Supply
The quantity of a good or service a firm (or multiple firms) is willing and able to produce for a given price in a given time period, ceteris paribus.
While in the real world, suppliers can be households or firms, we will focus on the product market.
This means that the suppliers will be firms that are selling goods or services to consumers.
The Law of Supply: relationship between price and quantity supplied
Law of Supply
There is a direct, positive relationship between price and quantity supplied.
The law of supply originates from the fact that:
- Producers are willing and able to supply more goods when prices rise because higher prices generally lead to higher profit margins and revenues.
- Conversely, when prices fall, producers supply less because profitability decreases per unit of good.
Let's say a firm supplies apples at a price $1$.
- If the price rises to $2$, for example, then they earn more now because they earn $2$ instead of $1$ for each apple!
- This acts as an incentive (encourages them) for them to produce more goods.
Assumptions underlying the Law of Supply (HL Only)
The law of supply is built on two critical assumptions:
- The law of diminishing marginal returns.
- Increasing marginal costs.
Both these concepts explain why firms require higher prices to supply more output.
Distinguishing short-run and long-run in microeconomics
- The short run is a time period during which at least one input is fixed and cannot be adjusted.
- Fixed inputs are resources that remain constant in quantity and quality, such as buildings, factories, and heavy machinery. These inputs cannot be changed quickly to respond to increases in production.
- Variable inputs, contrarily, can be adjusted in the short run. These include labor, raw materials, and tools that can be increased or decreased as needed.
- As long as at least one input remains unchanged, the firm is considered to be operating in the short run.
- The long run is a time period during which all inputs can be adjusted.
- In the long run, firms have the flexibility to expand or reduce all types of inputs, including fixed ones like factory size or machinery.
- In this period, firms can engage in large-scale adjustments such as constructing new facilities, upgrading machinery...
- If all input can be changed, the firm is considered to be operating in the long run.
In the short run, a firm aiming to increase production can hire more workers, but it cannot immediately expand the size of its factory.
However, in the long run, a firm can build additional factories, move to a larger production site, or upgrade to more advanced technology...
The Law of Diminishing Marginal Returns
Law of Diminishing Marginal Returns
As additional units of a variable input (e.g., labour) are added to fixed inputs (e.g., land), the marginal product increases by less and less each time, eventually decreasing.
Marginal Product
The additional output that results from adding one extra unit of a variable input (e.g., labour).
When firms add one more unit of variable input, the marginal product initially increases. This is because:
- Improved resource utilisation: adding variable inputs allows firms to better utilise existing fixed inputs.
- More specialisation: workers can divide tasks more efficiently, leading to higher productivity per unit of input.
In the beginning, more variable input leads to even more output.
