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Supply & Demand

Supply & Demand

The Supply Curve

But understanding demand is only half of the story. To understand the market we also need to understand supply. And as on the demand side of the equation, the basic law of supply is common sense: as prices rise, supply (quantity of X on the market) increases; as prices fall, supply decreases. In other words, when the price for a good goes up, suppliers of that good will produce more. When the price of a good goes down, suppliers produce less.

But similar to demand, the concept of supply is a bit trickier. Supply refers to the amount of a good or service that producers are willing and able to supply at a specified price. (Sound familiar) When we calculate supply we ask how much a producer is willing and able to supply at $3, and $4, and $5.

Supply curves are a lot like demand curves. Economists gather information about the amount of a specific good or service that a provider will supply at various prices and then they plot this information on a graph like this.

Supply Curve 1

But like demand curves, supply curves don’t provide all of the information we need. Supply is influenced by several factors: production costs, technology, the number of competitors, and the expectations of producers.

As production costs change, a producer’s willingness and ability to supply a product at a specific price will change. If our donut maker must pay more for flour and sugar, or higher wages to his employees, he will be less able to provide donuts at the sort of low prices he did in the past. The supply curve for donuts would shift to the left. (See Supply Curve 2.) On the other hand, if new technology allows the baker to produce goods more efficiently and inexpensively, he will be able to reduce the price of her donuts. (See Supply Curve 3.)

Supply Curve 2

Supply Curve 3

Factors decreasing supply and shifting the supply curve to the left: 

Increased production costs
Increased government regulation
Pessimistic market expectations
Withdrawal of market competitors

Factors increasing supply and shifting the supply curve to the right:

Decreased production costs
Decreased government regulation
Optimistic market expectations
Entrance of new market competitors
New technology

Why It Matters Today

How much oil is left in the world?  

That may end up being the most important question of the 21st century, but it comes with a bit of a twist.

In physical terms, the world has a finite supply of oil.  After all, no more new dinosaurs are going to die, be buried deep underground, and transform over thousands of years into sweet, delicious crude oil.

In economic terms, though, the supply of oil might actually grow.  

What?

That's because the real issue here isn't the physical supply of oil, it's the supply of oil that can be harvested at an economical price.  Right now, there are mediocre oilfields where oil exists under the ground, but it costs too much to make it worth pumping out at current prices.  But if the price of oil multiplied by ten, suddenly that oilfield becomes drillable.  Which just proves the most basic rule of supply curves... as prices rise, quantity increases.

And you don't even have to harm any more dinosaurs to make it happen.

Sometimes, a Song Says it Better: Can't Buy Me Love, by The Beatles

There is no supply of love that the Beatles can buy.

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