The law of supply states that higher the price, the higher the quantity supplied, for higher prices mean more revenues. However, other factors also influence supply, and such factors may cause a shift in the supply curve, right or left, even when prices remain constant.
What Is the Supply Curve?
Supply is the quantity of a particular good on offer by sellers, and the supply curve is a graphical representation of a supply schedule, illustrating the quantity that sellers are willing or are able to sell at different prices. This law is assuming everything else, such as technology and prices of various factors of production, remains the same. For example, a commodity firm may sell 800 bushels of wheat when price is $2 and 1,200 bushels when price is $3, everything else remaining equal.
The supply curve either moves or shifts. Changes in price cause movement along the supply curve. In such cases, when the price of the product changes, the quantity supplied changes in accordance with the original supply relationship. The shift in the supply curve occurs when "other" factors change.
Two big ways in which raw materials contribute to supply curve shifts are through price and availability. A sudden availability of a scarce raw material or decrease in the price of raw materials that causes the product to become more profitable for the manufacturer may lead to increased production, causing the supply curve to shift right. However, more often than not, the reverse happens.
Increase in the price of an input to the production process without the possibility of hiking product prices may cause reduction in potential profit, making the product unattractive to produce. Manufacturers may therefore produce more of some other products that bring greater profit, causing reduced supply of the product in the market. Similarly, a breakdown in machinery or non-availability of a critical input may cause reduced supply of a product, and the supply will curve to shift left.
Any profitable product soon attracts a host of manufacturers or sellers, trying to make profits. With each such player offering their products to the market, the supply will increase regardless of an increase in price, and cause the supply curve to shift right. A good case in point is electronic gadgets. The price for any new technology is invariably sky-high, until the patent expires, and competitors come in to glut the market with alternatives.
The prices of competing goods also influence a shift in the supply curve of a particular product. For instance, when the price of a substitute product increase and the price of the product in question remains the same, customers tend to shift patronage to the product, and the increased demand would cause manufacturers to produce more, causing a rightward shift of the supply curve.
Similarly, when prices of competing goods fall, and the price for the good in question remain unchanged the competing goods suddenly become more attractive proposition, and customers would flock to such goods. The reduced demand would cause manufacturers to produce less of the good, causing the supply curve to shift left.
Advancements in technology such as improved machinery may reduce manufacturing time, improve process efficiency to cut production costs, or improve product finish and/or quality while still using the same resources. Interventions such as Total Quality Management or Six Sigma may lead to better output and increased profitability by eliminating waste. Empowering the workforce may spin off innovations and process improvements.
All these changes make the product more attractive to manufacture, causing increase in supply, and causing the supply curve to shift right. Similarly, path-breaking invention may render some products obsolete, causing sellers to release whatever stock they have to the market before the new products hit the market and render such old products junk.
When sellers expect an imminent price rise, they tend to hoard products, especially non-perishable goods, in the anticipation of more profits. This leads to a short-term shift of the supply curve to the left. Conversely, when sellers expect an imminent price fall, they tend to glut the market, trying to sell as much of stock as possible at a higher price. This leads to the supply curve shifting right.
Such anticipation may be owing to seasonal factors, political changes, or any other reason. For instance, the supply curve of products depending on the vagaries of nature, such as agricultural products, depends on seasonal factors. For instance, a drought might cause crop failure, leading to a reduced supply of crops. Similarly, a rich harvest from the ocean may cause an increased supply of seafood. This happens even when prices remain constant owing to government regulations, higher storage costs, or other reasons.
While a shift in supply curve may be independent of the product price, such a shift usually causes increase or decrease of prices. For instance, demand remaining the same, if supply is constrained to the point that it falls below the equilibrium point, it leads to a situation where many buyers chase too few products, leading to price rise. Conversely, if supply expands to the extent that it outstrips the equilibrium point, too many products chase too few customers, leading to price wars and reduced prices.
The study of how the supply curve shifts allows manufacturers to factor in possible distorting factors to their projections, and how changes in the external environment may impact them. Such an understanding allows for better preparation to meet challenges.