The Allocation of Resources - Supply

Individual Supply and Market Supply

This section explores how individual firms decide how much to produce and how these individual decisions combine to determine the overall market supply of a good or service.

Individual Supply: The Firm's Decision

A firm's supply decision is based on the cost of production and the price it can achieve in the market. Firms aim to maximise their profits, and this involves considering the marginal cost (MC) and the marginal revenue (MR) of producing an additional unit.

The key principle is that a firm will supply a quantity of output where marginal cost equals marginal revenue (MC = MR). This is because producing more units beyond this point would mean the cost of producing those extra units exceeds the revenue they generate.

The supply curve of an individual firm is typically upward sloping. This reflects the law of diminishing returns – as output increases, the marginal cost of production tends to rise.

Shifts in Individual Supply

The individual supply curve can shift due to changes in the firm's costs of production. These shifts are independent of the market price.

• Changes in Input Costs: If the cost of a factor of production (e.g., wages, raw materials) increases, the firm's costs of production rise, leading to a leftward shift in the supply curve.
• Technological Advancements: If a firm can produce goods more efficiently due to new technology, its costs of production fall, leading to a rightward shift in the supply curve.
• Changes in Government Regulations: New regulations (e.g., environmental restrictions) can increase production costs, shifting the supply curve leftwards. Conversely, deregulation can lower costs and shift the curve rightwards.
• Changes in Expected Future Prices: If a firm expects the market price for its product to rise in the future, it may increase its current supply, leading to a rightward shift in the supply curve.

Market Supply: The Aggregate of Individual Supplies

The market supply curve is the horizontal summation of the individual supply curves of all firms in the market.

The market supply curve is typically upward sloping, reflecting the law of increasing supply. This means that as the market price rises, firms are incentivised to supply more of the good or service.

Factors Causing Shifts in Market Supply

Similar to individual supply, the market supply curve can also shift due to changes affecting the supply of the entire market.

Factor	Effect on Market Supply
Changes in Input Costs (for all firms)	Leftward shift (decrease in market supply)
Technological Advancements (affecting all firms)	Rightward shift (increase in market supply)
Changes in Government Regulations (affecting all firms)	Leftward shift (decrease in market supply) or Rightward shift (increase in market supply) depending on the nature of the regulation.
Changes in Expected Future Prices (for the market)	Rightward shift (increase in market supply)
Changes in the Number of Sellers in the Market	Increase in the number of sellers leads to a rightward shift in market supply. Decrease in the number of sellers leads to a leftward shift.

The Link Between Individual and Market Supply

The market supply curve is derived from the individual supply curves. The overall shape of the market supply curve is influenced by the characteristics of the individual firms in the market. For example, if the market consists of many small firms, the market supply curve will be relatively elastic. If the market consists of a few large firms, the market supply curve will be relatively inelastic.

Understanding the relationship between individual and market supply is crucial for analysing how changes in market conditions affect the quantity supplied and the overall market equilibrium.