Question

When summing individual supply curves to get the market supply curve, why does the economist add the curves "horizontally" rather than "vertically."

Short answer

Economists add supply curves horizontally rather than vertically to obtain the market supply curve because it accurately represents market conditions and competition. Horizontal addition considers the unique supply preferences of each firm and sums their quantities at corresponding price levels, accounting for the fact that market prices must be the same for all suppliers in a perfectly competitive market. Vertical addition, however, inaccurately assumes that firms supply goods at different prices for the same quantity, which is inconsistent with the competitive market model.

Step-by-step solution

Understanding the individual supply curves

Individual supply curves represent the relationship between the quantity of a good or service that a firm is willing to supply and its price, within a specific time frame. Each firm's supply curve is unique, depending on factors such as the cost of production, technology, and competition.

Adding supply curves horizontally

Adding supply curves horizontally means aligning them on the same price level, and then adding the various quantities at each corresponding price level. In other words, at any given price, the quantities from each individual supply curve are added to provide the total quantity that the market is willing to supply at that price. This method takes into account the heterogeneity of supply preferences among different firms and provides a more accurate representation of the market supply curve.

Adding supply curves vertically

Adding supply curves vertically means adding up the prices at which each firm is willing to supply a specific quantity. This is not an appropriate method for determining the market supply curve, as it does not account for the fact that market prices must be the same for all suppliers (assuming a perfectly competitive market). Firms supplying at different prices for the same quantity would not accurately reflect the competitive market conditions.

Comparison and conclusion

When determining the market supply curve, horizontal addition of individual supply curves is the preferred method for economists. This approach accounts for the competition and price alignment in a market, as well as the heterogeneity of supply preferences among firms. Vertical addition, on the other hand, does not adequately represent the prevailing market conditions, as it assumes that firms supply goods at different prices for the same quantity, which is not consistent with the perfectly competitive market model.

Key concepts

Individual Supply Curves

Imagine a lemonade stand in a neighborhood. The operator of the stand decides how many glasses of lemonade to sell at different prices. This decision-making process is visualized as an individual supply curve, which reflects the relationship between the price of the lemonade and the quantity the stand is willing to supply. For every possible price, there is a specific quantity that the stand owner feels compelled to offer. When the price is high, they might supply more because they can cover costs and earn more profit. Conversely, if the price dips too low, they might only offer a few glasses, or none at all, if the price can't cover the costs. This scenario is true for all producers in a market, whether they're selling lemonade, laptops, or landscaping services.

Factors such as production costs, available technology, and even weather can shift these curves by affecting supply. A sudden lemon shortage would mean our stand might supply less lemonade at each price point, shifting the supply curve accordingly. Understanding this concept lays the foundation for grasping more complex market mechanisms.

Horizontal Summation

Now, let's gather all the lemonade stands in the city and discover how much lemonade is supplied at each price point across the entire market. We perform what's known as a horizontal summation, where we combine each stand’s individual curve by adding up the quantities they supply at each price level, side-by-side, rather than stacking them on top of each other.

The key here is that prices must align for the summation to make sense. If one stand sells 30 glasses at \(1 each, and another sells 50 glasses at the same price, together, they supply 80 glasses at \)1 in the market. We repeat this process along all price levels to construct the market supply curve. This method acknowledges that while each stand operates independently, they collectively form a single lemonade market, influenced by the same price points. It also allows us to visualize the overall willingness of the market to supply lemonade at each price level, providing invaluable insights into market dynamics.

Competitive Market Conditions

In competitive markets, such as the one our lemonade stands are part of, certain conditions are typically met. These include the presence of many buyers and sellers, none of whom can control the market price on their own. In such an environment, the price of lemonade tends to be uniform across stands because consumers can choose freely where to buy. If one stand tried to charge significantly more, customers would simply buy from cheaper competitors. Therefore, individual producers take the market price as given and decide how much to supply based on that.

In competitive markets, profits attract new firms, which increases supply and can lead to a decrease in price, while losses push firms out, reducing supply and potentially increasing price. Understanding these dynamics is crucial for interpreting how market forces shape supply decisions and the resultant market supply curve.

Price and Quantity Relationship

Within a competitive market, there is a direct relationship between price and quantity supplied, commonly known as the law of supply. This principle holds that, ceteris paribus (all other factors being equal), an increase in price results in an increase in quantity supplied. Conversely, a decrease in price leads to a decrease in quantity supplied. For instance, if the price of lemonade suddenly spikes citywide, we can expect most stands to start supplying more lemonade to capitalize on the higher potential profits.

Price acts as a signal to producers; it's like a call to action. A rising price is a siren's song, luring producers to offer more of their goods to the market, while a falling price is a red flag, warning them to hold back. The market supply curve depicts this relationship by ascending to the right, confirming the fundamental economic notion that price and quantity supplied move in tandem under normal circumstances.