Supply

Supply and demand are probably two of the most commonly used words in our economics vocabulary, so a discussion of each is quite appropriate. Although the textbook definition for supply might include such words as aggregate production, marginal cost, or marginal revenue, let’s think of supply as the amount of an item available for purchase.

The supply of any good or service is the amount available for consumption in the marketplace. The amount of an item available for purchase is based upon factors such as the number of producers, the profit from producing the item, the number of customers, the selling price, and the costs for shipping the item around the country or globe. Of course, the typical consumer could care less about these factors. What is important is whether the item we want is available when and where we want it and at the price we want to pay. Many variables must be considered, so let’s take a look at an example.

Assume you are a wholesaler and your company supplies two products: gerbil bedding and gold necklaces. [ 15 ] You purchase gold chain directly from the manufacturer in 1000-inch rolls at $2.00 per inch. It costs you another $25.00 per necklace to cut the chain to length, add clasps, and prepare it for shipping. The bedding material is actually wood chips and mulch left over from a lumberyard. It costs you $0.10 per pound and comes by truckload. (A pound of the bedding material is about one cubic foot, which is about right for the typical gerbil cage.) It costs you another $0.15 to put one pound in a labeled plastic bag and prepare it for shipping.

Shipping presents an interesting problem for these vastly different products. Since shipping costs are based upon weight and size (volume), a small, heavy item costs no more than a large (bulky), light item. This makes gold necklaces very value-intensive products, meaning they are valuable, light, and small. The bedding, on the other hand, is very cost intensive. It is very light and inexpensive but must be shipped in much larger containers. The result is that 100 necklaces can be shipped for about the same cost as 20 bags of bedding. (Let's assume the shipping cost for either is $10.00.) So where is this discussion going? Let’s take a look at the total cost to prepare and ship one necklace versus one bag of bedding.

The gold for a twenty-inch necklace costs $40.00 ($2 per inch), and the clasps and packaging cost another $25.00, resulting in a total of $65.00 to assemble and prepare one necklace for shipping. Since jewelers place orders for 100 necklaces at a time, and 100 necklaces can be shipped for $10.00, shipping adds only an additional $0.10 to the cost of each necklace. This brings the total cost to assemble and ship one necklace to $65.10. In turn, we assume that we can sell the necklace to a jeweler for $100.

Next, let’s look at the bedding. The costs for the material and packaging for one bag of bedding is $0.25. Since it costs $10.00 to ship 20 bags, the cost to ship one bag is $0.50. This brings the total to $0.75 per bag. Let’s assume that you can sell them to pet stores for $0.65. The result? It is very cost effective for you to ship gold necklaces just about anywhere. The bedding, on the other hand, can only be sold locally, since to package, prepare it for shipping, and ship it costs more than the price for which you can sell it.

The bottom line is that you will not ship your gerbil bedding any distance. In fact, unless you can distribute the bedding locally at a total cost that is lower than your selling price, you won’t supply gerbil bedding at all. And as long as costs are about the same for all suppliers of gerbil bedding, all suppliers are faced with the same situation.

Now, let’s assume it costs about $0.10 per bag to distribute bedding locally, as opposed to $0.50 to ship it longer distances. That means it costs a total of $0.35 per bag ($0.25 material and packaging plus $0.10 transportation) to supply bedding locally. If you can sell it for $0.65, a gross profit of $0.30 per bag will be realized. As long as you don’t try to charge local retailers more than $1.00 or so, out-of-town suppliers won’t be enticed to compete with you. (Remember, out-of-town suppliers can ship it in to your local market at a total cost of $0.75 per bag. As long as the local selling price doesn’t make it profitable for outside suppliers to sell in your market, they won’t.)

Local suppliers want to maximize profits, so they want to sell at the highest price possible, without reaching the estimated $1.00 that would attract non-local competition. Note that price is the only thing that matters when gerbil-bedding suppliers compete among themselves in the local market. Gerbil bedding is gerbil bedding! Customers don’t care about the label on it or who provides it, so suppliers can’t compete on quality or service.

The bottom line is that the supply of bedding is constrained by the amount the local suppliers can provide. Gold chains, on the other hand, are a totally different product. Since it is profitable to ship them anywhere, the gold chains that consumers see in stores can be from anywhere in the world. This makes the supply of gold chains limited only by the worldwide supply of gold.

The above arguments are completely dependent upon the price suppliers receive. If the total cost to make and ship an item is sufficiently below the selling price, that item will be supplied. When the selling price does not provide revenues sufficient to cover all costs and provide a profit, the item is not supplied. This leads us to the law of supply, which states that as the price of a product moves higher, more of that product will be supplied. The higher price will make it more attractive for producers to produce and deliver more of the product.