Chapter 2 · Competitive markets: Demand and supply
Shift of the supply curve
Explain how production costs and other supply determinants shift the supply curve. Compare changes in equilibrium price and quantity.
The economic idea
A change in supply means that the quantity producers are willing and able to offer changes at every price. An increase in supply shifts the supply curve to the right and downward; a decrease in supply shifts it to the left and upward. It is caused by a non-price determinant, not by a change in the good’s own price.
A change in the good’s own price increases or decreases quantity supplied along the same supply curve. By contrast, a shift from “S₁” to “S₂” changes supply because producers offer different quantities at the same prices. Compare quantities at one price to tell the two changes apart.
Supply-side determinants work by changing firms’ costs, productive capacity, expected profitability or willingness and ability to produce. Lower input costs, improved technology or higher productivity allow more output to be offered at each price. Higher input costs or adverse natural conditions have the opposite effect.
An indirect tax raises firms’ costs and decreases supply, while a subsidy lowers firms’ effective costs and increases supply. A change in the number of firms changes market supply because market supply is the horizontal sum of the output offered by all firms.
An increase in supply
“Quantity” is measured on the horizontal axis. Moving to the right represents a greater quantity exchanged in the market.
“Price” is measured on the vertical axis. Moving upward represents a higher price per unit.
“D” is a market demand curve. Each point shows the total quantity consumers are willing and able to buy at the corresponding price during the stated time period, ceteris paribus. It is held constant so that the effect of the change in supply can be isolated.
“S₁” is a market supply curve. Each point shows the total quantity producers are willing and able to offer for sale at the corresponding price during the stated time period, ceteris paribus. It records the initial supply conditions before the non-price determinant changes.
“S₂” is a market supply curve. Each point shows the total quantity producers are willing and able to offer for sale at the corresponding price during the stated time period, ceteris paribus. It records supply after the non-price determinant changes and must be compared with the initial supply curve.
Starting point: E₁
“S₁” meets “D” at “E₁”, giving the original equilibrium price “P₁” and quantity “Q₁”. At this point quantity demanded equals quantity supplied, so the market has neither a shortage nor a surplus.
The change: S₁ to S₂
“S₂” lies to the right and below “S₁” over the visible market range. Supply has increased: at each price producers are willing and able to offer a greater quantity.
A non-price determinant has changed firms’ willingness and ability to offer output at every price. That is why the whole curve moves; a change in the good’s own price would produce movement along one supply curve instead.
Connect the cause to firms’ decisions
Use the change given in the question. For example, a rise in the cost of an input makes each unit more expensive to produce, so firms offer less at each selling price. Simply writing “costs rise, so price rises” misses the supply decision and the imbalance that changes price.
Then use the displayed comparison: “S₂” lies to the right and below “S₁” over the visible market range. Supply has increased: at each price producers are willing and able to offer a greater quantity. Explain how the shortage or surplus at the old price changes price and quantity demanded along “D”. Do not invent a second demand shift to explain the new equilibrium.
The market adjustment
At the old price “P₁”, “S₂” shows that quantity supplied is now greater than quantity demanded on “D”. The market develops excess supply—a surplus.
Unsold output gives sellers an incentive to lower price. The falling price signals that the good is less scarce relative to the quantity firms are offering.
As price falls, consumers increase quantity demanded along “D”, while producers reduce quantity supplied along the new “S₂” curve. Neither of these movements is another curve shift.
The process stops at “E₂”, where “S₂” meets “D” and the surplus has been eliminated.
What the current state establishes
Equilibrium price falls from “P₁” to “P₂” while equilibrium quantity rises from “Q₁” to “Q₂”.
The dashed guides project “E₁” and “E₂” to the axes, making the opposite movements in price and quantity visible without introducing numerical values.
Common mistakes to avoid
- “D” did not shift. The change from “Q₁” to “Q₂” includes a movement along demand caused by the changing market price.
- The shift from “S₁” to “S₂” is the cause; the movement along “S₂” during price adjustment is a change in quantity supplied after the shift.
- The size of the price and quantity changes depends partly on the price elasticity of demand. A more inelastic demand curve converts more of the supply change into a price change and less into a quantity change.
How to draw this diagram
- Title the diagram “Shift of the supply curve”. Label the horizontal axis “Quantity” and the vertical axis “Price”.
- Draw D first and label it clearly.
- Draw S₁ next and label it clearly.
- Draw S₂ next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Project important intersections to the axes with dashed guide lines and label the outcomes.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The explanation assumes demand and all other relevant supply determinants remain constant while the selected determinant changes.
- The diagram shows the direction of the new equilibrium but not the speed of adjustment or the precise magnitude of the response.
- The size of the price and quantity changes depends on the price elasticities of demand and supply and on the size of the supply change.
- If the supply curves cross, they do not represent a uniform textbook increase or decrease in supply across the market range.
- The model does not establish whether the new equilibrium is equitable or socially efficient when market failures are present.