Supply, elasticity, and market equilibrium

We’ve already covered demand and the key points you need for the BA1 exam. Supply is also affected by expansion and contraction, and price links demand and supply in opposite ways:

• When price rises, quantity supplied rises (supply expands) and quantity demanded falls (demand contracts).
• When price falls, quantity supplied falls (supply contracts) and quantity demanded rises (demand expands).

Elasticity of supply uses the same calculation methods as demand elasticity. The key difference is the sign — supply elasticity answers are typically positive (e.g. $+2.5$), while demand elasticity answers are typically negative. The interpretation is the same: the larger the number, the more responsive quantity is to a change in price.

Factors affecting the elasticity of supply

Availability of buffer stock

Definitions

Buffer stock

Extra inventory a firm keeps so it can respond quickly to higher demand.

If a firm holds buffer stock, it can release inventory into the market when demand rises, helping it respond without increasing production. This makes supply more elastic.

Example:

If demand increases by $10,000$ copies, a firm with buffer stock can release existing inventory to help meet that demand immediately.

Number of players in the market

In a monopoly, one firm controls supply and may struggle to respond quickly to rising demand. Where many firms compete, what one cannot supply, another can — making total market supply more elastic.

Spare capacity

Definitions

Spare capacity

The ability of a firm to increase output using existing resources, such as unused machinery time or available labour hours.

Spare capacity works similarly to buffer stock, though increasing production typically takes longer than releasing inventory. Firms with spare capacity can scale output to meet rising demand, which increases supply elasticity.

Seasonal factors

Some products are seasonal, so supply changes with the time of year. In agriculture, once crops are harvested, suppliers often have to bring them to market regardless of price — otherwise the goods spoil. This makes supply inelastic in the short term during harvest seasons when surpluses occur. During shortage seasons, suppliers may hold back supply while waiting for prices to rise to desired levels.

We’ll now look at shifts in supply (left or right). Here, it’s important to separate two ideas:

• A movement along the supply curve is caused by price changes (expansion or contraction).
• A shift of the supply curve is caused by non-price factors.

Sidenote

Remember this!

A rightward shift means an increase in supply. A leftward shift means a decrease in supply.

Factors causing a rightward shift in supply (increase)

Technological innovation

When firms adopt better technology, they can produce more output with the same inputs, or the same output at lower cost. This increases supply.

Availability of training facilities

In markets with strong training systems, skilled labour is more available, which supports higher and more consistent levels of production.

Example:

German car manufacturers benefit from strong technical training in their workforce, which supports high levels of car supply.

Cheaper cost of production

If the cost of raw materials or other production inputs falls, firms can produce more profitably, which typically increases output and expands supply.

Government subsidies or grants

When the government covers part of a firm’s production costs through subsidies or grants, production becomes cheaper. Lower costs make it more viable to produce more, increasing supply. Some governments also reduce or remove taxes on suppliers, which has a similar effect.

Factors causing a leftward shift in supply (decrease)

High production costs

Higher production costs reduce profitability. Firms may respond by producing fewer units, reducing supply.

The other factors that decrease supply are generally the reverse of those that increase it — for example, outdated technology, lack of skilled labour, or the removal of subsidies.

Example:

During the conflict between Russia and Ukraine, concerns about resource availability contributed to higher global commodity prices. Rising input costs reduce profitability and can lead firms to cut output.

Equilibrium point

Definitions

Equilibrium point

The point where quantity demanded equals quantity supplied — where the demand curve and supply curve intersect.

Illustration

KTA owns a rare 1910 car he wants to sell, so he takes it to an auction house. The auctioneer opens bidding at $\$5,000$ and $20$ people are willing to buy. The price rises to $\$10,000$ — $15$ people remain. At $\$25,000$, only $3$ people are still interested. At $\$40,000$, just $1$ buyer remains, and the car is sold.

Lesson:
The demand at first was $20$ vs supply of $1$. This means there was excess in demand but when the price was raised to $\$40,000$ the demand then matched supply, this is the point that is called the equilibrium point where demand and supply are exactly the same.

What causes an equilibrium point to move?
If the equilibrium point is moving along the curve, it means that it’s being caused by contraction and expansion. In our previous example, we saw that the equilibrium was reached at $\$40,000$. In a general business environment, when the price is raised supply doesn’t remain the same, it will increase because suppliers will make more profit when they sell their products at a higher price. Which means that the equilibrium point can move along the supply curve or the demand curve up or down. This will depend on if the factors causing the movement in equilibrium point are supply related or demand related.

An equilibrium point can shift from one point to another point which is now caused by either the conditions of supply or conditions of demand. Keep in mind if the equilibrium is moving along the same curve that’s just price affecting it, but the moment it moves from curve $1$ to curve $2$, regardless of if its demand or supply, those are other factors causing that to happen.