Health Economics (6200431)
LECTURE 6
Dr. Butheina Surkhi
balsurkhi@staff.alquds.edu
Faculty Of Medicine
Al-Quds University
2024
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Health Economics
Demand and supply
Simple model of Supply
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Learning objectives
✓define the term ‘quantity supplied’
✓explain when it might be better to
substitute between production inputs
✓define efficient and inefficient
production.
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Supply definition
• “The supply of goods is the quantity offered for sale in a given market
at a given time at various prices.”
• Supply may mean the amount offered for sale per unit of time."
• Producer or manufacturer of the goods always thinks to supply more
goods at high price for the consumer to get more income .
• Like demand, supply is not a given quantity—that is called quantity
supplied. It is a relationship between price and quantity.
• As the price of a good rises, producers are generally wants to sell in
larger quantity.
• The reverse is equally true: as price decreases, so the supplier don’t
like to sell or supply in large quantity.
• Like demand, supply can also be described in a table or a graph.
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Law of supply
• Law of supply of goods and services speaks from supplier / seller
point of view
• Like law of demand which states a relation between the price and the
quantity demanded for a good or service, law of supply states a
relation between price and quantity supplied.
• "Supply is a desired flow: how much firms are willing to sell per (unit)
period of time not how much they actually sell. "
• Law of supply refers to the amount of a goods or services that
producers are willing and able to offer for sale at each possible price
per unit.
• The law of supply simply states that, as the price of a good or service
rises, the quantity supplied (i.e., offered for sale) also rises.
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Law of Supply
• The law of supply
states that other
things being equal the
higher the price, the
greater the quantity
supplied or the lower
the price, the smaller
the quantity supplied.“
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https://www.youtube.com/watch?v=nKvrbOq1OfI&t=113s
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Table of supply schedule
• The Supply schedule is presented in the graphical form, wherein the
quantity Supplied is shown on X axis and the price of the oranges are shown
on Y axis.
• The supply of goods is at 100 when the price of the goods is at 10, similarly
the supply is increased from 100 to 250 by the producer / seller when the
price is increased from 10 to 13.
• As the price of the goods is increased the supply of goods is also increased
and the price is decreased the supply for goods is also decreased by the
seller, which is because of Law of Supply effect on goods and services.
• there is always direct relation in between price of the goods and services
and Supply for the goods and services.
• The supply curve always moves upwards from left to right.
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(producer point of view)
Prices of Quantity
pens supplied
10 100
Supply curve
11 150
12 200 13
13 250
12
Prices
of
pens 11
10
100 150 200 250
supply
Why does price increases when there is a shortage of
goods?
✓In below table , there is a shortage of goods (150-50 =100 units) at a price
of $5 and Quantity demanded (Qd) (150 units) is greater than quantity
supplied (Qs) (50 units), buyers will not be able to buy all they had hoped
to buy at $5.
✓Some buyers will bid up the price to get sellers to sell to them instead of
selling goods to other buyers.
✓Some sellers, seeing buyers more demand for the goods, sellers will realize
that they can raise the price of the goods that they have for sale.
✓Hence the higher prices will also make the sellers to add (production)
output.
✓Thus, there is a tendency for price and output to rise until equilibrium is
achieved. 10
Price Qs Qd Condition
15 $ 150 50 Surplus
10$ 100 100 Equilibrium
5$ 50 150 Shortage
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Determinants of Supply
• Innumerable factors and circumstances could affect a seller’s willingness or
ability to produce and sell a good. Some of the more common factors are:
• 1. Cost factor of production
Cost of production depends on the factors like:
• Price of raw materials
• Rents and interest on capital
• Cost of machinery
• Payments to human resources (wages and salaries)
• Transportation charges (logistics)
If cost of production of commodities is high, in general supply of
commodities in to the markets will be low.
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Determinants of Supply
2. Price of the Commodity:
• Since higher money income is necessary to induce producers to produce
more, the amount supplied therefore increases when producers get higher
price for the product.
3. Price of Other Goods:
• Change in the price of other goods in the market also has influence on the
supply of the commodity. For Example: if the price of good Y rises, the
producer of good X will start considering switching his production to good Y
as it has become relatively more attractive to produce Y now then before.
4 . Producer’s Objective:
• The producers may have many objectives like profit maximization, sales
revenue maximization, goodwill etc. Amount supplied of a commodity is often
influenced by the producer’s objective. A goodwill maximiser will sell more
commodities than the profit maximizer. 13
Determinants of Supply
5. State of technology
• Use of latest technology decreases the cost of production and increases the
production capacity which increases supply of goods.
6. Factors outside the economic sphere
• Supply depends upon the below said factors. These factors should not arise if
they arise; they affect the supply directly or indirectly.
• Weather conditions
• Floods
• Wars
• Epidemics (unexpected situations)
4. Tax and subsidy
• If tax subsidy (charge less tax) is given by the government the production cost
decreased. If that is not there production cost raises. Finally the production will
be low and effects to decrease in supply.
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SUPPLY FUNCTION
• The supply function is the mathematical expression of the relationship between supply
and those factors that affect the willingness and ability of a supplier to offer goods for
sale.
• X = Supply of goods
• PX = Price
• PF = Factor input employed (used) for production.
• Raw material
• Human resources
• Machinery
• O = Factors outside economic sphere.
• T = Technology.
• t = Taxes.
• S = Subsidies
• There is a functional (direct) relationship between price and supply.
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Elasticity of supply
• The Price Elasticity of Supply measures the rate of response of
quantity supplied due to a price change.
• Elasticity of supply is defined as the percentage change in quantity
supplied divided by percentage change in price.
• “Price elasticity of supply measures the relationship between change
in quantity supplied and a change in price. The formula for price
elasticity of supply is:
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•∆Q =change in the demand.(difference in demand)
•∆P=change in the price.(difference in the price)
•P1=initial price. (first price/ old price)
•Q1=initial demand. (first demand/ old demand)
The value of elasticity of supply is positive, because an increase in
price is likely to increase the quantity supplied to the market and vice
versa.
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Calculating the Price Elasticity of Supply
• Calculate the price elasticity of supply when the price changes from $9.00 to $10.00"
Using the chart on the bottom of the page, I'll walk you through answering this question.
• First we need to find the data we need. We know that the original price is $9 and the
new price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10.
• From the chart we see that the quantity supplied (make sure to look at the supply data,
not the demand data) when the price is $9 is 150 and when the price is $10 is 110. Since
we're going from $9 to $10, we have Q Supply(OLD)=150 and Q Supply(NEW)=210,
where "Q Supply" is short for "Quantity Supplied". So we have:
• Price(OLD)=9
• Price(NEW)=10
• Q Supply(OLD)=150
• Q Supply(NEW)=210
• To calculate the price elasticity, we need to know what the percentage change in quantity
supply is and what the percentage change in price is. It's best to calculate these one at a
time.
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• Calculating the Percentage Change in Quantity Supply
✓The formula used to calculate the percentage change in quantity supplied is:
✓[QSupply(NEW) - QSupply(OLD)] / QSupply(OLD)
✓By filling in the values we wrote down, we get:
✓[210 - 150] / 150 = (60/150) = 0.4
✓So we note that % Change in Quantity Supplied = 0.4 (This is in decimal terms. In
percentage terms it would be 40%). Now we need to calculate the percentage change in
price.
• Calculating the Percentage Change in Price
✓Similar to before, the formula used to calculate the percentage change in price is:
✓[Price(NEW) - Price(OLD)] / Price(OLD)
✓By filling in the values we wrote down, we get:
✓[10 - 9] / 9 = (1/9) = 0.1111
✓We have both the percentage change in quantity supplied and the percentage change in
price, so we can calculate the price elasticity of supply.
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Final Step of Calculating the Price Elasticity of Supply
• We go back to our formula of:
• PEoS = (% Change in Quantity Supplied)/(% Change in Price)
• We now fill in the two percentages in this equation using the figures
we calculated.
• PEoD = (0.4)/(0.1111) = 3.6
• When we analyze price elasticities we're concerned with the absolute
value, but here that is not an issue since we have a positive value.
• We conclude that the price elasticity of supply when the price
increases from $9 to $10 is 3.6.
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Five Types of Elasticities of Supply:
1. Unit Elastic Supply: When change in price of X brings about exactly
proportionate change in its quantity supplied then supply is unit elastic
i.e. elasticity of supply is equal to one, e.g. if price rises by 10% and
supply expands by 10% then, it is unit elasticity.
• Es = % change in Quantity Supplied of X
% change in price of X
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2. Relatively Elastic Supply: When change in price brings about more
than proportionate change in the quantity supplied, then supply is
relatively elastic or elasticity of supply is greater than one.
3. Perfectly Inelastic Supply: When a change in price has no effect on
the quantity supplied then supply is perfectly inelastic or the elasticity
of supply is zero.
4. Perfectly Elastic Supply: When a negligible change in price brings
about an infinite change in the quantity supplied, then supply is said to
be perfectly elastic or elasticity of supply is infinity.
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• All the five types of Elasticities of supply can be shown by different slopes of the
supply curve.
➢Fig. (1) Shows the supply is unit elastic because change in price from OP to OP1
brings about exactly proportionate change in the quantity supplied of commodity
X , from OM to OM1. In this case Es = 1.
➢Fig (2) shows that supply is relatively inelastic because change in price of from OP
to OP1 brings about less than proportionate change in quantity supplied of X. in
this case Es < 1.
➢Fig (3) shows that supply is relatively elastic because change in price of X from OP
to OP1 brings about more than proportionate change in quantity supplied of X. in
this case Es > 1.
➢Fig (4) shows that supply is perfectly inelastic because change in price of X from
OP to OP1 has absolutely no effect on quantity supplied of X. in this case Es = 0.
Thus, if the supply curve is vertical, i.e. parallel to Y-axis it represents perfectly
inelastic supply.
➢Fig (5) shows that supply is perfectly elastic because a small change in price of X
brings about infinite change in supply. Thus, if the supply curve is horizontal or
parallel to X- axis it represents perfectly elastic supply.
• Hence, the five different types of elasticities of supply can be shown by five
different slopes of supply curve. 23
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https://www.youtube.com/watch?v=dJ9tJqwvgdg
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The Supply and Demand (equilibrium)
• Equilibrium is defined to the price-quantity pair where the quantity
demanded is equal to the quantity supplied, represented by the
intersection of the demand and supply curves.
• In words, equilibrium exists when the sellers are willing to sell goods and
services equal to the amount that buyers are willing to buy.
• The market price of goods are determined by both the supply and demand
for it.
• Today, the supply-demand model is one of the fundamental concepts of
economics.
• The price level of a good essentially is determined by the point at which
quantity supplied equals quantity demanded.
• To illustrate, consider the following case in which the supply and demand
curves are plotted on the same graph.
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Equilibrium: What Happens to Price When There Is a Surplus or
a Shortage?
• What did the middlemen do when the price was $ 5.00 and there was a
surplus of apples? He lowered the price of apple.
• What did the middlemen do when the price was $2.5 and there was a
shortage of apple? He raised the price.
• The behavior of the middlemen can be summarized this way: If a surplus
exists, middlemen lower the price of apple ; if a shortage exists, middlemen
raise the price of apple.
• This is how the middlemen moved the apple market into equilibrium.
• Not all markets have middlemen. (But many markets act as if an middle
men were calling out higher and lower prices until equilibrium price is
reached.
• In many real-world middlemen-less markets, prices fall when there is a
surplus and rise when there is a shortage. Why?
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Why does price of goods fall when there is a
surplus?
• In the below table , there is a surplus of (150 Qs -50 Qd = 100) at a
price of $15 and the Quantity supplied (150 units) is greater than
quantity demanded (50 units).
• Suppliers will not be able to sell all they had hoped to sell at $15. As
a result, their inventories will grow beyond the level they hold in
preparation for demand changes.
• Then the sellers want to reduce their inventories by lowering prices to
clear-off their inventories, some will cut back on production and
others will do a little of both by reducing price and cutting back
production .
• As shown in the picture, there is a tendency for price and output to
fall until equilibrium is achieved.
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Why does price of goods increases when there is a
shortage?
• In below table , there is a shortage of goods (150-50 =100 units) at a price
of $5 and Quantity demanded (Qd) (150 units) is greater than quantity
supplied (Qs) (50 units), buyers will not be able to buy all they had hoped
to buy at $5
• Some buyers will bid up the price to get sellers to sell to them instead of
selling goods to other buyers.
• Some sellers, seeing buyers more demand for the goods, sellers will realize
that they can raise the price of the goods that they have for sale.
• Hence the higher prices will also make the sellers to add (production)
output.
• Thus, there is a tendency for price and output to rise until equilibrium is
achieved.
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By observing the below table it can be understood that the price of $3.00 is the
equilibrium price and the quantity of 70 is the equilibrium quantity. At any other
price, sellers would want to sell a different quantity than buyers want to buy.
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Equlilibrium
Quantity
Prices of demanded
oranges for
mangoes
5 10 Supply curve
6 8
8 5
10 2
Pricing
Price point
Prices of Quantity
pens supplied
10 100
Demand curve
11 150
12 200
13 250
Demand
Or
supply
Price mechanism to an allocative efficient allocation
• For the consumer, the price they are willing to pay measures the benefit or utility that the
consumers expect to receive from consuming the last unit.
• To be precise, the demand curve reflects the marginal utility (extra benefit) that consumers
receive from consuming the last unit.
• Consumers only buy something if it is worth as much as or more than the other things that the
same money could buy.
• So, if the price of something is greater than the benefit they get from consuming it, they will not
buy it.
• For the producer or seller, the price they are willing to accept measures the cost of the resources
involved in the production including the supplier’s own time and effort.
• Again to be precise, the supply curve reflects the seller’s marginal costs (the cost of producing an
extra unit).
• Thus, when a market is in equilibrium marginal benefit equals marginal cost equals price.
• The benefit received from the last unit consumed will exactly equal the resource cost of
producing that unit.
• This fulfils the condition for allocative efficiency.
• Competing producers chasing maximum profits will always choose the least cost combination of
factors to produce a given output. Consequently, the free market will also be productively
efficient. 34
Market equilibrium
• https://www.youtube.com/watch?v=9QSWLmyGpYc – review
• https://www.youtube.com/watch?v=kIFBaaPJUO0&t=5s
• https://www.youtube.com/watch?v=ze1XRwb4hD8
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