IB Economics - The Law of Supply and the Supply Curve

This study note for IB economics covers The Law of Supply and the Supply Curve

Definition:

• The law of supply states that, ceteris paribus, there is a positive causal relationship between the price of a good and the quantity supplied. As the price of a good increases, the quantity supplied increases, and as the price decreases, the quantity supplied decreases.

Positive Causal Relationship:

• Profit Motive: Higher prices provide an incentive for producers to supply more of a good because higher prices can lead to higher revenues and potentially higher profits.
• Cost Coverage: At higher prices, it becomes feasible for producers to cover the costs of production, making it worthwhile to increase output.

Individual Producer's Supply vs. Market Supply

Individual Supply:

• Refers to the quantity of a good that a single producer is willing and able to supply at various prices.

Market Supply:

• The total quantity of a good that all producers in the market are willing and able to supply at various prices. It is the horizontal summation of all individual supply curves.

Explanation:

• Aggregation: Market supply is derived by summing the individual supply of all producers at each price level. This reflects the overall supply in the market.

The Supply Curve

Definition:

• A supply curve is a graphical representation showing the relationship between the price of a good and the quantity supplied, ceteris paribus. It typically slopes upward from left to right, indicating a positive relationship.

Factors Changing Supply

1. Costs of Factors of Production:
   • Land: An increase in rent or land prices can decrease supply.
   • Labour: Higher wages can increase production costs and decrease supply.
   • Capital: Cost of machinery and equipment affects supply.
   • Entrepreneurship: Costs associated with managerial and organizational skills impact supply.

   Example: Rising wages in the tech industry can reduce the supply of software products due to higher production costs.

2. Technology:
   • Advances in technology can increase supply by making production more efficient and reducing costs.

   Example: The introduction of automation in manufacturing increases the supply of goods by reducing production time and costs.

3. Prices of Related Goods:
   • Joint Supply: When the production of one good also produces another good.
   • Competitive Supply: Goods that compete for the same resources.

   Example: An increase in the price of beef (joint supply) can lead to an increase in the supply of leather.

4. Expectations:
   • If producers expect higher prices in the future, they may reduce current supply to benefit from future higher prices.

   Example: Farmers might hoard grain if they expect prices to rise significantly due to future demand.

5. Indirect Taxes and Subsidies:
   • Indirect Taxes: Increase production costs, reducing supply.
   • Subsidies: Lower production costs, increasing supply.

   Example: A subsidy on solar panels increases their supply by reducing production costs.

6. Number of Firms in the Market:
   • More firms entering the market increase the overall market supply.

   Example: The entry of new smartphone manufacturers increases the total supply of smartphones.

Movements Along vs. Shifts of the Supply Curve

• Movement Along the Supply Curve: Caused by a change in the price of the good itself, resulting in a change in quantity supplied.

  Example: An increase in the price of coffee leads to a movement up the supply curve, increasing the quantity supplied.

• Shift of the Supply Curve: Caused by changes in non-price determinants of supply, leading to a new supply curve.

  Example: A technological advancement that reduces production costs shifts the supply curve to the right.

Real-World Examples

• Oil Supply: OPEC's production decisions influence the global supply of oil.
• Agricultural Products: Government subsidies can increase the supply of crops like corn and wheat.

Glossary of Key Terms

• Ceteris Paribus: A Latin phrase meaning "all other things being equal."
• Competitive Supply: Goods that compete for the same resources.
• Indirect Taxes: Taxes levied on goods and services rather than on income or profits.
• Joint Supply: Goods that are produced together.
• Market Supply: The total supply of a good from all producers in the market.
• Subsidies: Financial assistance granted by the government to encourage production.

Related Topics for Further Exploration

1. Price Elasticity of Supply: Measures the responsiveness of quantity supplied to a change in price.
2. Market Equilibrium: Understanding how supply and demand interact to determine prices and quantities.
3. Producer Surplus: The difference between what producers are willing to accept for a good and what they actually receive.
4. Government Intervention: The impact of taxes, subsidies, and regulations on supply.
5. Supply Chain Management: The coordination of production, inventory, location, and transportation among participants in a supply chain.

Worked Examples

Example 1:

• Supply Function: Qs = 30 + 10P
  • At P = 0, Qs = 30 + 10(0) = 30
  • At P = 2, Qs = 30 + 10(2) = 50
  • At P = 4, Qs = 30 + 10(4) = 70

Example 2:

• Supply Function: Qs = 50 - 5P
  • At P = 0, Qs = 50 - 5(0) = 50
  • At P = 5, Qs = 50 - 5(5) = 25
  • At P = 10, Qs = 50 - 5(10) = 0

Possible IB Economics Essay-Style Questions

1. Explain the law of supply and how it is represented by a supply curve. Provide real-world examples to support your explanation.
2. Discuss the factors that can cause a shift in the supply curve. Use diagrams and examples to illustrate your points.
3. Analyze the impact of technology on supply. How do technological advancements affect the supply curve?
4. Evaluate the effects of government intervention (taxes and subsidies) on the supply of goods and services. Provide specific examples.
5. Discuss the relationship between an individual producer’s supply and market supply. How does this relationship influence market outcomes?