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Theory of Supply

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Theories of Aggregate Supply

What do you mean by the Theory of Supply in Economics? Supply is the amount of any commodity that sellers are willing to offer for sale at a different price per unit of time. There is a direct relationship between the price of a given commodity and the quantity offered by a seller for sale over a specified time. 

If the price of the commodity rises, then other factors remain constant. Its quality which is offered for sale starts increasing as well and when the price of the commodity falls, the quantity of commodity available for sale decreases. This relationship between the price of the commodity and the quantity which the supplier is willing to sell is called the Theory of Supply.


Law of Supply

In simple words, the law of supply states that sellers supply more goods at higher prices and supply fewer goods at lower prices. The supply function is explained in the mentioned supply curve and schedule.


Market Supply Schedule of a Commodity:

Price ($)

4

3

2

1

Quantity

100

80

60

40


In the above schedule, it is clear that the seller is willing to sell 100 units of a good at $4. Observe, as the price falls the quantity that the seller is willing to sell also starts falling. Therefore, at $1 the quantity that is being offered to sale is 40 units only.

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In the figure, the price of the commodity is on the Y-axis and the quantity of the commodity is on the X-axis. The four points namely d, c, b, and a show the combination of each price and the specific quantity that is being supplied at that price. The slope is the supply curve slopes upwards from left to right, which indicates that less quantity is being offered for sale at a lower price. Economic students study the theory of supply Class 12 Economics in detail.


Theories of Aggregate Supply Explained

Theory of Aggregate Supply and Aggregate demand was given by John Maynard Keynes which was presented in his work in The General Theory of Employment, Interest, and Money. In Macroeconomics, aggregate supply (AS) is also termed as domestic final supply (DFS). Aggregate supply is the total supply of commodities that forms in an economy plan on selling during a specified amount of time.

In simple words, the theory of aggregate supply is the total supply in an economy’s Gross Domestic Product (GDP). Typically, a positive relationship is observed between the price level and the aggregate supply. The main components of aggregate supply are consumption and saving. The aggregate supply is the sum of consumption expenditure and savings. 

Aggregate Supply (AS) = Consumption Expenditure + Saving (S)


The Formula for Theory of Supply:

QxS = Φ (Px Tech, Si, Fn, X,........)

 

Qx = Quantity Supplied

Φ =  Function of

Tech = technology

Px = Price

F = Features of nature

X = Taxes and subsidies

[It is assumed that these variables remain constant.]


Difference Between Theory of Supply and Theory of Aggregate Supply

The theory of supply is a concept of Microeconomics and Aggregate Supply is a concept of Macroeconomics. The law of supply and demand is a fundamental economic theory that establishes a relation between what producers sell and what consumers demand. Whereas Aggregate Supply is the total supply in an economy, the total amount of a nation produces and sells.


Demand and Supply Theory of Wages

Wages are the price of services that are being rendered by the labour to the employer. As product prices are determined by its supply and demand curve, similarly wages are also obtained with the hero of demand and supply of labour. The Modern Theory of wages was given by J.R. Hicks.


Did You Know?

The shift in a supply curve is caused by a change in the cost of production, change in the number of producers, change in tax rates, or changes in the state of production technology in use.


Solved Example

Q. The supply schedule for firm A and firm B is given below. Compute the market supply schedule for the same.

Price

SS1 - FIRM A

SS2 - FIRM B

0

0

0

1

0

0

2

0

0

3

1

1

4

2

2

5

3

3

6

4

4

 

A1. The market supply will be the number of commodities supplied by firm A and firm B.

Price

SS1 - FIRM A

SS2 - FIRM B

MARKET SUPPLY ( SS1 + SS2)

0

0

0

0

1

0

0

0

2

0

0

0

3

1

1

2

4

2

2

4

5

3

3

6

6

4

4

8

FAQ (Frequently Asked Questions)

1. In Theories of Aggregate Supply, What Causes the Change in Aggregate Supply?

Ans. A shift in aggregate supply can be attributed to variables such as technological innovations, an increase in wages, change in producer taxes, changes in inflation, etc. Some of the mentioned factors will lead to positive changes while others tend to cause a decline in aggregate supply. For example, if labour efficiency increases, it will raise the supply output by decreasing the labour cost per unit if supply. 

Another example is government spending, an increase in government spending will shift the aggregate demand to the right and this will have an impact on aggregate supply of the economy - depending on the sector in which the government has increased its spending. The shift in aggregate supply can be short term as well as long term shift.

2. What is the Difference Between the Theories of Aggregate Supply and Aggregate Demand in the Short and the Long Run?

Ans. In the short run, the level of capital is a fixed variable, and the company will not be introducing a new technology or erect a new factory. Instead, for the company to produce more it will increase its usage of existing factors of production, which the company can achieve by assigning more work or increasing use of existing machines and resources. Whereas in the long run the aggregate supply is not at all affected by the price level and is only driven by improvements in efficiency and productivity levels. Examples of such improvements can be an increase in the skills of workers, an increase in capital, etc.