Download The Second Law of Supply

3.d. The Second Law of Supply
The Second Law of Supply states that supply is more responsive to price in the long run. While
the Second Law of Demand depends on how responsive consumers are to a change in price, the Second
Law of Supply relates to how flexible producers are in terms of how much of a good they produce. Supply
tends to be more elastic in the long run because given more time, producers can more easily adapt to the
change in the price. Within short periods of time, producers cannot as easily change the amount of a good
they produce (since changes in production often require adjustments within factories, with workers etc.) A
few determinants of supply include: cost of production, opportunity cost (i.e. what must be given up to
obtain something), and of course, the price of the good supplied.
Example 3:
The Second Law of Supply can be demonstrated in the housing market. See Figure 3.d.1. below.
Price
housing
(A) 1 month
supply
$1100
(B) 1 year
supply
$600
( C) original
price & qty.
100
125
225
Quantity
housing
Figure 3.d.1 demonstrates how the supply of housing, just like many other products, is more elastic in the
long run. At the original price of $600, the supply of housing is 100 units (C). As the price for housing
increases to $1100, suppliers want to produce more housing in order to increase their profits. However, in
a mere month, suppliers can only manage to produce 25 more units of housing (for a total of 125 houses).
The insignificant increase of supply in response to a rise in price is represented in the “1 month supply”
curve (A). Within a year, however, producers have had sufficient time to create many more houses. The
“1 year supply” curve (B) shows how, given more time, producers are better able to respond to a change in
price.
In certain cases, a “1 month supply” curve (such as (A)) for housing may be much closer to being
vertical since housing, unlike many other goods, require an extensive amount of time to produce. A “1
week supply” curve, for instance, would almost definitely be completely vertical since it is nearly
impossible to produce housing within a week. Thus, housing is said to have an “inelastic” supply.
Example 4: The Coffee Market
Suppose for instance that a frost had damaged a coffee bean crop, drastically reducing the supply.
Figure 3.d.2 shows how demand responds to this particular change in supply.
Price
coffee
(A) Supply (frost)
(B) Supply
(F)
$11
$10
$9
(E)
(G)
original price
& qty.
(C ) Demand
(6 months)
(D) Demand
(1 week)
25
30
35
Quantity
coffee
Figure 3.d.2 shows how a change in supply affects the demand both in the short run and the long run. At
the original equilibrium price of $9, 35 units of coffee are consumed (G). However, the frost cuts the
supply from (B) to (A) and the price initially jumps from $9 to $11. In the short run response, represented
by the “Demand (1 week)” curve (D), consumption only drops from 35 units to 30 units (F). However, the
“Demand (6 months)” curve (C) indicates that with the long-run reduction in consumption, the price is
eventually brought down closer to the equilibrium level and decreases from $11 to $10. Because the
supply still remains reduced (due to the frost) and because there is still a demand for coffee, the price still
remains higher than the original price. Consumption is also lower because of the high price and because
over time, consumers have had time to adjust their lifestyles to accommodate for the increase in price (E).