Market Supply

Market Supply

The incentive for any business to supply goods to market is to make
profits – to sell his/her product at a higher price than the COSTS OF
PRODUCTION involved in offering it for sale. Whether it be a personal
service, such as providing haircuts, the assembly of a luxury motor
Box 2.6 Coffee prices: part 1
All this analysis may seem a bit pedantic but, as you will see
later on, it is actually important in separating out causes and
effects of major crises in world markets. A quick example should
help explain. Coffee is (after oil) the world’s second most important
traded commodity. The livelihood of 25 million small
producers and more than half-a-billion other people linked to
the coffee trade in poor countries is directly influenced by the
price of coffee. At the time of writing, the world price of coffee is
close to a 100-year low – depressing the incomes, and lives, of
millions. Additionally, prices over the last twenty years have been
very volatile – hurting particularly the smaller farmer who cannot
insure against risk.
Is the price low because world demand is low or has some
other factor caused the slump in prices? And what causes the
sudden and great reversals in prices and fortunes? This is not an
insignificant matter. Careful analysis is called for . . .
200
150
100
50
0
Oct-83 Oct-86 Oct-89 Oct-92 Oct-95 Oct-98
Figure 2.9 Coffee Prices, 1983–2002.
Source: ‘Coffee Market Trends’ Kristina Sorby, World Bank (June 2002).
© 2004 Tony Cleaver
car with inputs from all over the world, or selling advertising space
on-line to invisible consumers, these goods and services will only be
supplied if the market price agreed on with the buyer sufficiently
rewards the entrepreneur for his/her efforts.
Assume that all suppliers wish to maximise profits. Given that
production costs and all other factors affecting the supply of a
certain good remain constant, then producers will increase supplies
to the market if prices rise. Conversely, supply will contract if price
falls.
There are many costs involved in offering coffee for sale in a
given market place. At low prices per cup, only the most efficient,
low-cost suppliers can afford to produce this beverage and the
quantities offered for sale will be limited. If consumers are willing
to pay higher prices, however, then other suppliers will be tempted
to enter the market and existing producers will also increase their
provision. At very high prices, businesses which had never previously
thought of making this product may well switch production
plans and become coffee suppliers.
We can illustrate the relationship between the price of a product
and the quantity supplied by the supply curve S in Figure 2.10.
Note that, as before, the slope of the supply curve indicates the
responsiveness of producers to alter supplies as price changes. If, for
example, a small increase in price calls forth a proportionally large
increase in quantity then supply is said to be price-elastic. The
rather steep curve shown here illustrates the opposite: relatively
low price-elasticity of supply.
Price-elasticity of supply is affected by time – the longer businesses
have to adjust production plans, the more responsive they
S
Price
Quantity
Figure 2.10 A supply curve.
© 2004 Tony Cleaver
can be to any market changes. A sudden increase in demand for
almost any product cannot be accommodated instantly, no matter
how high a price a customer is prepared to pay. Supplies of oil, cars
or coffee, for example are fixed by current stockpiles. If someone is
desperate to buy something then a high price may persuade another
consumer to leave the market (as in an auction) but supply itself
cannot be increased.
Over time, depending on the technology involved in production,
high prices call forth greater supplies. For oil, more may be pumped
out of the existing wells and refineries. More cars can roll off the
assembly line. In the case of coffee, if all existing stocks are already
committed, consumers will have to wait until the next harvest.
Typically, economists can identify three trading periods: the
instantaneous or SPOT MARKET, when supplies are fixed to existing,
identifiable stocks; the SHORT TERM when supplies are price-inelastic
and the LONG TERM when supplies are price-elastic (Figure 2.11).
The dividing line between the short term and long term is a
matter of judgement. The short term usually refers to the increase
in supplies that can be gained by relying on existing resources and
working them harder; the longer term tends to imply employing
more factors of production.