Law_of_Supply.pptx..........................

ECONOMICS

1. ENGINEERING ECONOMICS AND COSTING Module-I By- Dr. Ronismita Mishra

2. Meaning and Factors affecting Supply In economics, the supply refers to the quantity of a good or service that producers are willing and able to offer for sale at different prices during a specific period. The law of supply states that, all else being equal, as the price of a good or service increases, the quantity supplied also increases, and vice versa. Here are some key concepts related to the meaning and factors affecting supply: Meaning of Supply: 1. Quantity Supplied: The amount of a good or service that producers are willing to offer for sale in the market. 2. Price: Supply is typically depicted on a supply curve, which shows the relationship between the price of a good and the quantity supplied. 3. Time Frame: Supply can vary in the short run and the long run. In the short run, factors like production capacity and existing technology play a role. In the long run, factors like technological advancements and changes in input costs can affect supply.

3. Factors Affecting Supply: 1. Price of the Good or Service: As mentioned earlier, there is a direct relationship between the price of a good and the quantity supplied. An increase in price often leads to an increase in the quantity supplied, and a decrease in price leads to a decrease in quantity supplied. 2. Production Costs: The costs of producing goods and services, including raw materials, labour, and other inputs, can influence supply. If production costs rise, producers may supply less at a given price. 3. Technology: Advancements in technology can enhance production efficiency, reduce costs, and increase the quantity of goods supplied. 4. Number of Sellers: The total supply in the market is influenced by the number of sellers. More sellers can lead to a higher overall supply.

4. 5. Expectations of Future Prices: If producers expect prices to rise in the future, they may reduce current supply to sell at higher prices later. Conversely, if they expect prices to fall, they may increase current supply. 6. Government Regulations: Regulations, such as taxes, subsidies, and production quotas, can impact the cost of production and, consequently, the quantity supplied. 7. Natural Disasters and Weather Conditions: Events like natural disasters or adverse weather conditions can affect the supply of certain goods, especially in agriculture. 8. Availability of Inputs: The availability of factors of production, such as labor , raw materials, and technology, can affect the ability of producers to supply goods and services. Understanding these factors helps economists and businesses analyse and predict changes in supply, which is crucial for making informed decisions in the marketplace.

5. LAW OF SUPPLY The law of supply describes the relationship between price and amount supplied when all other variables remain constant (ceteris paribus). Price is a dominant factor in the determination of the supply of a commodity. As the price of a commodity increases, the supply of that commodity in the market also increases and vice-versa. This behaviour of the producers is studied through the law of supply.

6. Assumptions of Law of Supply The phrase “keeping other factors constant or ceteris paribus” is used when describing the law of supply. This expression refers to the following presumptions that the law is based on: The price of other commodities is constant. The state of technology has not changed. The price of factors of production is constant. The taxation laws remain the same. The producer’s objectives are constant.

7. The Law of Supply can be better understood with the help of the following table and graph. The above table indicates that when the price of the commodity rises, an increasing number of units are offered for sale. In the above graph, the rising slope of the supply curve (SS) indicates a clear relationship between price and quantity supplied.

8. Important points about Law of Supply: The law of supply states the positive relationship between price and quantity supplied of a commodity after assuming that the other factors remain constant. As the law of supply indicates the direction of the changes in quantity supplied of a commodity and not the magnitude of the change. it is considered as a quantitative statement. The law of supply does not establish any proportional relationship between the change in price and the respective change in quantity supplied of the commodity. The law of supply is one sided. It is because the law explains only the effect of change in price on the supply of the commodity and not the effect of change in supply on the price of the commodity.

9. Reason for Law of Supply The main reasons behind the law of supply are as follows: 1. Profit Motive: Maximising profits is the primary goal of producers when they supply a good or service. Their profits grow when the price of a commodity rises without a change in costs. Therefore, by increasing production, manufacturers increase the commodity’s supply. On the other hand, as price fall, supply also declines since low price result in lower profit margins. 2. Change in Number of Firms: When the price of a specific commodity increases, potential producers are encouraged to enter the market and produce the good to make money. The market supply rises as the number of businesses increases. However, once the price begins to decline, some businesses that do not anticipate making any money at a low price may stop production or cut it back. As the number of businesses in the market declines, it decreases the supply of the given commodity. 3. Change in Stock: When the price of an item rises, sellers are eager to supply additional things from their stocks. However, the producers do not release significant amounts from their stock at a significantly cheaper price. They work on building up their inventory in anticipation of potential price increases in the future.

10. Exceptions to the Law of Supply Generally, the slope of the supply curve is upwards, showing that with the rise in the price of a commodity, its quantity supplied also rises. However, there may be some cases when there is no positive relationship between the supply and price of a commodity. These cases are as follows: 1. Future Expectations: The law of supply is not valid if sellers expect a fall in the price in the future. The sellers will be willing to sell more in this situation, even at a cheaper price. However, if sellers expect an increase in the future price, they will reduce supply to deliver the item later at a higher price. 2. Agricultural Goods: Agricultural products are exempted from the rule of supply as they are produced in response to climatic circumstances. If the production of agricultural goods is low because of unexpected weather changes, supply cannot be expanded, even at higher prices. 3. Perishable Goods: Sellers are willing to offer more perishable commodities, such as fruits, vegetables, and other foods, even if prices are dropping. This occurs because sellers cannot keep such things for an extended period. 4. Rare Articles: The law of supply does not apply to precious, rare, or artistic items. For example, even if the price increases, the number of rare items like the Mona Lisa artwork cannot be increased. 5. Backward Countries: Due to the scarcity of resources, output and supply cannot be enhanced in economically underdeveloped countries.

11. Price Elasticity of Supply Law of Supply states that, other factors being constant, quantity supplied increases with a price increase and decreases with a decrease in the price of the commodity. The degree of change in quantity supplied in response to changes in price is known as Price Elasticity of Supply. Price Elasticity of supply undertakes how the supply of a particular product responds to price fluctuations. There are five types of elasticity of supply; Perfectly Elastic Supply, Perfectly Inelastic Supply, Unit Elastic Supply, More than Unit Elastic Supply, Less than Unit Elastic Supply, and.

12. The price elasticity of supply formula can be represented as: Price elasticity of supply = % change in quantity supplied/% change in price It is calculated by dividing the percentage change in quantity supplied (∆Qs/Qs) by the percentage change in price (∆P/P), which is mathematically represented as, Price Elasticity of Supply = (∆QS/QS) ÷ (∆P/P) = (∆QS/∆P) * (P/QS)

13. Types of Elasticity of Supply 1. Perfectly Elastic Supply: Price Elasticity of Supply is said to be perfect elastic supply when at a particular price, there is infinite supply for a commodity, and with even a small change in its price, the supply becomes zero. Perfectly Elastic Supply indicates that the suppliers are willing to sell only when the prices of commodities are high. The price elasticity in this case is infinite; i.e., ES = ∞, and the supply curve is a horizontal straight line parallel to the X-axis. Quantity supplied can be OQ, OQ1, or OQ2 at the same price as OP. Price (in ₹) Supply (in units) 20 150 20 250 20 35 The quantity supplied can be 150, 250, or 350 units at the same price of ₹20. However, it must be kept in mind that perfectly inelastic supply is an imaginary situation.

14. 2. Perfectly Inelastic Supply: Price Elasticity of Supply is said to be perfect inelastic supply when the quantity supplied does not change with the change in price. It shows that the supply would remain the same irrespective of the price. The price elasticity in this case is zero; i.e., ES = 0, and the supply curve is a vertical straight line parallel to the Y-axis. Quantity supplied remains the same at OQ, with the change in price from OP to OP1 to OP2. Price (in ₹) Supply (in units) 10 30 20 30 30 30 The quantity supplied remains the same at 30 units, whether the price is ₹10, ₹20, or ₹30.

15. 3. Unitary Elastic Supply: Price Elasticity of Supply is said to be unit elastic supply when a price change is precisely equal to the change in quantity supplied. The price elasticity of supply is 1 in such cases; i.e., ES = 1, and the supply curve is a straight line passing through the origin. The quantity supplied rises from OQ to OQ1 with a rise in price from OP to OP1. As QQ1 is proportionately equal to PP1, the elasticity of supply is equal to 1. Price (in ₹) Supply (in units) 20 200 30 300 The quantity supplied rises by 50% due to a 50% increase in price.

16. 4. More than Unit Elastic Supply/Highly Elastic Supply: Price Elasticity of Supply is said to be more than unit elastic when the percentage change in supply is relatively greater than the percentage change in price. The price elasticity of supply in such cases is greater than 1, i.e., ES > 1, and the supply curve intercepts on the Y-axis. The quantity supplied rises from OQ to OQ1 with a rise in price from OP to OP1. As QQ1 is proportionately more than PP1, the elasticity of supply is more than 1. Price (in ₹) Supply (in units) 20 200 30 400 The quantity supplied increases by 100% due to a 50% increase in price.

17. 5. Less than Unit Elastic Supply/Less Elastic Supply: Price Elasticity of Supply is said to be less than unit elastic supply when the percentage change in supply is relatively lower than the percentage change in price. Price Elasticity of Supply is less than 1 in such cases; i.e., ES < 1, and the supply curve intercepts on the X-axis The quantity supplied rises from OQ to OQ1 with a rise in prices from OP to OP1. As QQ1 is proportionately less than PP1, the elasticity of supply is less than 1. Price (in ₹) Supply (in units) 20 200 30 240 The quantity supplied rises by 20% due to a 50% increase in price.

18. Theory of production In simple words, the definition of production is the process in which various inputs, such as land, labour, and capital, are used to produce the outputs in the form of products or services. Each company is diverse and has a particular production strategy, but all businesses strive to combine their inputs in a way that maximizes their profits. Businesses must take into account several factors when deciding how much to produce to be profitable. Businesses must consider the cost of the inputs utilized in the production process.

19. In economics, the factors of production are the resources used in the production of goods and services. These factors are essential inputs that contribute to the creation of economic value. The traditional factors of production are often categorized into four main types: land, labour, capital, and entrepreneurship. 1. Land: Land refers to all natural resources that are used in the production process. This includes not only the physical land itself but also any natural resources that come from the land, such as minerals, water, and forests. 2. Labour: Labour encompasses the physical and mental effort contributed by individuals to the production of goods and services. It includes both skilled and unskilled workers. 3. Capital: Capital refers to the man-made goods used in the production process. It includes machinery, tools, buildings, and any other durable products that are used to produce other goods and services. 4. Entrepreneurship: Entrepreneurship involves the ability to combine the other factors of production (land, labor , and capital) to create and organize a business venture. Entrepreneurs take risks and make decisions to drive the production process.

20. Production Function The production function describes the link between physical inputs and physical output (final output). The production function is often expressed in the following way: Q = f(X1, X2) where X1 and X2 are inputs or production parameters, and Q is the ultimate output. 1. Total Product In simple terms, we can define Total Product as the total volume or amount of final output produced by a firm using given inputs in a given period of time. 2. Marginal Product The additional output produced as a result of employing an additional unit of the variable factor input is called the Marginal Product. Thus, we can say that marginal product is the addition to Total Product when an extra factor input is used. Marginal Product = Change in Output/ Change in Input Thus, it can also be said that Total Product is the summation of Marginal products at different input levels. Total Product = Ʃ Marginal Product 3. Average Product It is defined as the output per unit of factor inputs or the average of the total product per unit of input and can be calculated by dividing the Total Product by the inputs (variable factors). Average Product = Total Product/ Units of Variable Factor Input

21. Production Function can be Short Run Production Function: The short run refers to a period during which at least one input in the production process is fixed, typically the capital or plant size. In other words, some factors of production cannot be easily or quickly changed. During the short run, a firm can adjust its output by varying the variable inputs (like labor and raw materials), but it cannot alter its fixed inputs (like machinery or factory size). The law of diminishing returns is often more noticeable in the short run. As a firm increases the quantity of a variable input while keeping some inputs fixed, there comes a point where the marginal product of the variable input diminishes, leading to lower efficiency. The short-run production function is typically represented on a graph, with output on the vertical axis and the variable input on the horizontal axis. The total product curve and the marginal product curve are commonly used to illustrate the relationship between input and output in the short run. Long Run Production Function: The long run refers to a period during which all inputs in the production process can be varied. In this time frame, a firm can adjust its plant size, change technology, and make other structural changes to production. In the long run, a firm has the flexibility to adapt to changes in demand or production conditions by adjusting all factors of production, including capital. Firms can experience economies of scale in the long run, where increasing the scale of production leads to a proportionally larger increase in output. This can result from cost savings and improved efficiency. The long-run production function is also represented graphically, showing how changes in all inputs impact output. In the long run, there is no fixed input, so the firm can optimize its production process for the desired level of output.

22. The Law of Variable Proportions The law of variable proportions is a short period production law. It is also called returns to a factor. Let us first understand the meaning of variable proportions. In a production process when only one factor is varied and all other factors remain constant, as more and more units of variable factor are employed, the proportion between fixed and variable factors goes on changing. So it is termed as the law of variable proportions. This law states that if you go on using more and more units of variable factor (labour) with fixed factor (capital), the total output initially increases at an increasing rate but beyond a certain point, it increases at a diminishing rate and finally it falls. This law was initially called the law of diminishing returns Marshall who applied the law only in agriculture sector but modern economist called it the law of variable proportion and proposed its applicability to all the sectors of the economy.

23. Assumption of the law (i) The firm operates in the short run. (ii) There is no change in technology of production. (iii) The production process allows the different factor ratios to produce different levels out output. (iv) All the units of variable factor are equally efficient. (v) Full substitutability of factors of production is not possible.

24. In the above table:- Land is considered as fixed factor and labour is variable factor of production. As the labour are increased keeping land fixed, TP first increases that the increasing rate up to the 3rd unit of labour and increases at a diminishing rate up to the 5th unit of labour. TP is maximum at the 5th unit of labour and becomes stable up to the 6th units of labour and starts to fall. MP first increases, becomes maximum at the 3rd unit of labour and thereafter declines. MP is zero at 6th units of labour and thereafter negative. AP also increases at first, becomes maximum at the 3rd unit of labour and stable upto 4th unit of labour, and thereafter declines. AP and MP are equal at the 4th unit of labour. Though AP declines it never becomes zero.

25. Stage-I: Increasing Returns to a factor in this phase TPP increases at an increasing rate and marginal product of variable factor, labour increases. In the end of this phase MPP is maximum. So, this is the phase of increasing returns to a factor. Stage-II: Diminishing Returns to a factor In this phase TPP increases but at a diminishing rate MPP declines but remains positive. At the end of this phase MPP is zero. At this point TPP is maximums. So, this is the phase of diminishing returns to a factor. Stage-III: Negative Returns to a factor In this phase, MPP declines and it becomes negative. Here the TPP also starts falling. It operates from the level of output where MPP of labour is zero but subsequently becomes negative.

26. Law of Returns to Scale In the long run all factors of production are variable. No factor is fixed. Accordingly, the scale of production can be changed by changing the quantity of all factors of production. “The term returns to scale refers to the changes in output as all factors change by the same proportion.” Koutsoyiannis “Returns to scale relates to the behaviour of total output as all inputs are varied and is a long run concept”. Leibhafsky Returns to scale are of the following three types: 1. Increasing Returns to scale. 2. Constant Returns to Scale 3. Diminishing Returns to Scale

27. Explanation: In the long run, output can be increased by increasing all factors in the same proportion. Generally, laws of returns to scale refer to an increase in output due to increase in all factors in the same proportion. Such an increase is called returns to scale. Suppose, initially production function is as follows: P = f (L, K)

28. Now, if both the factors of production i.e., labour and capital are increased in same proportion i.e., x, product function will be rewritten as .

29. The above stated table explains the following three stages of returns to scale: 1. Increasing Returns to Scale: Increasing returns to scale or diminishing cost refers to a situation when all factors of production are increased, output increases at a higher rate. It means if all inputs are doubled, output will also increase at the faster rate than double. Hence, it is said to be increasing returns to scale. This increase is due to many reasons like division external economies of scale. Increasing returns to scale can be illustrated with the help of a diagram. In figure 8, OX axis represents increase in labour and capital while OY axis shows increase in output. When labour and capital increases from Q to Q1, output also increases from P to P1 which is higher than the factors of production i.e. labour and capital.

30. 2. Diminishing Returns to Scale: Diminishing returns or increasing costs refer to that production situation, where if all the factors of production are increased in a given proportion, output increases in a smaller proportion. It means, if inputs are doubled, output will be less than doubled. If 20 percent increase in labour and capital is followed by 10 percent increase in output, then it is an instance of diminishing returns to scale. The main cause of the operation of diminishing returns to scale is that internal and external economies are less than internal and external diseconomies. It is clear from diagram. In this diagram , diminishing returns to scale has been shown. On OX axis, labour and capital are given while on OY axis, output. When factors of production increase from Q to Q1 (more quantity) but as a result increase in output, i.e. P to P1 is less. We see that increase in factors of production is more and increase in production is comparatively less, thus diminishing returns to scale apply.

31. 3. Constant Returns to Scale: Constant returns to scale or constant cost refers to the production situation in which output increases exactly in the same proportion in which factors of production are increased. In simple terms, if factors of production are doubled output will also be doubled. In figure , we see that increase in factors of production i.e. labour and capital are equal to the proportion of output increase. Therefore, the result is constant returns to scale

32. ISO-QUANT CURVE The term Iso -quant or Iso -product is composed of two words, Iso = equal, quant = quantity or product = output. Thus it means equal quantity or equal product. Different factors are needed to produce a good. These factors may be substituted for one another. A given quantity of output may be produced with different combinations of factors. Iso -quant curves are also known as Equal-product or Iso -product or Production Indifference curves. Since it is an extension of Indifference curve analysis from the theory of consumption to the theory of production. According to Peterson “An Iso -quant curve may be defined as a curve showing the possible combinations of two variable factors that can be used to produce the same total product.”

33. Assumptions: 1. Two Factors of Production 2. Divisible Factor 3. Constant Technique 4. Possibility of Technical Substitution 5. Efficient Combinations

34. 1. 1 units of labour and 15 units of capital 2. 2 units of labour and 11 units of capital 3. 3 units of labour and 8 units of capital 4. 4 units of labour and 6 units of capital 5. 5 units of labour and 5 units of capital