Similar to a demand curve, a supply curve is a diagrammatic representation of its relationship with price. A supply curve may be that of the market, or of the firm. The law of supply states that there is a direct relationship between price and quantity supplied, under competitive conditions. The law of supply (and for demand) is made under the assumption of ‘ceteris paribus’, whereby all other variable factors other than the one being scrutinised remain constant. Market price, input prices, technology, expectations and the number of producers in that particular market determine the amount of a product that a producer is willing to sell. According to the law of supply, a supply curve can be represented in this way:
Not all supply curves are upward sloping like the one above – they can be downward sloping too, as well as horizontal or vertical. The extent to which this is possible is dependant upon the speed at which firms respond to changes in the market price of the good.
In practise, demand and supply curves are not used in isolation. They are combined together which is useful for a number of operations such as price and output determination, and illustrating how markets clear. Market clearing occurs when the level of demand matches supply, thus leaving no shortage or surplus, leaving the market in a state of equilibrium. Diagrammatically this can represented:
The point where the demand and supply curves intersect is the point of equilibrium, and this is the only point where the price of the product is sustainable. Any price above the point of equilibrium would lead to a surplus, and a price below that of the equilibrium point would lead to a shortage. At the price, P1, there is neither a shortage nor a surplus. The equilibrium price also illustrates the only price at which both suppliers’ and consumers’ demands are mutually agreed. In other words, it is the price at which suppliers are willing to supply their good at, and the price at which consumers are prepared to pay for that item. The equilibrium for the product will then stay constant, unless either the supply or demand curve shifts. If this occurs then a new equilibrium will be made. On the graph, Q* is known as the equilibrium quantity, and P1 is known as the equilibrium price.
When the supply or demand curve shifts, not only do they effect the position of equilibrium, it leads to a change in the price and output of the product. A change in demand will cause a shift of the curve either to the left or the right. This is usually caused by a change in one of its determinants other than price. Similarly, a change in supply will also cause the curve to shift either left or right, and is also caused by a change in a factor other than price.
If one of the factors affecting demand, other than price, it will cause the demand curve to move along the supply curve to a new equilibrium point. If, for example, Pepsi invested heavily into a new advertising campaign to try and increase its market share over Coca-Cola, the increase in advertising may affect consumer’s tastes and therefore increasing the quantity of Pepsi demanded:
In this example above, there would be a shortage of a-b at the original price of P1 if the demand curve shifted from D1 to D2. This would therefore cause the price of a can of Pepsi to rise to the new equilibrium of P2. In doing so this causes a movement along the supply curve from point a to point c, and also along the newly established demand curve from point b to c. As well as changing the equilibrium price, the equilibrium quantity has now increased and changed from Q1 to Q2. To summarise, the change in demand has caused a movement along the supply curve from the old equilibrium of a to the new equilibrium at point c.
For a car manufacturer, new technology may be introduced that therefore increases the costs of production. This would cause the supply curve to make a movement along the demand curve, creating a new equilibrium:
In this example the supply curve would shift to the left from supply curve S1 to S2. At the old price of P1, there would be a shortage of m-l. Price will then rise from P1 to P2, and quantity falls from Q1 to Q2.