Just as demand of a product or service is driven by its price – so is its supply. Considering all other factors remain constant, the quantity of a product supplied to a market will increase as the price of the product increases. As such, supply of a product or service is never fixed. Understanding supply is the next step to cracking the fundamentals of economics.
Supplying a product or a service always has an associated cost. If the market price of the product does not even cover the associated costs, then there is no incentive for a business to supply the product. Similarly, if the market price is much higher than the costs, the business has incentive to provide more of the product. Increasing the supply usually has increased costs to the business.
Understanding Supply: Shouldn't Prices Decrease??
For example, there are some oil refineries that can extract and process oil at a cost of 50$ per barrel. But other low-yield oil wells will have an additional cost for extraction & processing placing the overall cost at $100 per barrel. The market-price of oil would need to cover the costs of the average cost of oil per barrel -– which in this example is $75.
As such, if the market price of oil drops to $74, there is no incentive to extract and process the oil from the low-yield wells. The refineries at the low-yield oil wells are shut down and overall supply to the market is decreased.
This phenomenon holds true across all markets. Quantity supplied into the market varies depending on the price of the product. In the next couple of posts, I will use the iPhone as