Theory of Demand & Supply: STEP - 1: Meaning Definition of Supply, Law of Supply & Factors of Supply
Theory of Demand & Supply: STEP - 1: Meaning Definition of Supply, Law of Supply & Factors of Supply
Theory of Demand & Supply: STEP - 1: Meaning Definition of Supply, Law of Supply & Factors of Supply
From table (1), we can observe that as price of the commodity increases; with other things re-
maining constant, quantity supplied also increases. Plotting these combinations in fig (1) a
supply curve is obtained, which is upward sloped i.e. positive relationship between price &
quantity supplied, known as law of supply.
Note: The main reasons behind an upward sloping supply curve are :-
(i) Law of diminishing marginal productivity:-
The Law states that as more units of variable factor are employed, the addition made to to-
tal production falls, i.e. cost of production rises. Thus, more quantity is supplied only at
higher prices so as to cover the rise in cost of production.
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
Market supply curve is the graphical representation of market supply schedule. It is the ag-
gregation of individual supply curves.
Determinants or factors of supply are : Qsx = f (Px, py, SI, Cp, Tech, obj, GP).
(i) Px Price of commodity x : Explained in table 1.
(ii) Py Price of other related commodity
When price of related goods ‗y‘ changes, with other things remaining unchanged
quantity supplied of concerned commodity ‗x‘ also changes. E.g., if price of wheat
rises, to increase quantity supplied of wheat farmers may shift lands to wheat produc-
tion instead of corn & soyabeans (supply of these will fall). Further, when price of
Maruti Zen rises, to supply more of Zen, Maruti Udyog Ltd. shifts assembly line from
Maruti 800 to Zen & supply of Maruti 800 diminishes.
(iii) SI (Supplies of input): There are four inputs — land, labour, capital,organization. As
supply of factors increases, producer is able to supply more & vice-versa. SS of input
& production are directly related.
(iv) CP (Cost of production) : As per unit of cost of production increases, additional unit
of output adds more to cost than to revenue & amount of production decreases. The
ss curve shifts towards left & vice versa.
(v) Technology : As state of technology improves, innovation takes place & producer is
able to produce better goods with increase in supply, & per unit cost of production
decreases. Therefore, additional unit of output will add more to revenue than to cost
& as profit increases, supply also increases.
(vi) Objective or Goal of firm : Generally, the goal of any firm is maximization of profit.
But there are other objectives also, like maximization of sales, maximization of output
or maximization of employment. If the firm intends to maximize the other goals at the
stake of maximize profit, supply will be more than maximization of profit. So supply
depends on priority of firm.
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
Es =
ii) In fig (3) supply line starts from origin & upward linear.
Qs Qs/Qs
Here, = P =1
Qs P P/P
Supply curve is parallel to vertical axis as in Fig. 5 Supply curve is parallel to Qty axis is in Fig. 6
ARC Method: Point elasticity relates to a situation where the two price & quantity situations
are far very close to each other. ARC elasticity relates to a situation where the two Price &
Quantity situations are far from each other, such that they relate to an arc over the supply
curve.
Qs
Q1 + Q2
2
es = –––––––––––––––
P
P1 + P2
2
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
Qs P + P2
es = × 1
P Q1 + Q2
e.g. (i) Find out elasticity of supply if price of rice rises from ` 20 to ` 40 per kg & I
creases from 10 kg to 15 kg in a month.
Ans. Q1 = 10, Q2 = 15, P1 = 20, P2 = 40
5
es = 10+ 15 = 0.6
20
60
e.g. (ii) Let the supply function be Q = – 40 + 10P. Calculate ARC elasticity between price
of ` 10 & ` 12
Ans. When P = 10, Q1 = – 40 + 10.10 = 60
When P = 12, Q2 = -40 + 10(12) = 80
20
es = 140 = 1.57
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STEP – 4 : Factors affecting elasticity of supply:
Some important factors influencing elasticity of supply are giv-
en below:
(i) Nature of the commodity
(ii) Cost of production
(iii) Techniques of production
(iv) Availability of resources & facilities
(v) Time period :
It is the very important determinant of elasticity of supply. In the
very short period, time is not sufficient to make changes in out-
put.Hence, supply will be inelastic as represented by the curve S 1S1 in Fig 1; which is vertical.
In the short period, output can be changed to some extent by changing the amount of variable
factors only. The supply here will be S2S2 which is inelastic indicating less than unity supply.
The supply here increases somewhat in response to an increase in price. The supply curve
S3S3 represents the supply of the same commodity in the long period. The small change in
price here brings a larger change in supply because time is enough to enable the producers to
make changes in the output.
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
(19) If the supply curve of a product is Sx = 20 + 1.5Px. Find the supply corresponding to
market price of Rs.4 per unit:
(a) 16 (c) 18
(b) 26 (d) None
(20) When the supply curve of a product is Sx = 10 + 1.5Px. Find the aggregate market
supply corresponding to market price of Rs.4 per unit if there are 1000 suppling in
the market.
(a) 10,000 (c) 16,000
(b) 18,000 (d) 15,000
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
(23) If the percentage change in supply is less than the percentage change in price it is called
(a) Unit elasticity of supply (c) More elastic supply
(b) Less elastic supply (d) Perfectly Inelastic supply
(25) A horizontal supply curve parallel to the quantity axis implies that the elasticity
of supply is:
(a) Zero (c) Equal to one
(b) Infinite (d) Greater than zero but less than one
(26) Commodities which are perishable in nature have …………………. Elastic supply.
(a) Less (c) Perfectly
(b) more (d) None
(28) Elasticity of supply for a positively sloping supply curve that starts from price
axis or origin is
(a) Zero (b) Greater than one
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
(29) For a positively sloped straight line supply curve that intersects the price axis elas-
ticity is:
(a) Equal to zero (c) Greater than one
(b) Equal to one (d) Constant
(30) Any straight-line supply curve, which cuts the x-axis, will have:
(a) An elasticity greater than one. (c) An elasticity less than one.
(b) Unitary elasticity of supply (d) Zero elasticity of supply.
(31) If the quantity supplied is exactly equal to the relative change in price then the elas-
ticity of supply is:
(a) Less than one (c) one
(b) Greater than one (d) None
(35) For portraits & paintings of eminent artists the value of elasticity of supply is
(a) es 1 (c) es 1
(36) If price of computers increases by 10% & supply increases by 25%. The elasticity of
supply is
(a) 2.5 (c) 3.5
(b) 0.4 (d) 0.4
(37) If the supply of a commodity falls by 20% due to decrease in price of the commodity
by 10%, then elasticity of supply will be:
(a) Elastic
(b) Unit elastic
(c) Perfectly elastic
(d) None
(38) The supply function is given as Qs = – 100 + 10 P. find the elasticity of supply, when
price is `15.
(a) 4 (c) – 5
(b) – 3 (d) 3
(39) The supply function is P = - 50 + 0.5Q. Find out elasticity of supply, When P = 10.
(a) 0.12
(b) 2
(c) 0.16
(d) None
(40) The supply function is given as Qs = - 500 + 20P. Find out elasticity of supply, When
P = 30.
(a) 3
(b) – 6
(c) 6
(d) None
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J. K. SHAH CLASSES CPT – GENERAL ECONOMICS
POINTS TO REMEMBER
THEORY OF DEMAND AND SUPPLY
Income Elasticity of Demand (EY) :
Five in one
Interior Necessi- ENGEL’S CURVEY (ICC)
Goods ties INCOME
YD Y Y Consumption curve
EY < 0 e<0
Income
D EY = e=
Income
e<1
0
0
D
Interior Goods
Y EY < 0
D
e=1
Income
D
O X
Quantit
y
O X O D O e<1 D
Quantity X X
Q Quantity Q Quantity
Utility is also known as ‘Satiety’ and TU is known as ‘Full Satiety’ and MU is also known as
marginal satiety’.
(D) CONSUMER’S SURPLUS (CS) :- Alfred Marshall – CS is the difference between maxi-
mum price a person is willing to pay for a goods and its market price.
CS = what a consumer is ready to pay – what he actually pays,
‘What a consumer ready to pay’ is taken in terms of ‘MU’ and ‘what he actually pays’ is taken
in terms of ‘Price’. So CS = MU - P
The concept is derived from the law of diminishing utility. As the consumer purchase more
units of a good its marginal utility goes on diminishing. The consumer is in equilibrium when
MU=P. But for the preceding units, the MU> P he actually pays for them. This is because the
price is constant for him.
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Y Consumer Surplus
30 MMU = P
28
26
Price & MU
24
22
20
18
16
14
12
10
Quantity
8
6
4 X
20 1 2 3 4 5 6 7
In the above table and figure consumer is in equilibrium at the 6 th unit because here MU = P
i.e. ` 20 and in this way when he will consume 6 units then he is total ready to pay ` 150
(30+28+26+24+22+20) but total amount actually paid is ` 120 (20+20+20+20+20+20), So total
consumer surplus will be 30 (150-120), which is maximum.
Assumptions: The assumptions are same as mentioned in law of DMU.
Limitations –
1. Consumer’s surplus cannot be measured because it is difficult to measure the MU.
2. In the cases of necessaries, the marginal utilities of the earlier units are highest. In
such case the consumer’s surplus is always infinite.
3. CS is affected by the available of substitutes.
4. There is no simple rule of deriving the utility of articles of prestige value diamond [wa-
ter-diamond paradox]
5. Mum does not remain constant and this assumption is unrealistic.
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