Supply curves - movements/swivels/shifts

breadmonkey

I'm doing a bit of an introductory economics course this year and I'm not completely happy that I understand what causes the various changes in a supply curve.

Change in quantity supplied = movement along a given S curve. I'm ok with that one.

Introduction of a tax payable by the seller (for example) = shift up. I think I get this too.

The swiveling has gotten me a bit confused. I'm thinking specifically about questions I'm going to be asked like who does the burden of a tax ultimately fall on. I know it's the side that's most inelastic and I get that but it's when assessing the long term that the problem arises.

Take for example a question I have where I have to show the effects of a subsidy on the purchase of new houses (given to the buyers). In my notes, I have the S curve swiveling about the initial intersection between the D and S curve as the supply becomes more elastic in the long term. But why does it swivel? And what, in general, causes a supply curve to swivel?

I hope that was understandable.

Thanks

Time Magazine

How's your mathematical intuition?

The equation of a supply curve is:

Q = a + bP

Q = quantity
a = where the line hits the Y-axis ("the intercept")
b = the slope of the line
P = price

Any straight line is essentially defined by its intercept and slope. A direct change in Q or P does not change either of these, so the line stays the same. You do move along that line, though.

A tax is not quite the same thing as a change in price. It adds either x% or €y to every P. This includes the P when Q=0, i.e. at the intercept. As a result the line shifts up. This is captured by increasing the intercept. If you increase the intercept then every point on the line has moved up.

The last thing left is the slope of the line, b. A pivot is where the slope alone changes. A swivel is where both a and b change. These capture changes in tastes, essentially. If the government subsidise house builders today, I'm not going to set up a company tomorrow. But over time I might. My tastes have changed. Typically this will change both the intercept and the slope.

I think the question about why a subsidy given to house buyers will change suppliers is begging the answer "it makes no bloomin' difference who gets the subsidy". Why?

1. Equilibrium in a free market is determined by "real" demand and "real" supply.
2. If you subsidise demand, that doesn't make things cheaper. Essentially you're adding whatever subsidy to "real" demand so it just makes demand higher.
3. When demand is higher, suppliers will raise price.

So, in a way, it's like you're giving the subsidy to the house builders in the first place. The raised prices in the market makes things nicer for the supplier just a subsidy would. Of course, just as I'm not setting up a construction company tomorrow but may do eventually, over time this "nicer situation" might get more people to enter the market, etc. This will alter the parameters a and b, so making the curve swivel/pivot/dance.

Hope this helps, best of luck in the exams

breadmonkey

That's perfect, thanks.

One thing: what sort of thing would cause only the slope (b) to change as opposed to a change in both (a) and (b)?

Also, I'm fine with maths so any explanation heavy on maths is no prob.

breadmonkey

Here's a question from past papers that I'm not really sure about:

"Assuming that the demand for a substance, the supply of which is currently illegal, is, and continues to be, price inelastic. Use a diagramto show who (i.e. what groups) financially gain/lose from ligalisation/liberalisation of the supply of the substance. Explain very briefly. (Do not discuss moral/sociological issues.)"

What I think is the following:

Once the substance is legalised, it is introduced into the tax system. Then say that tax is administratively paid by the sellers (since it doesn't matter). The S curve would shift up and price would rise. In the long term the demand would become more elastic (since people now have mroe choice and there is an element of competition?) and the burden would be more equitably shared.

However, would the supply curve not instantly change post-legalisation? In the very short term, there would be nobody around to sell the stuff legally in the shops (while licences, suppliers etc. were being sourced) so people would still be buying from dealers and paying the old price.

I'm a bit confused. Any insight would be greatly appreciated.

Time Magazine

Supply would rocket post-legalisation. This would drive the price down, increase consumer surplus and knock out the huge profits smugglers earn.

If there was then an imposition of a tax, it's the usual story: quantity goes down (with the resulting welfare effects) and there's a deadweight loss.

Time Magazine

breadmonkey wrote: »

One thing: what sort of thing would cause only the slope (b) to change as opposed to a change in both (a) and (b)?

I know it's stating the obvious, but b is the sensitivity of demand to changes in price. So it will change to anything that changes the sensitivity of demand to price. An example might be a including a manual with a high-tech gadget. This doesn't really impact those with the highest demand (those near the intercept) since they probably know how to use it already. However it might increase the demand for those less interested in it, i.e. those lower down the curve.