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OKUN'S LAW: A relationship that says that the gap between actual and full employment output level of gross domestic product widens by 3.0% for each percentage point increase in the unemployment rate. When Arthur Okun discovered this empirical relationship he was on President Kennedy's Council of Economic Advisers (CEA). Okun cautioned that the relationship was valid only within unemployment rates of 3% and 7.5%.

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SUPPLY DECREASE:

A decrease in the willingness and ability of sellers to sell a good at the existing price, illustrated by a leftward shift of the supply curve. A decrease in supply is caused by a change in a supply determinant and results in a decrease in equilibrium quantity and an increase in equilibrium price. A supply decrease is one of two supply shocks to the market. The other is a supply increase.
A supply decrease results from a change in one of the supply determinants. The leftward shift of the supply curve disrupts the market equilibrium and creates a temporary shortage. The shortage is eliminated with a higher price. The comparative static analysis of the supply decrease is that equilibrium quantity decreases and equilibrium price increases.

Supply Determinants

A decrease in supply can result from a change in any of the five supply determinants.
  • Resource Prices: An increase in resource prices.
  • Production Technology: A decrease in production technology.
  • Other Prices: An increase in the price of a substitute-in-production or a decrease in the price of a complement-in-production.
  • Sellers' Expectations: Expectations by sellers of an increase in the price in the future.
  • Number of Sellers: A decrease in the number of sellers in the market.

Old to New

Comparative Statics

First, consider the simple comparative static analysis of the supply decrease. The diagram at the right presents the Shady Valley market for Hot Momma Fudge Bananarama Ice Cream Sundaes. The equilibrium price is Po and the equilibrium quantity is Qo. This market equilibrium will, of course, persist until and unless a determinant changes, which is the nature of equilibrium. The particular change under scrutiny is a decrease in supply caused by a change in any of the five supply determinants noted above.

Suppose, for example, that a global chocolate cartel flexes its market control and raises the price of chocolate, which causes the price of hot fudge to skyrocket. As a key resource used in the preparation of Hot Momma Fudge Bananarama Ice Cream Sundaes, which works through the resource prices supply determinant, this is just the sort of thing that is bound to decrease the supply of Hot Momma Fudge Bananarama Ice Cream Sundaes. And when supply decreases, the original market equilibrium is disrupted.

How is the Hot Momma Fudge Bananarama Ice Cream Sundae market affected? An increase in hot fudge prices triggers the resource prices supply determinant and causes the supply curve to shift leftward. Click the [Supply Decrease] button to illustrate the leftward shift of the supply curve. The OLD market equilibrium is no longer equilibrium. A NEW market equilibrium is found at the intersection of the original demand curve and the new supply curve. Click the [New Equilibrium] button to highlight this result. The new equilibrium price is Pe and the new equilibrium quantity is Qe. Note that the price is higher and the quantity exchanged is less.

Step by Step

Six Steps


Now, consider how this supply shock to the Hot Momma Fudge Bananarama Ice Cream Sundae market can be divided into six steps. While the directions of the changes may differ, these six steps apply to the comparative static analysis of other demand and supply shocks.
  • First, a determinant changes. In this case, the price of hot fudge, a key resource in the preparation of Hot Momma Fudge Bananarama Ice Cream Sundaes, increases. A determinant change ALWAYS starts the market adjustment process.

  • Second, the determinant change causes a curve to shift. The higher hot fudge price decreases the supply of Hot Momma Fudge Bananarama Ice Cream Sundae and causes a leftward shift of the Hot Momma Fudge Bananarama Ice Cream Sundae supply curve. Click the [Supply Decrease] button to illustrate this shift.

  • Third, the shifted curve disrupts the market equilibrium, causing either a shortage or a surplus. In this example, the decrease in supply creates a shortage. While sellers are now willing and able to sell fewer Hot Momma Fudge Bananarama Ice Cream Sundaes, buyers want to buy the original quantity at the original price. Up to this point, they have no reason to change. Click the [Shortage] button to highlight this imbalance.

  • Fourth, the market imbalance causes the price to change. In this case, the buyers are not able to buy all of the Hot Momma Fudge Bananarama Ice Cream Sundaes that they would like, which is the original quantity. As such, they are willing and able to pay a higher price for Hot Momma Fudge Bananarama Ice Cream Sundaes. Click the [Price Increase] button to illustrate this result.

  • Fifth, the change in price causes changes in both quantities demanded and supplied. In this Hot Momma Fudge Bananarama Ice Cream Sundae market, the higher price has the intended effect of increasing the quantity supplied--which is the law of supply. It also has the unintended effect of decreasing the quantity demanded--which is the law of demand. Note that while the change in the resource prices supply determinant induces sellers to supply fewer at all prices, including the original equilibrium price, the price increase subsequently causes the quantity supplied to increase.

  • Sixth, changes in the quantities demanded and supplied both act to eliminate the market disequilibrium. In this example, the decrease in the quantity demanded and the increase in the quantity supplied eliminate the shortage. The price continues to change as long as the market is out of balance with a shortage. The new equilibrium price at Pe is higher and the new equilibrium quantity at Qe is smaller. Click the [New Equilibrium] button to highlight this result.

One of Eight

A supply decrease is one of eight market disruptions--four involving a change in either demand or supply and four involving changes in both demand and supply. The other three single shift disruptions are demand increase, demand decrease, and supply increase. The four double shifts are demand and supply increase, demand and supply decrease, demand increase and supply decrease, and demand decrease and supply increase.

<= SUPPLY CURVESUPPLY DETERMINANTS =>


Recommended Citation:

SUPPLY DECREASE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: April 23, 2014].


Check Out These Related Terms...

     | supply increase | demand increase | demand decrease | supply shock | demand shock |


Or For A Little Background...

     | supply determinants | comparative statics | ceteris paribus | economic analysis | graphical analysis | supply curve | equilibrium | equilibrium price | equilibrium quantity | market equilibrium | change in supply |


And For Further Study...

     | demand and supply increase | demand and supply decrease | demand increase and supply decrease | demand decrease and supply increase | price ceiling | price floor | demand determinants | elasticity determinants |


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