No Such Thing as a Free Lunch: Principles of Economics (Part 14)

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

Warren Buffett

Demand, Supply, and Market Equilibrium

(Part F)

by

Charles Lamson

Shift of Supply versus Movement along a Supply Curve

A supply curve shows the relationship between the quantity of a good or service supplied by a firm and the price that good or service brings in the market. Higher prices are likely to lead to an increase in quantity supplied, ceteris paribus. Remember: The supply curve is derived holding everything constant except price. When the price of a product changes ceteris paribus, a change in the quantity supplied follows---that is, a movement along the supply curve takes place. As you have seen in previous posts, supply decisions are influenced by factors other than price. New relationships between price and quantity supplied come about when factors other than price change, and the result is a shift of the supply curve. When factors other than price cause supply curves to shift, we say that there has been a change in supply. 

Increases in input prices may also cause supply curves to shift. If Farmer Brown faces higher fuel costs, for example, his supply curve will shift to the left---that is, he will produce less at any given market price. If Brown's soybean supply curve shifted far enough to the left, it would intersect the price axis at a higher point meaning that it would take a higher market price to induce Brown to produce any soybeans at all. 

As with demand, it is very important to distinguish between movements along supply curves (changes in quantity supplied) and shifts in supply curves (changes in supply):

From Individual Supply to Market Supply

Market supply is determined in the same fashion as market demand. It is simply the sum of all that is supplied each period by all producers of a single product. Figure 8 derives a market supply curve from the supply curves of three individual firms. (In a market with more firms, total market supply would be the sum of the amounts produced by each of the firms in that market.) As the table in Figure 8 shows, at a price of $3 farm A supplies 30,000 bushels of soybeans, farm B supplies 10,000 bushels, and farm C supplies 25,000 bushels. At this price, the total amount supplied in the market is 30,000 + 10,000 + 25,000 or 65,000 bushels. At a price of $1.75, however, the total amount supplied is only 25,000 bushels (10,000 + 5,000 + 10,000). The market supply curve is thus the simple addition of the individual supply curves of all the firms in a particular market---that is, the sum of all the individual quantities supplied at each price.

The position and shape of the market supply curve depend on the positions and shapes of the individual firms' supply curves from which it is derived. They also depend on the number of firms that produce in the market. If firms that produce for a particular market are earning high profits, other firms may be tempted to go into that line of business. When the technology to produce computers for home use became available, literally hundreds of new firms got into the act. The popularity and profitability of professional football has three times led to the formation of new leagues. When new firms enter an industry. The supply curve shifts to the right. When firms go out of business, or "exit" the market, the supply curve shifts to the left. 

*MAIN SOURCE: CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 57-60*

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