Theories of Aggregate Supply
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The law of supply is a fundamental principle of economic theory that states that, keeping other factors constant, an increase in price results in an increase in quantity supplied. In other words, there is a direct relationship between price and quantity: quantities respond in the same direction as price changes.
Law of Supply and Theories
The law of supply says that a higher price will induce producers to supply a higher quantity to the market, therefore, increasing the normal supply of the product. Supply in a market can be depicted in a graph as an upward-sloping supply curve that shows how the quantity supplied will actively respond to fluctuations in various prices over any period of time.
Example
A samosa shop increases the number of samosas they prepare and supply every day when the price is increased. When the selling price of a product goes up, what could be the relationship to the quantity actually supplied? It becomes practical to produce more and more of that product.
More About the Topic
What do you mean by the Theory of Supply in Economics? Supply is the amount of any commodity that sellers are willing to offer for sale at a different price per unit of time. There is a direct relationship between the price of a given commodity and the quantity offered by a seller for sale over a specified time.
If the price of the commodity rises, then other factors remain constant. Its quality which is offered for sale starts increasing as well and when the price of the commodity falls, the quantity of commodity available for sale decreases. This relationship between the price of the commodity and the quantity which the supplier is willing to sell is called the Theory of Supply.
Law of Supply
In simple words, the law of supply states that sellers supply more goods at higher prices and supply fewer goods at lower prices. The supply function is explained in the mentioned supply curve and schedule.
Market Supply Schedule of a Commodity:
In the above schedule, it is clear that the seller is willing to sell 100 units of a good at ＄4. Observe, as the price falls the quantity that the seller is willing to sell also starts falling. Therefore, at ＄1 the quantity that is being offered to sale is 40 units only.
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In the figure, the price of the commodity is on the Y-axis and the quantity of the commodity is on the X-axis. The four points namely d, c, b, and a show the combination of each price and the specific quantity that is being supplied at that price. The slope is the supply curve slopes upwards from left to right, which indicates that less quantity is being offered for sale at a lower price. Economic students study the theory of supply Class 12 Economics in detail.
Theories of Aggregate Supply Explained
Theory of Aggregate Supply and Aggregate Demand was given by John Maynard Keynes which was presented in his work in The General Theory of Employment, Interest, and Money. In Macroeconomics, aggregate supply (AS) is also termed as domestic final supply (DFS). Aggregate supply is the total supply of commodities that forms in an economy plan on selling during a specified amount of time.
In simple words, the theory of aggregate supply is the total supply in an economy’s Gross Domestic Product (GDP). Typically, a positive relationship is observed between the price level and the aggregate supply. The main components of aggregate supply are consumption and saving. The aggregate supply is the sum of consumption expenditure and savings.
Aggregate Supply (AS) = Consumption Expenditure + Saving (S)
The Formula for Theory of Supply:
Qx = Quantity Supplied
Φ = Function of
Tech = technology
Px = Price
F = Features of nature
X = Taxes and subsidies
It Is Assumed That These Variables Remain Constant.
Difference Between Theory of Supply and Theory of Aggregate Supply
The theory of supply is a concept of Microeconomics and Aggregate Supply is a concept of Macroeconomics. The law of supply and demand is a fundamental economic theory that establishes a relation between what producers sell and what consumers demand. Whereas Aggregate Supply is the total supply in an economy, the total amount a nation produces and sells.
Demand and Supply Theory of Wages
Wages are the price of services that are being rendered by the labour to the employer. As product prices are determined by its supply and demand curve, similarly wages are also obtained with the hero of demand and supply of labour. The Modern Theory of wages was given by J.R. Hicks.
Did You Know?
The shift in a supply curve is caused by a change in the cost of production, change in the number of producers, change in tax rates, or changes in the state of production technology in use.
Solved Example
Q. The supply schedule for firm A and firm B is given below. Compute the market supply schedule for the same.
A1. The market supply will be the number of commodities supplied by firm A and firm B.
FAQs on Theory of Supply: Meaning and Examples
1. What is meant by 'supply' in economics, and can you give an example?
In economics, supply refers to the total quantity of a specific good or service that a producer is willing and able to sell at a given price over a certain period. It's not just about the stock available but the quantity a seller is actively offering for sale. For example, if a farmer is willing to sell 500 kilograms of wheat at a price of ₹20 per kg, then the supply at that price is 500 kg.
2. What is the law of supply? Provide a simple example.
The law of supply states that, other factors remaining constant (ceteris paribus), the quantity of a good supplied increases with an increase in its price, and decreases with a fall in its price. This demonstrates a direct or positive relationship between price and quantity supplied. For instance, if the market price of handmade jackets rises, a clothing boutique will be motivated to produce and offer more jackets to maximise its profit.
3. Why does the supply curve generally slope upwards from left to right?
The upward slope of the supply curve reflects the law of supply. The primary reason for this is the profit motive. As the price of a good increases, it becomes more profitable for firms to produce and sell it. Higher prices can cover the higher marginal costs of producing more units, incentivising producers to increase their output. Conversely, at lower prices, production is less profitable, leading to a reduced quantity supplied.
4. What is the key difference between a 'change in quantity supplied' and a 'change in supply'?
This is a crucial distinction in the theory of supply. A 'change in quantity supplied' refers to a movement along the same supply curve, caused solely by a change in the price of the good itself. In contrast, a 'change in supply' refers to a shift of the entire supply curve (either to the right for an increase or to the left for a decrease). This shift is caused by factors other than the good's own price, such as changes in technology, input costs, or government policies.
5. What are the main determinants that can cause a shift in the supply curve?
Several factors, known as determinants of supply, can cause the entire supply curve to shift. The most important ones include:
Cost of Inputs: A decrease in the price of raw materials or labour reduces production costs and increases supply, shifting the curve to the right.
Technology: Technological advancements improve efficiency, lower production costs, and increase supply.
Government Policies: Taxes increase production costs and decrease supply (shift left), while subsidies lower costs and increase supply (shift right).
Prices of Related Goods: If the price of a substitute in production (e.g., another crop) rises, producers may switch, decreasing the supply of the original good.
Number of Firms: An increase in the number of producers in the market increases the total market supply.
6. How does a change in government policy, like a new tax, affect the supply of a good?
Government policies directly impact the cost of production and, therefore, the supply of a good. For example, if the government imposes a new excise tax on a product like sugary drinks, it effectively increases the cost for producers to make and sell each unit. To maintain their profit margins, producers will supply a smaller quantity at any given price. This leads to a decrease in supply, which is represented by a leftward shift of the supply curve.
7. What is a supply function, and how is it typically expressed?
A supply function is a mathematical expression that shows the relationship between the quantity supplied of a commodity and its various determinants. It provides a precise way to represent how much of a good will be supplied at different values of factors like price, input costs, and technology. A simple linear supply function is often expressed as: Sx = f(Px, P₀, T, G, ...), where Sx is the quantity supplied, Px is the price of the good, and the other variables represent the determinants of supply.
8. Are there any real-world exceptions to the law of supply?
While the law of supply holds true in most cases, there are a few exceptions where a higher price does not lead to a higher quantity supplied. These include:
Fixed Supply Goods: For items with a fixed supply, like agricultural land or rare antiques, the supply curve is a vertical line. Even if the price increases, the quantity supplied cannot be increased.
Perishable Goods: Sellers of perishable items like fresh fish or flowers may be willing to sell more at lower prices as the end of the day approaches to avoid a total loss, temporarily violating the law.
Labour Supply: At very high wage rates, an individual might choose to work fewer hours and enjoy more leisure, causing the labour supply curve to bend backwards.
