All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Determinants of Supply
"Why do they do what they do?"

In every market there are buyers and sellers.  In the labor market individuals are the sellers who are offering their services, and firms looking for workers for their offices and factories are the buyers.  In the capital market people who save some of their income and put it in a savings account or a mutual fund are suppliers, and people who borrow funds to buy a car or a home are demanders. 

At this time, in an effort to make life easy, we are going to restrict our discussion to the output market where individuals are the demanders and firms are the suppliers.  If we are to understand supply, then we must 'get inside the heads' of those running the firms.  We must try to answer the question: what influences choices concerning the amount to supply?  The firm's choice regarding the amount of a good or service to supply depends upon a number of factors that affect either the number of sellers or the behavior of the sellers. A partial list of some of the important factors, including the nature of the relationship between each factor and supply, is provided below. 

For example, what will happen to supply if the price of inputs falls?  If we are Apple computer, what will happen to supply if the price of the computer chips fall.  If you are GM, what will happen to the supply of autos if workers receive a wage increase?   A supplier should be able to sell the same output at a lower price if the supplier's costs are down, while GM would be in a position to charge a higher price to cover additional costs associated with the wage increase.  In the first case we would be talking about an increase in supply, while in the second we would be talking about a decrease in supply.   In this situation we would characterize Apple's situation as an increase in supply since the decrease in the price of the input resulted in an increase in supply. 

The same would be true if there were an increase in productivity that allowed a firm to produce the same output with fewer inputs.  In this situation the firm's cost of production would decrease because fewer inputs were used.  The firm (supplier) would thus be able to sell more output at the same price - once again an increase in supply.  

When we are talking about the number of sellers we are talking about market structure - the main topic of the second part of the microeconomics course where we will talk about monopoly, oligopoly, and perfect competition.  At this time we can make the simplifying assumption that the number of sellers will also affect supply - an increase in the number of sellers will increase the supply as the new firms' output arrived in the market.  Other factors which we will not delve into now would be the motivation of the seller and the impact market structure has on the control individual firms would have over price. 

The final factor is price.  The supply of automobiles would be dependent upon the price of autos; the supply of rental units dependent upon the level of rents; the supply of oil dependent upon the price of oil.  We can expect an increase in price will prompt sellers to bring more to the market.  If you are a farmer deciding what crops to grow, when the price of wheat increases you can be expected to increase the land you devote to growing wheat.  As interest in American wine has grown and driven up the price, more land has been devoted to the cultivation of grapes.  This increased the supply of American wine.  If the price of mini vans falls as people shift from mini vans to sport utility vehicles (SUV), you could expect car companies to increase their supply of sport utility vehicles and decrease the supply of mini vans.  You could certainly see this in the late 1990s as a number of new SUV's came into the market (ex. Lexus and Mercedes). 

As you go through the analysis of supply - demand, you need to be sure you can differentiate between the change in quantity supplied caused by a change in price (movement on the curve) from the change in  supply caused by a change in any of the other factors (movement of the curve).

• Price of the Good
• Availability of Factors /Inputs
• Price of Factors /Inputs
• Productivity of Inputs
• Motivation of Supplier
  • (maximization of profit, growth, market share...)
• Market Structure number of buyers and sellers (+)
  • (monopoly, perfect competition, oligopoly...)

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