Forces behind the Supply Curve

In examining the forces determining the supply curve, the fundamental point to grasp is that producers supply commodities for profit and not for fun or charity. One major element underlying the supply curve is the cost of production. When production costs for a good are low relative to the market price, it is profitable for producers to supply a great deal. When production costs are high relative to price, firms produce little, switch to the production of other products, or may simply go out of business.

Production costs are primarily determined by the prices of inputs and technological advances. The prices of inputs such as labor, energy, or machinery obviously have a very important influence on the cost of producing a given level of output. For example, when oil prices rose sharply in the 1970s, the increase raised the price of energy for manufacturers, increased their production costs, and lowered their supply. By contrast, as computer prices fell over the last three decades, businesses increasingly substituted computerized processes for other inputs, as for example in payroll or accounting operations; this increased supply.

An equally important determinant of production costs is technological advances, which consist of changes that lower the quantity of inputs needed to produce the same quantity of output. Such advances include everything from scientific breakthroughs to better application of existing technology or simply reorganization of the flow of work. For example, manufacturers have become much more efficient over the last decade or so. It takes far fewer hours of labor to produce an automobile today than it didjust 10 years ago. This advance enables car makers to produce more automobiles at the same cost. To give another example, if Internet commerce allows purchasers more easily to compare the prices of necessary inputs, that will lower the cost of production.

But production costs are not the only ingredient that goes into the supply curve. Supply is also influenced by the prices of related goods, particularly goods that are alternative outputs of the production process. If the price of one production substitute rises, the supply of another substitute will decrease. For example, auto companies typically make several different car models in the same factory. If there's more demand for one model, and its price rises, they will switch more of their assembly lines to making that model, and the supply of the other models will fall. Or if the demand and price for trucks rise, the entire factory can be converted to making trucks, and the supply of cars will fall.

Government policy also has an important impact on the supply curve. Environmental and health considerations determine what technologies can be used, while taxes and minimum-wage laws can significantly raise input prices. In the local electricity market, government regulations influence both the number of firms that can compete and the prices they charge. Government trade policies have a major impact upon

Factors affecting the supply curve

Example for automobiles

1. Technology

Computerized manufacturing lowers production costs and increases supply.

2. Input prices

A reduction in the wage paid to autoworkers lowers production costs and increases supply.

3. Prices of related goods

If truck prices fall, the supply of cars rises.

4. Government policy

Removing quotas and tariffs on imported automobiles increases total automobile supply.

5. Special influences

Internet shopping allows consumers to compare the prices of different dealers more easily and drives high-cost sellers out of business.

TABLE 3-4. Supply Is Affected by Production Costs and Other Factors

TABLE 3-4. Supply Is Affected by Production Costs and Other Factors supply. For instance, when a free-trade agreement opens up the U.S. market to Mexican footwear, the total supply of footwear in the United States increases.

Finally, special influences affect the supply curve. The weather exerts an important influence on farming and on the ski industry. The computer industry has been marked by a keen spirit of innovation, which has led to a continuous flow of new products. Market structure will affect supply, and expectations about future prices often have an important impact upon supply decisions.

Table 3-4 highlights the important determinants of supply, using automobiles as an example.

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