What is a Supply Curve?

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Definition:

The supply curve is a microeconomic concept that illustrates how production tends to increase as the price of a product rises.

🤔 Understanding the Supply Curve

The supply curve is a visual representation of the law of supply, a microeconomic concept describing the relationship between the price of a product and a company’s willingness to make it. The supply curve slopes upward because as a product’s price rises, the business would tend to be more willing to make it. Also, since businesses are efficient and would exhaust the cheapest production inputs first, the cost of production tends to rise as output increases. A supply curve is drawn in two dimensions, with the cost to produce each unit on one axis (usually the y-axis) and the quantity produced on the other (usually the x-axis). If any dimension other than price or quantity changes, such as labor costs or a technological advance, it establishes a new supply curve.

Example

Imagine a company that manufactures wooden chairs. The business owner purchases lumber from a local sawmill and turns it into beautifully designed, hand-crafted furniture. Then a celebrity posts a picture of their new chair, and it goes viral. Suddenly, the demand for the chairs goes through the roof. The rising demand signals that the price can go up, so the woodworker wants to make more, thus moving up the supply curve. But if he wants to increase production, he will need a new source of lumber, additional employees, and new equipment — all of which costs more money. The supply curve would then reflect this increase in costs associated with higher production.

Takeaway

A supply curve is like counting how long it takes to chop down trees…

Imagine a lumberjack out in the forest with an ax. At first, it may take 25 strikes with a sharp blade before the lumberjack yells “timber!” The next tree might be harder, as the edge begins to dull, and the tenth tree might require 100 swings of the ax to get the job done. If you put the number of trees on one axis and the number of swings on the other, it would look a lot like a supply curve, for a very similar reason.

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What is a Supply Curve?

A supply curve is a graph that displays the relationship between the price of a product and the quantity being produced. Typically, a company will respond to higher prices by increasing production, which economists call the law of supply. Therefore, supply curves slope up. Also, in many cases, the cost of production for an additional unit tends to be higher than how much it cost to produce the previous units. A supply curve only demonstrates a relationship between price and quantity when everything else is held constant (which is called a ceteris paribus assumption). If one of those underlying factors changes, that creates a new supply curve. On a two-dimensional graph, these alternative supply curves represent shifts to the left or right.

What is the equation for the supply curve?

The equation for a supply curve is a supply function that represents the change in product costs as the volume of production increases. In the simplest example, a supply curve can be represented by a linear function. For example, assume that you hire a man to retrieve seashells from the beach, paying him \$10 per hour. These imaginary shells are heavy and awkward to carry, so they arrive one at a time. When you send him out for the first shell, your employee goes and gets the closest one. It takes 12 minutes, so your cost for the first shell is \$2. When you send him out for the next one, he has to go a little further away, which takes more time and effort. It takes 24 minutes, so the labor cost for that second shell is \$4. For simplicity, imagine that each additional shell requires 12 minutes longer to retrieve than the previous one.

The equation for this supply curve is: Cost of shell = \$2 * shell number

It is important to remember that the supply curve represents the marginal cost of production (how much cost is added by increasing production by one unit). The total cost of production would require adding up the costs of each unit. In the real world, the equation for supply curves can be much more complicated.

How does a supply curve work?

A supply curve is plotted in two-dimensional space, meaning there is a horizontal axis (x) and a vertical axis (y). The x-axis holds the independent variable, which causes a change in the dependent variable on the y-axis. Traditionally, economists list the quantity on the horizontal axis and the price (which can also be the marginal cost of production) on the vertical axis.

You can read the supply curve in either direction to see how it works. First, you can find the number of units that you want to produce. Then, locate the cost that corresponds to that level of production. If you can’t sell that last unit for at least that cost, it’s not worth doing.

Or, you can use the supply curve the other way. First, determine the price customers are willing to pay for the product. Then, locate the quantity that corresponds to that given price. That volume is the maximum you should produce.

How does a supply curve reflect the law of supply?

The law of supply states that a higher price must be offered if greater levels of production are desired. Economists formalize the law of supply with mathematical equations. Creating a table of prices and production levels from such an equation is called a supply schedule. And drawing this relationship between price and quantity on a graph results in a supply curve.

Why does the supply curve slope upwards?

To understand why the supply curve slopes upward, consider the cost of making burgers at a local diner. During a typical week, you order your supplies from a warehouse that offers a great deal on bulk orders. But imagine that a plane full of people makes an emergency landing in your small town. Suddenly, you are overwhelmed with hungry customers. To meet the higher demand, you have to increase production. But your normal processes aren’t enough. You run out of meat, cheese, and vegetables, so you send someone to the local grocery store to buy more. Of course, these products cost more than what you pay your typical vendor. And you don’t have enough staff to keep up, so you end up paying overtime to keep people on the clock.

All of these extra costs are associated with increasing your level of production. That’s what the supply curve demonstrates. And the upward slope reflects the fact that businesses often can’t increase production levels without corresponding price increases to cover these additional costs.

What causes shifts in the supply curve?

A supply curve shows one relationship between price and quantity, holding everything else constant. But if one of those determinants of supply changes, so does the supply curve. Economists call this a shift in the supply curve.

To understand the concept of a supply curve shift, imagine a block of Swiss cheese. It’s a three-dimensional object that has holes in random places. Now, if you take an extremely thin slice out of the cheese, you’ve basically reduced the three dimensions (height, length, and width) to two dimensions (length and width). The slice of Swiss cheese will have missing circles in random places. Now, if you take a different slice out of the cheese, you should still have holes, but in different places. If you compare the two slices of cheese, which were taken from different heights along the block, the holes will appear to have shifted positions. This idea also applies to the supply curve. Every supply curve is a slice out of a bigger picture. But rather than moving up and down a block of cheese, the curve runs along with some other determinant. The most significant determinants of supply are the costs of the factors of production (labor, land, capital, and enterprise). A supply curve shows how the cost of production increases as production increases, for a given set of expenses related to things like labor, materials, equipment, and energy.

If any of those determinants change, it’s like taking a new slice of cheese. For instance, if the government passes a new minimum wage, the cost of production changes with every increase in quantity. Or, if the state of technology changes, a new piece of equipment might improve efficiency, which reduces the cost of production at every level of production. These are different supply curves, which we view as shifts in supply.

In short, if the cost of production increases in response to higher output, that is a movement along the supply curve. But if the cost of production changes at every level of output, that’s a fundamental shift in the supply of goods. In that case, we would say that supply increases.

What does a supply curve show?

Essentially, what the supply curve shows is how the marginal cost of production (the additional expenses directly associated with one more unit of production) changes as a business adjusts its level of output. Supply curves slope upward to demonstrate how the incremental production comes at an additional expense.

The slope of the supply curve also provides other important information. It demonstrates how quickly expenses increase as you ratchet up output, which is called the price elasticity of supply. And when the supply curve is drawn on the same graph as a demand curve, the spot where the lines intersect shows the market equilibrium (the price and quantity combination at which the number of buyers and sellers are equal).

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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Updated June 18, 2020

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