The Determinants of Supply

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What Are the Determinants of Supply?

Economic supply—how much of an item a firm or market of firms is willing to produce and sell—is determined by what production quantity maximizes a firm's profits. The profit-maximizing quantity, in turn, depends on a number of different factors.

For example, firms take into account how much they can sell their output for when setting production quantities. They might also consider the costs of labor and other factors of production when making quantity decisions.

Economists break down the determinants of a firm's supply into 4 categories:

  • Price
  • Input Prices
  • Technology
  • Expectations

Supply is then a function of these 4 categories. Let's look more closely at each of the determinants of supply.

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Price as a Determinant of Supply

Price is perhaps the most obvious determinant of supply. As the price of a firm's output increases, it becomes more attractive to produce that output and firms will want to supply more. Economists refer to the phenomenon that quantity supplied increases as price increases as the law of supply.

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Input Prices as Determinants of Supply

Not surprisingly, firms consider the costs of their inputs to production as well as the price of their output when making production decisions. Inputs to production, or factors of production, are things like labor and capital, and all inputs to production come with their own prices. For example, a wage is a price of labor and an interest rate is a price of capital.

When the prices of the inputs to production increase, it becomes less attractive to produce, and the quantity that firms are willing to supply decreases. In contrast, firms are willing to supply more output when the prices of the inputs to production decrease.

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Technology as a Determinant of Supply

Technology, in an economic sense, refers to the processes by which inputs are turned into outputs. Technology is said to increase when production gets more efficient. Take for example when firms can produce more output than they could before from the same amount of input.Alternatively, an increase in technology could be thought of as getting the same amount of output as before from fewer inputs.

On the other hand, technology is said to decrease when firms produce less output than they did before with the same amount of input, or when firms need more inputs than before to produce the same amount of output.

This definition of technology encompasses what people usually think of when they hear the term, but it also includes other factors that impact the production process that are typically not thought of as under the heading of technology. For example, unusually good weather that increases an orange grower's crop yield is an increase in technology in an economic sense. Furthermore, government regulation that outlaws efficient yet pollution-heavy production processes is a decrease in technology from an economic standpoint.

Increases in technology make it more attractive to produce (since technology increases decrease per unit production costs), so increases in technology increase the quantity supplied of a product. On the other hand, decreases in technology make it less attractive to produce (since technology decreases increase per-unit costs), so decreases in technology decrease the quantity supplied of a product.

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Expectations as a Determinant of Supply

Just as with demand, expectations about the future determinants of supply, meaning future prices, future input costs and future technology, often impact how much of a product a firm is willing to supply at present. Unlike the other determinants of supply, however, the analysis of the effects of expectations must be undertaken on a case by case basis.

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Number of Sellers as a Determinant of Market Supply

Although not a determinant of individual firm supply, the number of sellers in a market is clearly an important factor in calculating market supply. Not surprisingly, market supply increases when the number of sellers increases, and market supply decreases when the number of sellers decreases.

This may seem a bit counterintuitive, since it seems like firms might each produce less if they know that there are more firms in the market, but this is not what usually happens in competitive markets.