Supply Theory

By: EconomyWatch   Date: 13 October 2010

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The Supply Theory is one of the fundamental theories of economics. It is also a foundation on which many other theories are based. The supply theory generates lots of other models that are equally important to economics. Supply directly influences resource allocation. Therefore, it is a valuable tool that is used to analyze the working of a market economy.

Definition of Supply

Supply is the quantity of goods and services that a producer is willing and able to produce for market transaction at a given price in a given time period. The demand of a product impacts the supply of the product and vice versa. The rise in the market price of a product enables producers to produce more. Hence, the rise in price means an increment in the supply. The rise in price and rise in supply is directly proportional to each other. There are three reasons for this condition. They are:

  • With the rise in the market price the producer’s opportunity to make a profit increases. They produce more output so as to sell them at a good price in the market and gain from that.
  • The large-scale production firms can adjust their cost of production with the rising market price. In fact the producers can incur profit from this phenomenon since they get an opportunity to not only compensate their cost of production but also earn something more than that.
  • Rise in the market price also generates scope for the other firms to produce and sell their products, which will help them earn a good amount of money. The rise in the market price proves to be advantageous for these companies since they can get a fair price for their products.

    Shifts in Supply Curve

    Shift in supply curve takes place due to various reasons. There are a number of factors, which cause the shift in the supply curve. The factors are as follows:

  • Costs of Production are a vital factor, which causes shift in the supply curve. The lower the cost of production the more is the supply of the company, which in turn will contribute in the profit.
  • Technological advancement also contributes a lot towards enhancement in supply. Supply of goods increase with the technological advancement.
  • Government decisions also influences a lot towards increasing supply. If government imposes tax on the production then the cost of production increases which in turn decreases supply. Whereas the subsidy affects in the opposite way. The subsidy increases the supply of a company.
  • Climatic conditions also affect the supply of a good. If the weather is favorable then the production of crops is more and if the conditions are not conducive then the production of crops is less.
  • If a substitute is produced then that affects the supply of the original.
  • The number of traders in a market also increases supply. With the increasing number of traders the supply in the market increases and the price also decreases.
  • Theory of Labor Supply
  • Money Supply Theory
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