Factors that affect the supply price–quantity relationship

Michael Dicks Veterinary Economics Division, AVMA, 1931 N Meacham Rd, Schaumburg, IL 60173.

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Few things affect the supply of goods and services as much or as frequently as technology. In the 1960s, for example, I first began developing least-cost rations for livestock. This involved developing a ration formulation on the basis of available feedstuffs that would provide minimum nutritional requirements for a specific group of animals being raised for a specific purpose (eg, growth, maintenance, or finishing) while maintaining the lowest cost per pound for the ration. I accomplished this task by solving a series of simultaneous equations by hand with pencil and paper. The process was laborious, taking up to a week, even though I rarely started from scratch, instead using the composition of a previous ration as my starting point.

In the 1970s, computers came along, and I no longer had to solve simultaneous equations by hand, instead programming the equations on punch cards that were fed into a computer. If no mistakes in programming were made, then formulating a least-cost ration would only take a day or so. Of course, these were large programs that required lots of computing power, so I usually ran the program late at night, when demand on the computers was low.

By the 1980s, personal computers made it possible to formulate least-cost rations in a few hours, with much of that time needed simply to input all of the necessary data. Today, these rations are formulated in real time, with the price and nutritional composition of various feedstuffs obtained directly from various websites, and the final formulation sent directly to the feed mill's mixing computer. This advancement in technology lowered the cost of developing feed rations and increased the supply of feeds at steady prices.

Remember that the supply function (or supply curve) represents all of the possible prices offered and the corresponding quantities producers are willing to sell at that price. Each producer occupies his or her own point on the supply curve—the point representing the specific quantity of goods or services the producer is willing to sell at a specific price. The price at which a producer is willing to sell depends on the cost of producing the good or service plus a reasonable economic return (profit). As price increases, the number of producers willing to sell will increase, and thus, the quantity supplied will increase.

The cost of production is based on the technical relationship between inputs and outputs (ie, the production function). The addition of computers changed the production function for least-cost rations by reducing the amount of labor required to produce the same formulation. The reduced labor input lowered the cost of production. Because technology reduces the cost of production for every producer in the industry, all producers will be able to sell their goods or services at a lower price while maintaining the same level of profit. This implies that at any specific price, producers will now be willing to sell a larger quantity of goods or services. In essence, technology results in a shift of the entire supply curve to the right.

Factors other than technology can also cause shifts in the supply function. As an example, an increase in the minimum wage increases the cost of labor for all firms either directly (by increasing the salary of minimum wage employees) or indirectly (by increasing the salary of employees making more than the minimum wage to maintain wage incentives). This increase in labor costs, assuming no other changes to the production function to make labor more efficient, will increase the cost of production for all firms and shift the supply curve to the left, effectively reducing the quantity that each business is willing to supply at the same price.

During a recession, governments seek to stimulate the economy by lowering the interest rate or reducing taxes. Lowering the interest rate reduces the cost of borrowing, and reducing taxes increases the profit margin. As the cost of borrowing money decreases, firms with current liabilities or annual operating loans will be able to reduce their production costs. Other firms may be able to afford to buy new technology that increases their production efficiency, again lowering production costs. The lower production costs shift the supply curve to the right, effectively increasing the quantity businesses are willing to supply at the same price.

Taxes on income and sales are an added cost of doing business and don't directly affect a firm's production function, but they do directly affect profit. That is, these taxes rarely have any impact on the mix of inputs used in the production process, but are an added cost to the output. Generally, therefore, reducing taxes on income and sales shifts the supply curve to the right, again effectively increasing supply.

One rarely discussed business cost is the cost of complying with industry or government standards. For instance, colleges that receive any type of federal funding are required by law to provide the federal government with numerous reports to ensure, among other things, that no harm was done to animals or humans during research done by university personnel, that hiring guidelines were followed, that no discrimination occurred in the awarding of scholarships or academic assistance, and that equal access was provided to persons with disabilities. The AVMA Council on Education sets standards that veterinary colleges must adhere to as a requirement for accreditation. State licensing boards have requirements, including the payment of fees, that veterinarians must comply with to be licensed to practice veterinary medicine. The American Animal Hospital Association requires accredited veterinary practices to use anesthesia when performing dental procedures. All of these various standards require additional costs associated with the labor required to meet the standards or to complete the reporting requirements. Adding new standards increases costs, which in turn could be expected to shift the supply curve to the left, reducing supply.

Shifts in the supply curve can also affect the price elasticity of supply, which is defined as the percentage change in quantity divided by the percentage change in price. When the price elasticity of supply for a particular good or service is > 1, then the supply of that good or service is considered to be elastic. If the price elasticity of supply is < 1, the supply of that good or service is considered inelastic. As an example, if, for a particular good, an increase in price of 5% was associated with an increase in the quantity supplied of 10%, then the price elasticity of supply for this good would be 2 (10/5). When the supply curve shifts to the right, however, a higher quantity is supplied at the same price. Thus, the percentage change in quantity for a given percentage change in price will decrease simply because there was a higher quantity at the begining.

Just as with demand, the quantity of a particular good or service that sellers are willing to supply changes as the price that buyers are willing to pay changes, with these changes in quantity and price representing movements along the supply curve. On the other hand, factors that affect production, such as technological improvements, tend to shift the supply curve, changing the quantity supplied at the same price. For both demand and supply, a change in the quantity demanded or supplied is a movement along the curve, whereas a change in demand or supply is a movement of the entire curve. For economic discussions, this is an important distinction.

Contributor Notes

This article has not undergone external peer review.

Address correspondence to Dr. Dicks (mdicks@avma.org).