Supply Analysis
Supply is the quantity of a good or service that producers are willing and able to sell at various prices during a given period, ceteris paribus. Together with demand, supply determines market prices and quantities.
Law of Supply
The law of supply states that, ceteris paribus, as the price of a good increases, the quantity supplied increases, and vice versa. This positive relationship creates an upward-sloping supply curve. Reason: higher prices make production more profitable, encouraging existing firms to produce more and attracting new firms.
Determinants of Supply
Factors that shift the supply curve: Input costs — higher wages, raw materials decrease supply (shift left). Technology — improvements reduce costs, increase supply (shift right). Number of sellers — more firms = more supply. Government policy — subsidies increase supply; taxes decrease. Expectations — expected higher future prices may reduce current supply. Natural conditions — weather affects agriculture. Prices of related goods in production — if wheat prices rise, farmers may switch from rice.
Price Elasticity of Supply
PES = %ΔQs / %ΔP. PES > 1: elastic (manufactured goods with spare capacity). PES < 1: inelastic (agricultural products, unique goods). Factors: time period (more elastic in long run), availability of inputs, spare capacity, ability to store, production complexity.
Market Equilibrium
Equilibrium occurs where demand = supply. If price is above equilibrium: surplus pushes price down. If below: shortage pushes price up. Markets naturally tend toward equilibrium — Adam Smith’s ‘invisible hand.’
Changes in Equilibrium
Increase in demand: price rises, quantity rises. Decrease in demand: price falls, quantity falls. Increase in supply: price falls, quantity rises. Decrease in supply: price rises, quantity falls. When both shift, one variable is indeterminate.
Producer Surplus
Difference between price received and minimum acceptable price. Area between market price and supply curve. Total surplus (consumer + producer) is maximised at competitive equilibrium.
Government Intervention
Price ceiling (below equilibrium): creates shortage, black markets, reduced quality. Price floor (above equilibrium): creates surplus (unemployment in labour market). Taxes: shift supply left, burden shared based on relative elasticities. Subsidies: shift supply right. All interventions create deadweight loss.
Summary
Supply analysis completes the demand-supply framework. Market equilibrium maximises total surplus. Government interventions create predictable effects that business managers must understand.
Worked Example: Market Equilibrium
The demand and supply functions for a product are: Qd = 100 − 2P and Qs = −20 + 3P. Find the equilibrium price and quantity.
Solution: At equilibrium, Qd = Qs:
100 − 2P = −20 + 3P
100 + 20 = 3P + 2P
120 = 5P
P = Rs 24
Q = 100 − 2(24) = 100 − 48 = 52 units
Verify: Qs = −20 + 3(24) = −20 + 72 = 52 ✔️
What happens at P = 30? Qd = 100−2(30) = 40, Qs = −20+3(30) = 70. Surplus = 70−40 = 30 units. Sellers will lower prices to clear excess stock, pushing price back toward Rs 24.
What happens at P = 15? Qd = 100−2(15) = 70, Qs = −20+3(15) = 25. Shortage = 70−25 = 45 units. Buyers compete for scarce goods, pushing price upward toward Rs 24.
Worked Example: Impact of Tax on Equilibrium
Government imposes a tax of Rs 5 per unit on the above product. The new supply function becomes Qs = −20 + 3(P−5) = −35 + 3P.
New equilibrium: 100 − 2P = −35 + 3P → 135 = 5P → P = Rs 27 (buyer pays), Q = 100−2(27) = 46 units
Seller receives: Rs 27 − 5 = Rs 22. Tax revenue = 5 × 46 = Rs 230.
| Before Tax | After Tax | Change | |
|---|---|---|---|
| Price (buyer pays) | Rs 24 | Rs 27 | +Rs 3 (↑) |
| Price (seller receives) | Rs 24 | Rs 22 | −Rs 2 (↓) |
| Quantity | 52 | 46 | −6 (↓) |
Tax burden: Buyers bear Rs 3/5 = 60% of the tax. Sellers bear Rs 2/5 = 40%. The side with more inelastic demand/supply bears more of the tax burden. Since demand is relatively more inelastic here (slope = −2 vs supply slope = 3), buyers bear a larger share.
Nepal Examples
Vegetable market: During monsoon, supply of tomatoes increases (shift right) → price drops sharply. In winter, supply decreases (shift left) → price rises. Kathmandu’s Kalimati market prices fluctuate widely with seasonal supply changes. Fuel pricing: Nepal Oil Corporation sets a price floor above world oil prices to cover costs and taxes, creating surplus revenue used for cross-subsidisation. Minimum wage: Nepal’s minimum wage (Rs 17,500/month as of 2081) acts as a price floor in the labour market — critics argue it causes unemployment in low-productivity sectors; supporters argue it ensures basic living standards.
Exam Tips
Tip 1: Set Qd = Qs and solve algebraically for equilibrium. Tip 2: After finding P, substitute back into BOTH equations to verify Q matches. Tip 3: For tax problems, adjust the supply equation (not demand) — tax shifts supply left. Tip 4: Always state direction of shifts clearly (left/right/upward/downward). Tip 5: Draw diagrams — examiners award marks for correctly labelled supply-demand diagrams.