Question

1.) Using the determinants of supply, explain when the supply of a good will increasse and when it will decrease

Answer 1

Supply of a good refers to the different quantities of a good a producer is willing to sell at different prices over a given period of time. Supply depend on the following factors:

Q_x = f (P_X, P_r , I_P , G_{p ,} T, E_p)

where P_X= price of the good

         P_r = price of the related good

         I_P = Input prices

         G_P = Government policy

         T = technology

          E_P = Expectation of change in future prices

Other than price of the commodity (that leads to movement along the supply curve), change in any of the above mentioned factors leads to increase or decrease in the supply or shift in the supply curve.

Factors leading to change in supply

1. Price of related goods

Rise in price of related goods leads to decrease in supply of the good under consideration (as the producer may switch to the production of the other good) while fall in price of related goods may lead to increase in the supply of the concerned good as the latter's production has become relatively lucrative.

     2. Change in input prices

Rise in input price leads to increase in cost of production leading to rise in marginal cost and hence decrease in supply as the profit margin goes down.

Fall in input price leads to fall in cost of production, further leading to decrease in marginal cost and increase in supply.

     3. Government Policy

Imposition of tax : imposition of tax leads to increase in cost of production, rise in marginal cost, decrease in profit margin and hence decrease in supply.

Subsidy: Subsidy leads to fall in cost of production, fall in marginal cost, increase in profit and thus increase in supply.

     4. Technology

Improvement in technology leads to increase in supply due to fall in cost of production while deteroration in technology leads to decrease n supply due to rise in cost of production.

   5. Expectation of change in future prices

If prices in future are expected to rise then at present the supply of the good will fall as the producers will wait for the price to rise to earn more profits, thus supply will decrease in present.

On the other hand, if prices are expected to fall in future then supply will rise in present.