Suppliers of a good change how much they supply as the price changes. And a supply curve shows us how much suppliers are willing to supply at different prices.

Suppliers of a good change how much they supply as the price changes. And a supply curve shows us how much suppliers are willing to supply at different prices. There’s a supply curve for every good and service out there (just like with the demand curve).

Let’s take a look a the classic economic example of oil. As the price of oil increases, the quantity of oil that suppliers (in this case, oil companies) are willing to supply also increases. It’s a pretty intuitive relationship.

But why is it the case that the higher the price, the more oil supplied?

Oil is a global product. You can find it – and it’s used – all over the world. However, ease of extraction is not so global. In some places, like Saudi Arabia, it's easy, and therefore cheap, to get oil out of the ground. But Alaska? Not so much. Extraction requires drilling deep in the earth and the cost can be eight times as high as it is in Saudi Arabia. Oil rigs off the Gulf Coast have even higher extraction costs. They have to drop a mile underwater just to begin drilling.

These varying extraction costs means that some suppliers can turn a profit even when the price of oil is relatively low. But many others cannot. However, when prices rise, it suddenly becomes profitable to drill in places like Alaska and the Gulf Coast.

Starting to make sense? The supply curve slopes upward because, to increase the quantity of oil supplied, companies have to use higher cost sources. The supply curve for oil summarizes how oil companies respond to changes in cost per barrel. But the idea is essentially the same no matter the good or service and its suppliers.

Now, you may be wondering, how are prices actually determined? That’s up next as we explore the Equilibrium Price and Quantity.

Download
Options
Translate Practice Questions

Transcript

Now that we've got the demand curve down, let's move on to the supply curve. A supply curve shows how much of a good suppliers are willing and able to supply at different prices. As with the demand curve, there's a supply curve for every good and service. And again the ideas are the same, so let's look at the supply curve for oil.

 

We see an intuitive relationship between price and the quantity supplied. As the price goes up, the quantity of oil that companies are willing to supply increases. In this example, in a low price, $5 per barrel, let's say 10 million barrels of oil are supplied per day. At $20 per barrel, 25 million barrels are supplied, and at $55 per barrel, 50 million barrels are supplied. So in general, a higher price means a greater quantity supplied.

 

Let's delve deeper and see why. Oil exists all over the world, but it's not equally easy to extract. In some places like Saudi Arabia, it's really easy to get oil out of the ground. It's costs about $2 a barrel to extract. Oil in the US, like from Alaska, is a lot deeper and getting it out cost more, at least $10 per barrel. And producing oil from an oil rig, like the Atlantis rig in the Gulf Coast, is even more expensive. That rig has to descend more than a mile underwater before drilling even begins.

 

When oil prices are relatively low, the only suppliers that can turn a profit are those who can get to the oil cheaply, like Saudi Arabia. As the price goes up, other suppliers in Nigeria, Russia, and Alaska, who have higher extraction costs, start to become profitable so they can enter the market. As the price gets higher, even the most expensive extraction techniques become profitable. The supply curve slopes upward because the only way the quantity of oil can be increased is to exploit higher and higher cost sources of oil. As the price of oil goes up, the depth of the oil wells goes down. With this simple line the supply curve summarizes the way suppliers respond to a change in price including how suppliers will enter and exit the market depending on the price.

 

So far, we've said things like if the price goes down, buyers will want to buy more or if the price rises, suppliers will want to sell more. But we haven't said anything about how prices are determined. That's the subject for the next video, Equilibrium.

 

Ask a Question

 
Show 1 Answer (Answer provided by Alex Tabarrok)
user's picture

Yes, a historical quirk. Demand and supply graphs and functions were used by both Cournot (1838) and then Marshall in his famous principles text (1890). Cournot thought of price as the independent variable and put price on the horizontal axis as per convention. Marshall in contrast thought of quantity as the independent variable and put quantity on the horizontal axis. Each had the "correct" diagram for the story they told. Economists overall, however, settled on Cournot's price story but kept Marshall's graph! Thus, the supply-demand graph visual and story don't look quite right to an engineer or physicist.

As we discuss more in the equilibrium video it is in fact legitimate to think of either price or quantity as the independent variable. In fact, both perspectives are useful because this is a simultaneous equation system so both stories are going on at the same time.

Now for the most important point. Can you safely skip this stuff? Absolutely not! Supply and demand are critical. Keep in mind that the independent variable on horizontal axis is just a convention. The convention in economics may be slightly odd to someone used to a different convention but that is all it is, different conventions or language and it is key that you learn the language of economics even if it seems a bit odd at first.

> In fact, both perspectives are useful because this is a simultaneous equation system so both stories are going on at the same time.

Ah, thank you, that makes it quite a bit easier.

Please register or login to answer a question
 
user's picture
Please register or login to ask a question