Learn about diverse and integrated markets for primary energy, and the essential considerations driving business leaders and policy makers in development of global energy resources.
Law of Supply
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En provenance du cours de University of Colorado System
Fundamentals of Global Energy Business
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Energy Supplies and Market Allocations
A broad range of primary resources are used to satisfy our need for energy. Accessing these resources depends on many factors, including available technologies and skills, and a number of political factors. We will address these factors as well as issues and trends in energy supply.
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Michael J. OrlandoLecturer
Global Energy Management, Business School
Now just because primary energy resources are available in various places around the
globe doesn't mean that we will necessary bring those resources to the marketplace.
So in this video, we're going to discuss determinants
of supply and as was the case with demand,
the number of factors help to determine the amount
of a resource that energy developers will bring to market.
So of course, prices provide incentives for businesses to develop these
resources, but naturally also costs are an important determinant.
So, costs maybe in the form of obvious things like the cost of labor, operating
expenses but they be maybe in less obvious ways things like weather disruptions can
be thought of as costs of production or technological change can be labor saving
or capital saving and that could be though of as a, as a impact costs.
Of course technological change can also be thought of as an impact to output.
Now it may be because I'm a bit of a finance person
but I find it useful when thinking about the supply curve
to frame it in terms essentially similar
to The way firms value perspective enterprises.
And when they value operations of perspective
enterprises, what they're really concerned with are
the free cash flows that are going to
become available from those, from those activities.
So what you can do is you can think about a statement of cash flows.
And I think it's sort of a useful a
useful instructive way for framing thinking about the supply curve.
So for example, let's say we have prices increase
okay, let's think about what, what does an increase in price
do to the statement of cash flows?
And to these 3 cash flows, which are the basis for project valuation in particular.
Well of course since your revenue is equal to your price times
quantity, and of course if price increase, the primary
effect is going to be an increase in this operating revenue.
Now, firms are going to respond to that increase in price and
possibly try to ramp up operations and take advantage of it, so
they're going to incur possibly additional costs of various types.
But the net effect of all of that is
to increase the free cash flows associated with this activity.
Okay?
And if the free cash flows associated with this activity are
increasing, then firms are going to basically expand this type of activity.
So if all firms do that, then you're going to see the supply curve go out.
Supply will increase.
Then if all firms experience an increase in free cash flows associated with that
activity, they'll be inclined to increase their
supply, their supply associated with that, this activity.
So supply will increase.
Similarly, naturally, if price falls,
then your revenue is going to fall.
So the main effect with a fallen price is to reduce the revenue associated
with that, this activity of course as with an increase in price firms are going to
respond to this change in price so it will fall in price, there response will
be possibly a cutback and economize on certain
costs associated with this now less profitable activity.
Nonetheless the net effect of this drop in price is going to be a drop in free cash
flows associated with activity, with this activity, and if
that's the case, then firms are going to reduce supply.
So as price increases, you're going to see an increase in supply.
And as price decreases, you're going to see a decrease in supply.
And we could also depict this naturally
in the form of a supply curve.
So imagine recall when last week when we talked about demand, we represented
demand by consumers for certain goods in the space of price versus quantity.
So here we're looking at price versus quantity supplied.
Imagine there's a particular price out there,
the prevailing price.
So at that prevailing price, what's going to
happen is firms are going to each decide
what's the appropriate quantity for them that maximizes
their profits associated with operations at that price.
And when you sum all that up, they're going to
produce a certain amount of output, okay?
Now you might ask, well why wouldn't they produce more?
Well think about it this way, presumably, if they were at that price anyone were
to consider producing more would require really putting an extra tax and burden
on their machinery possibly paying overtime wages,
and the margin that they're going to make
at that price, on that extra amount of production they can, they can produce with
all of those excessive costs just don't justify the excessive cost and the burden.
So they're not going to bother producing more at that price.
Similarly, why wouldn't they produce less at this price?
Well presumably at at this particular price if, if it justifies
a certain quantity, producing anything less would just leave resources idle.
It would leave capital idle, it would leave labor idle, and it
would be more profitable for them to expand output to a higher level.
So there, so that level of output associated with that price is unique.
It's just a particular level of output associated with that price.
Now on the other hand if price is increased, now it would make sense for a
firm to, say, expand its output by maybe paying overtime because the price that
they're going to get for all of those new units of production that they could expand
into are going to justify maybe putting the extra
burden on their capital and their labor resources.
And of course you can tell a similar
story If prices decline, they're going to want to economize
and pull back on those inputs on those
resources that they were, that they were just using,
because those last few workers that they had
working overtime, or the last little extra work they
tried to get out of their machines before you
know, while, while deferring maintenance, for instance, just don't,
don't justify, are no longer justified at this lower price.
So the schedule of quantities supplied at these
various prices is what we call the supply curve.
And the fact that this is an upward sloping curve, that there's a
positive relationship between price and quantity, is
what we call the law of supply.
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