Imagine you own a company that manufactures cars. Steel is one of the main materials your company uses when producing cars. One day the price of steel skyrockets. How would you respond to the increase in the price of steel? Will you reduce the number of cars you produce in a year? What are some of the determinants of supply of cars?
Determinants of supply include factors that directly impact the supply of a good or service. This can be factors such as the steel you use to manufacture cars or the technology you implement during production.
Determinants of supply are important as they directly influence the number of goods and services provided in our economy. Why don't you read on and find out all there is about the determinants of supply?
Determinants of Supply Definition
Determinants of supply definition refer to factors that influence the supply of certain goods and services. These factors include the price of inputs, the company's technology, future expectations, and the number of sellers.
Determinants of supply are factors that directly affect the supply of a good or service.
If you need to refresh your knowledge of what supply is, check out our explanation:
- Supply.
The law of supply states that when the price of a good increases, the quantity supplied for that good also increases, holding everything else equal. On the other hand, when the price of a good drops, the quantity supplied for that good will also drop.
Many people confuse price as being one of the determinants of supply. While price can determine the quantity supplied, price doesn't determine the supply of a good or service. The difference between the quantity supplied and supply is that while the quantity supplied is the exact number of goods supplied at a specific price, the supply is the entire supply curve.
Fig. 1 - Price determining quantity supplied
Figure 1 shows how the quantity supplied changes due to a price change. When the price increases from P1 to P2, the quantity supplied increases from Q1 to Q2. On the other hand, when there is a decline in price from P1 to P3, the quantity supplied declines from Q1 to Q3.
It is important to note that price changes only cause movement along the supply curve. That is to say, a change in price does not cause a shift in the supply curve.
The supply curve shifts only when there is a change in one of the non-price determinants of the supply curve.
Some non-price determinants include the prices of inputs, technology, future expectations.
The supply curve can experience a rightward or a leftward shift.
Fig. 2 - Shifts in supply curve
Figure 2 shows shifts in the supply curve while the demand curve remains constant. When the supply curve shifts down and to the right, the price decreases from P1 to P3, and the quantity supplied increases from Q1 to Q2. When the supply curve shifts up and to the left, the price increases from P1 to P2, and the quantity supplied drops from Q1 to Q3.
- A rightward shift in the supply curve is associated with lower prices and higher quantity supplied.
- A leftward shift in the supply curve is associated with higher prices and lower quantity supplied.
Non Price Determinants of Supply
There are many non-price determinants of supply, including input prices, technology, future expectations, and the number of sellers.
Unlike price, non-price determinants of supply do not cause a movement along the supply curve. Instead, they cause the supply curve to shift to the right or left.
Non Price Determinants of Supply: Input prices
Input prices significantly influence the supply of a particular good or service. That's because input prices directly impact the company's cost, which then dictates how much profit a firm makes.
When the price of input rises, the cost for a company producing a good also rises. This, in turn, causes the company's profitability to drop, pushing it to decrease the supply.
On the other hand, when the price of an input used during the production process declines, the firm's cost also declines. The profitability of the firm increases, encouraging it to increase its supply.
Non Price Determinants of Supply: Technology
Technology is another important factor that determines the supply of a good or service. That's because technology has a direct impact on the cost that the firm faces while turning inputs into outputs.
When a company employs technology that makes the production process more efficient, manufacturers can boost their productivity while decreasing the amount of money they spend on labor. This then contributes to an increase in supply.
Non Price Determinants of Supply: Future expectations
The expectations that companies have about the price of a good in the future have an impact on their present supply of goods or services.
For example, if companies believe they will be able to sell their goods at higher prices the next month, they will cut down on their supply levels for the time being and then boost those levels the following month to maximize their profits.
On the other hand, if a company expects prices to decline, it would increase the supply and try to sell as much as possible at the current price.
- Notice the important role of expectations. Although the price might not increase in the future, when companies expect it to happen, they decrease their current supply. Lower supply means higher prices, and the price indeed increases.
Non Price Determinants of Supply: Number of Sellers
The number of sellers in a market impacts the supply of a good or service. That's because when you have more sellers in the market, the supply of that good will be larger.
On the other hand, markets with fewer sellers do not have an ample supply of goods.
Determinants of Supply Examples
Determinants of supply examples include any change in the supply of a good or service due to changes in input prices, technology, number of sellers, or future expectations.
Let's consider a company that manufactures sofas in California. The cost to produce the couch for the company is dependent on the price of wood. This summer, fires have destroyed most of the forests in California, and as a result, the price of wood has skyrocketed.
The company faces a much higher cost of producing the sofa, contributing to a shrink in the company's profitability. The company decides to lower the number of sofas it makes in a year to cover the costs arising from the increase in the wood price.
Imagine that the company has read a report by McKinsey, one of the largest consulting firms in the world, saying that next year the demand for home renovations will increase. This will potentially impact the price of sofas as more people will seek to buy new sofas for their homes.
In such a case, the company will lower its current supply of sofas. They can keep some of the couches they produce this year in storage and sell them the following year when the price of sofas increases.
Determinants of Price Elasticity of Supply
Before we dive into the determinants of price elasticity of supply, let's consider the meaning of price elasticity of supply. Price elasticity of supply is used to measure the change in the quantity supplied when there is a change in the price of a particular good.
Price elasticity of supply measures the change in quantity supplied when there is a change in the price of a particular good.
If you need to refresh your knowledge of the price elasticity of supply, click here:
- Price Elasticity of Supply.
And if you want to master calculating the price elasticity of supply, click here:
- Price Elasticity of Supply Formula.
The formula to calculate the price elasticity of supply is as follows:
\(Price\ elasticity\ of\ supply=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\)
For example, when the price of an item increases by 5%, the firm will respond by increasing the quantity supplied by 10%.
\(Price\ elasticity\ of\ supply=\frac{\%\Delta\hbox{Quantity supplied}}{\%\Delta\hbox{Price}}\)
\(Price\ elasticity\ of\ supply=\frac{10\%}{5\%}\)
\(Price\ elasticity\ of\ supply=2\)
The higher the elasticity of supply, the more responsive supply is to a change in price.
It is important to note that the determinants of the price elasticity of supply relate to the firm's production process.
Suppose a firm has employed efficient production processes. In that case, the firm can quickly adjust its quantity supplied when there is a price change, making supply more elastic.
Fig. 3 - Elastic supply curve
Figure 3 shows an elastic supply. Note that when the price increases from P1 to P2, the quantity supplied increases by much more from Q1 to Q2.
Some of the main determinants of the price elasticity of supply include technological innovation, time period, and resources as seen in Figure 4 below.
Determinants of Price Elasticity of Supply: Technological innovation
The rate of technological advancement is one of the most important factors that determine the price elasticity of supply across many different sectors.
Companies implementing the latest cutting-edge technologies can be much more responsive to a price change by adjusting the quantity produced. They can quickly adjust the size of their products according to the price without having to incur a significantly high cost.
Additionally, technological innovation makes companies more efficient, enabling them to reduce costs. Consequently, a rise in the price would result in a more considerable increase in quantity, which would make the supply more elastic.
Determinants of Price Elasticity of Supply: Time period
The behavior of supply over the long term, in general, is more elastic than its behavior over the short term. In a short time period, companies are less flexible in making changes to the size of their facilities to produce more or less of a particular item.
This makes it more difficult for businesses to respond quickly when the price of specific goods changes. Therefore, during the short run, the supply is more inelastic.
On the other hand, in the long run, companies can adjust their production processes accordingly. They can hire more workers, build new factories, or use some of the company's cash to buy more capital. As a result, the supply will become more elastic in the long run.
Determinants of Price Elasticity of Supply: Resources
The degree to which a company can adjust its output in response to shifts in pricing is directly correlated to the amount of flexibility it has with regard to its use of resources.
Companies that have their production process entirely dependent on scarce resources may find it hard to adjust the quantity supplied soon after there is a price change.
Determinants of Demand and Supply
Determinants of demand and supply are factors that influence the demand for goods and services as well as the supply for them.
- While the determinants of supply include input prices, technology, number of sellers, and future expectations, demand is determined by other factors.
- Some of the main determinants of demand include income, price of related goods, expectations, and the number of buyers.
- Income. Income directly impacts the number of goods and services one can buy. The higher the income, the higher the demand for goods and services.
- Price of related goods. When the price of a good that can be easily substituted by another good increases, the demand for that good will fall.
- Expectations. If individuals expect that the price of a good will increase in the future, they will rush and buy it while the price is low, leading to an increase in demand.
- The number of buyers. The number of buyers in a market determines the demand for that good or service. The higher the number of buyers, the higher the demand is.
Demand and supply are the cornerstones of Economics.
To learn more about them, click here:
- Demand and Supply.
Determinants of Supply - Key takeaways
- Determinants of supply are factors that directly affect the supply of a good or service.
- There are many non-price determinants of supply, including input prices, technology, future expectations, and the number of sellers.
- A change in price of a good or service, causes movement along the supply curve.
- Some of the main determinants of the price elasticity of supply include technological innovation, time period, and resources.
