Market Supply Dynamics: Profit Maximization and Economic Equilibrium

The Offer: Market Supply Fundamentals

The market supply consists of goods and services provided by firms, whose behavior has been established in the previous block.

Profit Maximization

The benefit (profit) of the business is determined by the difference between total revenues and total costs. The aim of the firm will be the maximization of profit, which occurs when the marginal revenue coincides with the marginal cost.

Defining the Supply Function

The supply function represents the amount of goods and services that companies want to offer in the market.

Construction of the Supply Function

The relation between price and quantity is directly proportional. If prices are too low, the employer will not cover their costs and will not produce. As prices rise, so does the quantity of product offered.

Quantity Offered

The quantity offered is the amount that sellers are willing to supply of a given good for a specified period at a particular price.

Inputs (Factors of Production)

Inputs are goods and services incorporated into the production process to be transformed into other goods and services. Traditionally, these factors are made up of:

• Land
• Capital
• Labor

Determinants of Market Supply

The Price of the Good

As in the case of the demand function, variations in the price of the good cause movements along the supply function.

The Price of Production Factors

The price of production factors shapes the costs of the company. Therefore, if these prices vary, amendments will occur in their costs, modifying the supply.

Technology

The technology used in the production of the good is included in the function of the company. An improvement in this factor can lead to the company manufacturing more products with the same resources. This means the quantity offered may be higher with the same costs, implying a greater supply.

The Price of Other Related Products

Variations in the price of other goods may cause variations in the number of companies that constitute the market, as companies prefer to manufacture and sell products with prices high enough to cover their costs.

Supply Shifts and Market Balance

Supply Shifts

The supply function shifts when changes occur due to one of the factors listed above (excluding the price of the good itself).

• A rightward shift causes increases in the quantity supplied.
• A leftward shift causes reductions in the quantity supplied.

Economic Equilibrium (Balance)

Equilibrium is a very important economic concept. It consists of the state where the individual (or market) achieves its objectives taking into account the constraints to which it is subjected within the economic model.

Market Disequilibrium

Disequilibrium is a transitory situation in which supply and demand do not match. It may be due to an excess of supply or an excess of demand.

Excess Supply

Excess supply occurs when market prices are superior to the equilibrium price. At these prices, the amounts that companies are willing to offer in the market are much higher than the amounts consumers are disposed to consume.

Excess Demand

Excess demand occurs when market prices are below the equilibrium price. Therefore, the quantity demanded at that price is much higher than the quantity offered.