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Topic: Concept Of Supply
Lesson Objectives: At the end of the lesson, learners should be able to:
- Define the term elasticity of supply;
- List and explain the types of price elasticity of supply with diagrams;
- Explain the phenomenon of shift or change in supply;
- Carryout simple computation given the demand and supply equations.
Elasticity of supply
Elasticity of supply may be defined as the degree of responsiveness of supply to little changes in the price of a commodity.
Elasticity of supply measures the extent to which the quantity of a commodity supplied by a producer changes as a result of a little change in the price of the commodity.
Types Of Price Elasticity Of Supply
i. Elastic supply: Supply is said to be elastic if a small change in price leads to a greater change in the quantity of goods supplied. In this case, elasticity is greater than one or unity, i.e E =>1< infinity. This type of elasticity is also known as fairly elastic.
Fig. 1: Elastic Or Fairly Elastic Supply Curve
ii. Inelastic supply: Supply is said to be Inelastic if a large change in price leads to a smaller or a slight change in quantity of goods supplied. In this case, elasticity is less than one but greater than zero.
Fig 2: Inelastic supply curve
iii. Unity or Unitary elastic supply: Supply is said to be Unitary when a change in price leads to an equal change in the quantity of goods supplied. In other words, a 5% change in price will lead to a 5% change in supply. In this situation, elasticity is equal to one, i.e E = 1.
Fig 3: Unitary elastic supply curve
iv. Perfectly elastic supply or infinitely elastic supply: Supply is said to be perfectly elastic when a change in price brings about an infinite effect on the quantity of goods supplied. In other words, a slight increase in price can make producers to increase the supply of the commodity while a slight decrease in price will make producers to stop the supply of the commodity. In this
case, elasticity is equal to infinity.
Fig 4: Infinitely or perfectly elastic supply curve
V. Perfectly Inelastic Or Zero Elastic Supply: Supply is said to be perfectly inelastic if a change in price has no effect whatsoever on the quantity of goods supplied. In this situation, elasticity is equal to zero, i.e E = 0.
Fig 5: Zero or perfectly Inelastic supply curve
Measurement Of Elasticity Of Supply
Elasticity of supply can be measured or calculated by using the co-efficient of price elasticity of supply. The formula used in calculating the Elasticity of supply is:
As explained earlier, when:
(a) Elasticity is equal to one, elasticity of supply is unity.
(b) Elasticity is greater than one, elasticity of supply is elastic.
(c) Elasticity is less than one, elasticity of supply is inelastic.
At #10.00 per tuber yam, 24 tubers we’re supplied and when the price increased to #12.00 per tuber, 30 tubers were supplied.
(a) present the above data in a table
(b) calculate the co-efficient of price elasticity of supply
(c) what type of elasticity is this and how did you arrive at your conclusion
(c) The co-efficient of elasticity of supply is elastic. This is because the elasticity is greater than one.
Factors Affecting Elasticity Of Supply
i. Cost of production: Other things being equal, low cost of production normally results in elastic supply and vice versa
ii. Nature of commodity: While durable commodities are Inelastic due to their nature, perishable ones are elastic in the supply.
iii. Cost of storage: Producers will supply all their commodities to the market if the cost of storage is very high thereby making the supply to be elastic and vice versa.
iv. Time: This relates mainly to agricultural products which remains for a long time in the farm before they are harvested. Before their harvest, their supply is Inelastic but after harvest, it becomes elastic.
v. Market discrimination: Elasticity of supply of a commodity depends on where it is sold. When few commodities are sold at a particular location ad a result of lower prices, such commodity can be taken to another location where the prices are higher. In this case, supply is elastic and vice versa.
vi. Availability of storage facilities: The availability of storage facilities leads to Inelastic Supply after harvest while non-availability leads to elastic supply.
Determination Of Price By Demand And Supply
In a perfectly competitive or free market economy, prices are determined by the interaction of the forces of demand and supply. The determination of prices by the interaction of the forces of demand and supply. The determination of prices by the interaction of the forces of demand and supply is what is referred to as the price system or price mechanism.
As explained from the laws of demand and supply, it is known that the higher the price, the lower the quantity demanded while the lower the prices, the higher the quantity of commodity demanded. On the other hand, the higher the price, the higher the quantity supplied. But there will be a price at which the quantity demanded equals the quantity supplied. This is known as the equilibrium price.
Equilibrium price is that price at which the quantity demanded is equal to the quantity of commodities supplied. The point where the demand curve meets the supply curve is called Equilibrium position or point. The quantity demanded and supplied at equilibrium price is called equilibrium quantity. Under this condition, both producers and consumers can be satisfied and there will be no pressure on price. Market equilibrium can be explained better by a schedule and a graph below:
Table 1: Market Demand And Supply Schedule For Yam
Fig 6: Equilibrium price of yam
From the table and graph above, it is seen that at #15.00, 60kg of yam was demanded and 60kg of yam was equally supplied. #15.00 is the equilibrium price while 60kg is the equilibrium quantity and the point of intersection is between supply curve and demand curve is called equilibrium point.
Shortage, Surplus And Equilibrium Price
Price tends towards the level which equates supply with demand
i. Price of goods is determined by the interaction of the forces of demand and supply.
ii. If the price is at a level where supply is less than demand, then there will be excess demand which may increase the price, e.g the portions under the price of #15.00 in the graph.
This situation represents shortage. When there is a problem of shortage, the seller may want to increase the price or buyers may want to buy more of the commodities.
iii. When the prevailing market price of a commodity is higher than the equilibrium price, then supply will definitely be higher than demand and the market will experience excess supply resulting in a situation which represents surplus. Under this situation, the seller will be interested to reduce the price to enable him sell more goods. Excess supply, which results in surplus, usually occurs in portions above #15.00.
iv. In summary, buyers raise the price during the period of shortage in order to buy while the sellers reduce the price during the period of surplus in order to sell. This market interaction or activity leads to equilibrium point where the sellers and buyers will be willing to supply and buy at a given price over a period of time.
Supply and Demand Schedule
Table 2: Demand And Supply Schedule
Use the schedule above to answer the following questions;
(a) At what price and quantity does the market attain equilibrium and why?
(b) At what price does the market exhibit excess demand and by how many units?
(c) At what price does the market exhibit excess supply and by how many units?
(d) At what price will the supplier be willing to sell most? What quantity will he be willing to sell at that price?
(a) Equilibrium price is the price at which the quantity demanded equates quantity supplied. The equilibrium price is 7. The equilibrium quantity is 300 units.
This is because at that price of 7, the quantity of demanded was equal to the quantity supplied.
(b) Excess demand arises at price 5 and 6
At 5 = 500 – 60 = 440 units
At 6 = 400 – 150 = 250 units
(c) Excess supply at prices 8, 9 and 10
At #8, = 400 – 250 = 150 units
At #9, = 500 – 150 = 350 units
At #10, = 600 – 50 = 550 units
(d) The supplier will be willing to sell most at price #7. The quantity is 300 units.
Concept of Equilibrium
Equilibrium is a situation which occurs when there is a balance between quantity demanded and supplied. It represents a situation where there is no tendency to change. The price which equates demand with supply is equal to equilibrium price. The existence of equilibrium price gives rise to the third law of demand and supply which states that: ” The equilibrium pro is that price which equates demand with supply”.
However, a temporary deviation either in the form of shortage or surplus has to be corrected by the forces of demand and supply, which are capable of restoring equilibrium to its normal position. Changes in demand and supply lead to price changes. Once there is a change in either demand or supply, the initial equilibrium will be disrupted and a new equilibrium will be created.
Changes in equilibrium
Changed in equilibrium are caused by the same factors that cause changes in demand and supply. They include;
Fig 7: Effect of increase in demand on equilibrium
i. Increase in demand: If the demand for a commodity increases while supply remains constant, there will be an excess demand over supply. This will lead to an increase in the equilibrium price of the commodity as well as an increase in the equilibrium quantity.
In fig 7, there ia a shift in the demand curve to the right due to increase in demand. It shifted from D1D1 to D2D2 and the price increased from P1 to P2. The new equilibrium position is at the price P2 and quantity Q2.
ii. Decree in demand: If the demand for a commodity decreases while supply remains constant there will be an excess of supply over demand. This results in decrease in the equilibrium price and quantity of the commodity.
Fig 8: Effect of decrease in demand on equilibrium
In fig 8, with a decrease in demand, the demand curve shifts to the left from D1D1 to D2D2 and price decreases from P3 to P2. The new equilibrium position is at the price P2 and quantity Q3.
Note: The increase and decrease in demand as explained above give rise to the fourth law of demand and supply, which states that “An increase in demand will cause an increase in both the equilibrium price and quantity supplied, while a decrease in demand will cause both the equilibrium price and the quantity supplied to fall”.
iii. Increase in Supply: If supply increases while demand remains constant, there will be an excess of supply over demand. This will bring about a decrease in the equilibrium price of the commodity and an increase in the equilibrium quantity.
Fig 9: Effect of an increase in supply on equilibrium
In the above figure, an increase in supply makes the supply curve to shift to the right from S1S1 to S2S2 and the price to fall from P2 to P1. Here, the new equilibrium position is at the price P1 and quantity Q2.
Iv. Decrease in supply: A decrease in supply without any change in demand will lead to an excess demand over supply making the equilibrium price to increase and a decrease in equilibrium quantity.
Fig 10: A Leftward shift In Supply Curve
The above figure shows that the supply curve shifts to the left from S1S1 to S2S2. The price increases from P1 to P2. The new equilibrium position is at the price P2 and quantity Q1.
Note: The increase and decrease in supply as explained above give rise to the fifth law of demand and supply, which states that: “An increase in the supply of a commodity will cause the equilibrium price to fall and the quantity demanded to increase, while a decrease in supply will cause the equilibrium price to rise but the quantity demanded to fall”.
Price legislature is also known as price control policy, refers to how the government or its agency fixes the price of essential commodities. Price control was carried out in Nigeria by the Price Control Board.
Types Of Price Control Policy
1. Minimum price control policy: The minimum prices are the lowest prices by law below which the specified goods and services cannot be sold or bought. Minimum prices may be fixed on commodities if the aim is to protect Producers (especially agricultural producers) from the income fluctuations brought about by poor harvests.
2. Maximum price control policy: A maximum price control is the highest price level above which goods and services cannot be sold. Under this condition, nobody is allowed to sell goods and services above the maximum price but selling below is allowed.
Objectives Of Price Control Policy
The objectives of price control policy, both minimum and maximum, are:
i. To prevent the exploitation of consumers by producers.
ii. To avoid or control inflation.
iii. To help low income earners, e.g minimum wage earners
iv. To control the profits of companies (especially Monopolists).
v. To prevent fluctuation of prices of some products, e.g agricultural produce.
vi. To stabilize the income of some producers, e.g farmer’s.
vii. To make possible planning for future output.
Effects of price control policy
i. It stimulates excess demand, which cannot be satisfied, i.e shortage in the market.
ii. It encourages hoarding of commodities by wholesalers and retailers.
iii. It leads to the creation of “black market” or undercounter sales and its attendant high prices.
iv. It encourages conditional sales of products.
v. It discourages shortages, which might result in queues and racketeering.
Mathematical Approach To Demand And Supply Functions
Demand and Supply Functions can be discussed with the aid of mathematical equations. Linear and simultaneous equations are used to solve problems associated with demand and supply functions.
Given that quantity demanded per period of time is a function of price and that the relation is expressed as: Q = 60 – 1/3P, where Q is quantity demanded and P is the price.
(a) find the quantity demanded when price is;
i. #30.00 ii. #210.00 iii. #0.00
(b) Comment on (aii) above
(c) Suppose the relation is now expressed as P = #(180 – 3Q); find P when Q is:
i. 0 ii. 60 iii. 59
(b) In (aii) above, the law of demand comes into play here. The law demand states that “The higher the price, the lower the quantity demanded”. This explains why the price ia as high as #210, and consumers are not willing to buy more.
Done studying? See all previous lessons in Economics
i. What is price elasticity of supply?
ii. Explain the types of price elasticity of supply with diagrams.
iii. Explain the phenomenon of shift or change in supply.
iv. What do you understand by abnormal supply?
v. Given the demand and supply equations:
Qd = 55 – 1/3P and Qs = 10 + 2/3P
Where Qd = Quantity demanded, Qs = Quantity supplied, and P = Price
(Ai) the equilibrium price
Aii. The equilibrium quantity
(B) If the price falls to #15, what will be the excess demand?
(C) If the price rises to #60, what will be the excess supply?
Questions answered correctly? Kudos!!
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