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Discover the relationship between the quantity of a good or service that is produced and its price. This lesson explains the supply side of a market, including the factors that lead to a shift in supply.

The Upward-Sloping Supply Curve

We’re talking about the upward-sloping supply curve.

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In order to do so, let’s use cake as an example, since that’s exactly what I’m wishing I was eating right at this moment.Imagine that your next door neighbor Mandy is a cake boss. Her business, Mandy’s Cake Walk, makes cakes all day long for a profit – they make chocolate cakes, vanilla cakes, and ice cream cakes. Sounds good, huh? They make fancy wedding cakes, and they also make cakes shaped like a volcano that sell in the grocery store. One time, they even made a cake in the shape of the Leaning Tower of Pisa. The challenge was that the ingredients in the cake were not as strong as the materials in the tower and the cake tower fell over on top of Bob, who owns a well-known lawn-cutting business. The only way to see that cake is by looking in your neighbor’s photo album!So let’s talk about the supply of cakes and what happens to it under different circumstances – but first, a general principle.

The nature of supply in almost any market is as follows:The greater the price of a good or service is, the greater the quantity that will be supplied.If the price of a good or service goes up, the supply for it will also go up, and if the price goes down, the supply of it will decrease. How do we know this? Because we can look at a supply schedule, which is a table that illustrates the quantity supplied for a good or service at different prices. For example, the supply for cakes throughout the whole economy can be seen by looking at the market schedule for cakes, and here it is:

Market Supply Schedule for Basic Round Cakes
$15 100,000 cakes per week
$20 150,000 cakes per week
$25 175,000 cakes per week
$30 180,000 cakes per week

As you can see, at a price of $15 per cake, cake suppliers are willing and able to supply 100,000 cakes.

However, at a price of $30, they’ll have a much higher profit potential and would be willing and able to supply as many as 180,000 cakes.

The Supply Curve Comes from the Supply Schedule

In economics, we illustrate supply using the upward-sloping supply curve, which is a graph that illustrates the relationship between price and quantity supplied for a good or service. The supply curve is a visual representation of the supply schedule, which shows quantity supplied at different prices.If we’re talking about cakes, then we take the supply schedule for cakes and use it to create the supply curve for cakes.

Here’s the corresponding supply curve taken directly from the supply schedule. Notice that a change in price results in movement along the supply curve.

The supply curve illustrates the market supply schedule for cakes
Upward Sloping Supply Curve Cakes

Supply Shifters

Let’s talk about supply shifters now.

Factors besides price that cause a shift in supply, whether it’s an increase or a decrease, are called supply shifters. The factors that lead to a shift in the supply curve are not related to the buyers of a good or service; they’re related to the suppliers of the good or service, so they’re mostly about the production process. Supply shifters include:

  • Prices of inputs
  • Technology
  • The number of sellers in the market
  • Returns from alternative activities
  • Seller expectations
  • Natural disasters

Let’s look at an example of each one of these supply shifters using Mandy’s Cake Walk.When the price of inputs change, this generally leads to a change in supply. Last year, Mandy’s Cake Walk paid $1 for a dozen eggs, which is one of the most expensive ingredients in a cake. However, this year, the price of eggs rose to $2 per dozen – a 100% increase. Since eggs are an input to the cake production process, the price of that input really matters.

When the prices of inputs go up, the profit potential goes down, decreasing supply. Assuming all other things are equal, Mandy will want to produce fewer cakes when the profit potential goes down.Now imagine that Mandy sees an online news story about the price of eggs and learns that prices are expected to go up by 20% overnight. What’s she going to do when she hears this news? Mandy grabs her purse, gets into her car, and heads over the store as quickly as possible so she can buy extra eggs before the price goes up.

This is what we call seller expectations.Mandy also has special ovens that enable her to bake two cakes per oven at the same time. But Ray, an oven salesman, shows up at Mandy’s door and offers her a new and improved oven that enables her to bake five cakes per oven.

Wow! This is an example of improvements in technology. If Mandy buys the new oven, this improvement means her business can supply even more cakes to the market.Now let’s say that it’s been six months since Mandy has been selling cakes all over town.

She’s been in the newspaper and she’s also been on TV. Bob, a local businessman, still remembers the time when a Leaning Tower of Pisa cake fell on him in public, and although it was something that he’d like to forget, he did taste the cake and loved it, and so did Bob’s wife, Linda. With Bob’s help, Linda starts a cake business and competes with Mandy. The number of people who demand cakes throughout the year hasn’t changed; in fact, nothing has, except that there are now two cake suppliers instead of one, which means that the supply of cakes just went up. An increase in the number of suppliers leads to an increase in the supply.One day, Mandy wakes up and realizes that the price of soup has risen by 50%. She’s been baking cakes for a long time, but she realizes that she could be earning a much higher profit by making soup instead.

This is what we call the returns from alternative activities, and it also leads to a shift in supply. Mandy will probably choose to make fewer cakes so she can make and sell soup to increase her profit. She may choose to completely give up the cake business and pursue making soup since Bob’s wife Linda decided to start making cakes and compete with her.

So, in the end, the supply of cakes goes down because of the return on an alternative activity, which, in this case, is soup.Two months later, let’s say, a major storm comes through town and destroys half of Mandy’s cake ovens and equipment. What a terrible thing.

This natural disaster decreases her ability to produce cakes, which will decrease the supply of cakes in the market, at least until Mandy can get back on track. Thankfully, Mandy had a great insurance policy to cover her business, so she’s up and running again within three months.You can begin to see now how each one of these things will affect and shift the supply curve.

Summary

To summarize what we’ve talked about in this lesson, the nature of supply in almost any market is as follows:The greater the price of a good or service is, the greater the quantity that will be supplied.If the price of a good or service goes up, the supply for it will also go up, and if the price goes down, the supply of it will decrease.

This is shown by the upward-sloping supply curve, which is a graph that illustrates the relationship between price and quantity supplied for a good or service. The supply curve is a visual representation of the supply schedule, which shows quantity supplied at different prices.Factors that lead to a shift in supply are called supply shifters, and they’re related to the suppliers of the good or service, so they’re all mostly about the production process. Supply shifters include:

  • Prices of inputs
  • Technology
  • The number of sellers in the market
  • Returns from alternative activities
  • Seller expectations
  • Natural disasters

Lesson Objectives

By the end of this lesson you’ll understand the relationship between the quantity of a good and its price. You’ll also recognize factors that contribute to supply shifts.

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