coffee is at $6 coffee companies are now willing to sell 14 units of coffee. When the price falls to $2 they are willing to sell 6 units of coffee.
- When the Supply Curve shifts to the right (S2) companies are willing to sell more units then they were previously willing to sell (S1) at every price point.
- The opposite is also true. If the cost to produce coffee increases, coffee companies would be willing to sell fewer units of coffee at every price point.
Two major takeaways
- Changes in price cause movements up and down the supply curve
- Changes in factors such as the cost of production shift the entire supply curve to the right (increased supply at any price) or the left (decreased supply at any price)