The compilation of these The Theory of Firm Under Perfect Competition Notes makes students exam preparation simpler and organised.
Determinants of a Firm’s Supply Curve and Market Supply Curve
As students of the Indian economy, you must be aware of the new taxation policy under GST. This development altered the market prices of various products. But do you know that for the products whose taxes were decreased, their respective producers pumped up their production? Let us understand this by studying the determinants of the market supply curve.
Revisiting the Supply Curve
A supply curve is the graphical representation of a firm’s behaviour under market conditions. Technically, the supply curve is the graphical representation of a supply schedule. Alternatively, the supply curve is also the graphical representation of the law of supply. The law of supply states the direct relationship between price and quantity supplied, keeping other factors constant (ceteris paribus).
Recollect that, unlike a demand curve, the supply curve slopes upwards from left to right, which indicates a direct relationship between the price of a commodity and its quantity supplied.
Note that there are two types of supply curves- a firm’s supply curve and the market’s supply curve. We will study determinants for both in separate sections.
Determinants of Firm’s Supply Curve
We already know that the principal factor affecting the supply of a commodity is definitely its price. However, there are loads of other factors that are determinants of the supply curve and can alter it drastically. Since price is one of the major determinants of the supply curve, the factors governing supply are classified as ‘factors other than price’ and ‘price’. It’s time to explore these factors.
Price
Undoubtedly, the price is the puppet master of supply. The law of supply talks about this essential relationship. Notably, there exists a direct relationship between the price of a commodity and its quantity supplied. Simply put, as the prices increase, the quantity supplied also increases and vice-versa. This happens because at higher prices the firms stand a bigger opportunity to earn good profits.
Factors other than Price
Prices of Other Goods
A given resource can probably be employed to produce more than one good. Hence, a producer has to choose between the production of two or more two goods. Of course, the motive to increase profits induces this choice. Hence, a change in the price of a product alters its profitability, which in turn affects the supply of a given product.
Substitute goods are the ones that can be used in place of each other or are replaceable. For example, coffee and tea. There is an inverse relationship between price and quantity supplied of substitute goods. Suppose the price of coffee increases. This would induce the firms to increase the supply of coffee, eyeing the greater profit-earning opportunities. This further means that in order to increase the supply of coffee, the supply of its substitute good i.e. tea is decreased.
Prices of Factors of Production
Prices of factors of production are inversely related to the supply of a commodity. The prices of factors of production form a major chunk of the cost of production. The lower is the cost of production, the more will be the chances of profit maximization. An increase in the cost of production decreases the profitability, which in turn induces the firms to cut down supply.
For example, ice cream production involves the use of a wide variety of inputs like cream, sugar, machine etc. An increase in the price of any combination of these inputs decreases the supply of ice cream and vice versa.
Other Significant Factors
Government Taxation Policy
The incidence of change in taxes is inversely felt on the supply of a product. As the government increases the taxes, the profit margin of the product goes down. This, in turn, makes the producer decrease the supply. On the contrary, tax concessions and subsidies are tools generally used by the government to increase the supply of certain products as such measures ensure an increased profit margin for the suppliers.
State of Technology
The state of technology is an important determinant of supply. The state of technology controls the cost of production and quality of products. Effectively, an improvement in the state of technology reduces the cost of production and increases the profit margin. This signals an opportunity for the producers to increase the supply. Conversely, technological degradation increases the cost of production as a result of which producers decrease the supply.
Objectives of the Firm
According to the law of supply, the supply of a commodity increases with its price. However, some firms are ready to supply more even at prices that do not ensure profit maximization. The reason behind this move is to capture extensive markets and establish themselves as major players in the market.
Determinants of the Market Supply Curve
Note that all the factors that affect a firm’s supply curve also affect a market’s supply curve in a similar way. However, when talking about the market in general some other determinants also jump into the scene. These are as follows:
Number of Firms in the Market
The market supply is the sum total of individual contributions to supply. As a result, if the number of firms in the market increase, the total supply or the market supply will definitely rise. In contrast, if some firms decide to cease their part of the supply, the market supply will decrease.
Future Expectations regarding Price
Sellers tend to mobilize their supply based on future expectations. This is done to increase their chances of earning a greater profit. If sellers expect a rise in price, they will cut short the supply to hold back their product and will raise the supply when the prices rise, Conversely, if they expect a fall in prices, they would open up the tap of supply to avoid selling products at low prices in future and hence trying to avoid losses.
Transportation and Communication
Proper infrastructural developments like improvement in means of transport and communication, help in maintaining an adequate supply of the commodity.
Example:
Question:
Explain the relationship between the supply of a product and the price of factors of production.
Answer:
The factors of production directly affect the cost of production of a commodity. An increase in the cost of production pulls the profit margin down and vice versa. In the light of such conditions, the price of factors of production is inversely related to the supply of a product.