Supply and Quantity Supplied, Law of supply, Market Supply Curve

Ø Supply and Quantity Supplied:

To set the stage for an understanding of this difference, take note of two related concepts:

• Quantity Supplied: Quantity supply is a specific quantity that sellers are willing and able to sell at a specific supply price. It is but ONE point on a supply curve.
• Supply: Supply is the range of quantities that sellers are willing and able to sell at a range of supply prices. It is ALL points that make up a supply curve.

• Change in Quantity Supplied: A change in quantity supplied is a change from one price-quantity pair on an existing supply curve to a new price-quantity pair on the SAME supply curve. In other words, this is a movement along the supply curve. A change in quantity supplied is caused by a change in price.

Change in Supply: A change in supply is a change in the ENTIRE supply relation. This means changing, moving, and shifting the entire supply curve. The entire set of prices and quantities is changing. In other words, this is a shift of the supply curve. A change in supply is caused by a change in the five supply determinants.

Ø Market Supply Curve:

Economists distinguish between the supply curve of an individual firm and between the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus, in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the  market supply curve.

    Ø Supply curve: 

The supply curve is a graphical representation of the relationship between the price of a good or service and the quantity supplied for a given period of time. In a typical representation, the price will appear on the left vertical axis, the quantity supplied on the horizontal axis.

   

    Ø Law of supply :

The law of supply is a fundamental principle of economic theory which states that, all else equal, an increase in price results in an increase in quantity supplied.^[1] In other words, there is a direct relationship between price and quantity: quantities respond in the same direction as price changes. This means that producers are willing to offer more products for sale on the market at higher prices by increasing production as a way of increasing profits.^[2]

In short, Law of Supply is a positive relationship between quantity supplied and price and is the reason for the upward slope of the supply curve.

Key Concepts: Market, Demand Curve,Equilibrium Price, Market Demand Schedule

Ø What is a 'Market'?:

A market is a medium that allows buyers and sellers of a specific good or service to interact in order to facilitate an exchange. This type of market may either be a physical marketplace where people come together to exchange goods and services in person, as in a bazaar or shopping center, or a virtual market wherein buyers and sellers do not interact, as in an online market.

Ø Definition of 'Demand Curve':

The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity demanded for a given period of time. In a typical representation, the price will appear on the left vertical axis, the quantity demanded on the horizontal axis. 

 

Ø Equilibrium price:

In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services at a market equilibrium determined by intersection  of  supply & demand. In modern economies, prices are generally expressed in units of some form of currency.

Ø Market demand curve;

  The market demand curve is the summation of all the individual demand curves in a given market. It shows the quantity demanded of the good by all individuals at varying price points. For example, at $10/latte, the quantity demanded by everyone in the market is 150 lattes per day.

Ø Market demand schedule:

 Market demand schedule  refers to a tabular statement showing various quantities of a commodity that all the consumers are willing to buy at various levels of price, during a given period of time. It is the sum of all individual demand schedules at each and every price.

Economic goods, free goods, Public Good, Private Good

Ø Economic goods and free goods:

·        The vast majority of goods and services are what economists call economic goods. An economic good is one which takes resources to produce it. As a result, its production involves an opportunity cost. Thus the possession of those goods require financial payments.

·        Free goods are abundant in nature. They do not involve the use of resources to produce them and so they do not have an opportunity cost. Thus the possession of those goods require no financial payments as  such. Examples include sunlight and air.

Ø What is a 'Public Good'?

A public good is a product that one individual can consume without reducing its availability to another individual, and from which no one is excluded. Economists refer to public goods as "nonrivalrous" and "nonexcludable." National defense, sewer systems, public parks and other basic societal goods can all be considered public goods.

   Ø Characteristics of public goods:

There are two specific characteristics of a public good.

·        It must be non-excludable. This means that once the good has been provided for one consumer, it is impossible to stop all other consumers from benefitting from the good.

    Ø It must also be non-rival. As more and more people consume the good, the benefit to those already consuming the product must not be diminished.

Ø What is a 'Private Good'?

A private good is a product that must be purchased to be consumed, and its consumption by one individual prevents another individual from consuming it. Economists refer to private goods as rivalrous and excludable. A good is considered to be a private good if there is competition between individuals to obtain the good and if consuming the good prevents someone else from consuming it.

MRT or Marginal rate of transformation i.e. Slope of PPC/PPF

Ø Marginal rate of transformation:

The slope of the production–possibility frontier (PPF) at any given point is called the marginal rate of transformation (MRT). The slope defines the rate at which production of one good can be redirected (by reallocation of productive resources) into production of the other. It is also called the (marginal) "opportunity cost" of a commodity, that is, it is the opportunity cost of X in terms of Y at the margin. It measures how much of good Y is given up for one more unit of good X or vice versa. The shape of a PPF is commonly drawn as concave to the origin to represent increasing opportunity cost with increased output of a good. Thus, MRT increases in absolute size as one moves from the top left of the PPF to the bottom right of the PPF

Ø Explanation of PPC/PPF:

Economists also use the PPF model to illustrate two categories of goods, both consumer goods and capital goods. So here is what that PPF curve looks like. aaaEvery point along the curve is efficient; points outside the curve are unobtainable or inefficient.

Why are most production possibility curves outward bowed (concave)? and Limitations of PPC

Ø Why are most production possibility curves outward bowed (concave)?

Production Possibility Curve is concave to the origin because to produce each additional unit of good X, more and more unit of good Y is to be sacrificed. Opportunity cost of producing every additional unit of good A tends to increase in terms of the loss of production of good Y. It is so because factors of production are not perfect substitute of each other.

Ø Limitations of PPC:

• Preferences: Production possibilities analysis is designed to analyze production capabilities. It can answer questions about the quantity of one good produced, given the production of another good. This analysis does not say if anyone actually wants the goods produced. Production possibilities says nothing about which goods people want and which provide the most satisfaction. It only indicates the available options.

Economic Efficiency: Because production possibilities is unrelated to preferences, it provides no indication of economic efficiency. While production possibilities might indicate what quantities can be produced, it does NOT indicate if this is an efficient use of resources. It does not indicate if this combination of goods provides the most satisfaction possible

Assumptions of PPC and Different Shapes of PPC/PPF

Ø Assumptions of PPC:

The four key assumptions underlying production possibilities analysis are: 

(1) resources are used to produce one or both of only two goods, (2) the quantities of the resources do not change, (3) technology and production techniques do not change, and (4) resources are used in a technically efficient way.

Ø What happens if the production possibilities curve is a straight line?

If the production possibility frontier is straight, it means that the resources released by producing one fewer unit of peanut butter are just sufficient to allow the economy to produce the same added amount of jelly, regardless of how much of each item is currently being produced. In economic terminology, we say that the marginal rate of substitution between the two items in question is constant. That’s very unlikely to be the case if more than one input is used in the production process of either.

One implication is that if the economy is producing both peanut butter and jelly, the price of peanut butter must be three times the price of jelly. That outcome is most likely if the economy is isolated from international trade.

On the other hand, if the country is exposed to international trade, a straight-line PPF will normally imply that the country will fully specialize in the production of one good or the other: if the world price of peanut butter is more than three times the price of jelly, this country will produce only peanut butter and no jelly; and conversely if the world price of peanut butter is less than three times the price of jelly. This kind of specialization is a familiar result from the Ricardian theory of comparative advantage.

Production Possibility Curve (PPC)/Frontier (PPF)

Ø What is the 'Production Possibility Curve(PPC)/Frontier(PPF)'?

 

The production possibility frontier (PPF) is a curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors. The PPF assumes that all inputs are used efficiently.

Factors such as labor, capital and technology, among others, will affect the resources available, which will dictate where the production possibility frontier lies. The PPF is also known as the production possibility curve or the transformation curve.

Ø Usefulness of PPC as an economic tool:

A Production Possibility Cruve (PPC) is a graph that shows the maximum attainable combinations of output that can be produced in an economy within a specified period of time. The usefulness of an economic tool is dependent on the extent to which a certain economic model reflects reality, and its relevance to decision making. While there are limitations of the PPC, I believe that, overall, it is a very useful economic tool.

Firstly, the PPC is an oversimplified model that only reflects the trade-off between two goods, when the real world is a lot more complex than this. In any economy, with other facts and goods in place, the pursuit of one type of good often comes at the opportunity cost of many other types of good – rather than just one other type, as the curve suggests. 

Secondly, the PPC also makes an assumption that there is a fixed amount of resources, and production beyond the curve is “unattainable”. However, we understand by the law of comparative advantage and the possibility of trade that an economy can indeed produce beyond the curve. Since trade is evident in the real world.

Ø Merits /Advantages of the PPC:

·        The PPC is used as a simple economic model for understanding the concepts of scarcity and efficiency. Production within the PPC is inefficient, for not all the resources are utilised; production out of the PPC is “unattainable” within the limitations of the economy. 

·        The PPC also reflects the trade off and opportunity cost. From the shape of the graph, it is possible to tell how much one good has to be sacrificed in order to produce more goods of another.

·        By plotting the PPC, it is possible to observe real economic growth. When there is an outward shift of the PPC, it is possible to conclude that a country’s capacity to produce has increased, which is real economic growth. 

·         The shape of the PPC also reflects the suitability of production with the resources available. Very often, a skewed PPC hints that an economy is more capable of producing one type of good than another. 

Economic systems: • A Market Economy • A Planned Economy • A mixed economy

Ø Economic systems defined:

An economic system is a system of production, resource allocation, and distribution of goods and services within a society or a given geographic area. It includes the combination of the various institutions, agencies, entities, decision-making processes, and patterns of consumption that comprise the economic structure of a given community. As such, an economic system is a type of social system. The mode of production is a related concept.

There are three main types of economic systems:

• A market economy

• A planned economy

• A mixed economy

Ø What is a 'Market Economy'?

A market economy is an economic system in which economic decisions and the pricing of goods and services are guided solely by the aggregate interactions of a country's individual citizens and businesses. There is little government intervention or central planning. This is the opposite of a centrally planned economy, in which government decisions drive most aspects of a country's economic activity.

Ø Characteristics of a Market Economy: 

A market economy is a type of economic system where supply and demand regulate the economy, rather than government intervention. A true free market economy is an economy in which all resources are owned by individuals

   One of the most important characteristics of a market economy, also called a free enterprise economy, is the role of a limited government.

·    In a market economy, almost everything is owned by individuals and private businesses- not by the government. Natural and capital resources like equipment and buildings are not government-owned..

·        A market economy has freedom of choice and free enterprise. Private entrepreneurs are free to get and use resources and use them to produce goods and services. They are free to sell these goods and services in markets of their choice

·         A market economy is driven by the motive of self-interest. Consumers have the motive of trying to get the greatest benefits from their budgets. Entrepreneurs try to get the highest profits for their businesses. Workers try to get the highest possible wages and salaries

·        Competition is another important characteristic of a market economy. Instead of government regulation, competition limits abuse of economic power by one business or individual against another. Each competitor tries to further his own self-interest. This economic rivalry means that buyers and sellers are free to enter or leave any market.

·        Consumers compete for goods and services. If the supply of a needed good or service is low, the consumer must pay a higher price. Consumers must compete to get goods or services by paying more or going out of their way to buy the products they need or want.

Ø What is a 'Mixed Economic System'?

A mixed economic system is an economic system that features characteristics of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims. According to neoclassical theory, mixed economies are less efficient than pure free markets, but proponents of government interventions argue that the base conditions such as equal information and rational market participants cannot be achieved in practical application.

Ø Characteristics of Mixed Economy:

 

The following are the main characteristics of mixed economy:

1. Co-existence of the Private and Public Sectors

Co-existence of the private and public sectors is the outstanding feature of mixed economy. In mixed economy, both public sector as well as private sector industries will be functioning.

2. Existence of Joint Sector

Joint sector is one where both Government and private individuals establish an organization jointly by contributing the necessary capital.

3. Regulation of Private Sector

Under mixed economy, Government exercises strict control and regulation over private sector industries.

4. Planned Economy

The entire economic structure is subject to the planning of the Government. Mixed economy is a planned economy. The planning commission decides the objectives, targets and allocation of resources etc.

5. Private Property

Under mixed economy, private firms and individuals have right to own and use property.

6. Provision of Social Security

Under mixed economy, Government takes steps to provide social security.

7. Motive of Business Concerns

The motive of the business concerns is profit but coupled with the objective of social welfare.

Ø What is a 'Centrally Planned Economy'?

A centrally planned economy is an economic system in which the state or government makes economic decisions rather than the interaction between consumers and businesses. Unlike a  market  economy in which private citizens and business owners make production decisions, a centrally planned economy controls what is produced and the distribution and use of resources. State-owned enterprises undertake the production of goods and services.

Ø Characteristics of a 'Centrally Planned Economy:

The following are the main characteristics of a Centrally Planned economy:

1.     The government makes the economic decisions. This is different from the market economy that we are familiar with, in which businesses decide what they will produce, not the government.

2.     The government controls all aspects of the economic production. In other words, the government decides what goods will be produced and how they will be produced.

3.     The government decides how resources are distributed and used. For example, if the government thinks we need more goods in a particular area, they will make that decision, not the businesses in that area.

4.     The government needs to make the decisions. It is assumed that the needs of the people are not met in a market economy; therefore, in a centrally planned economy, the government controls decision-making.