Why Higher Prices Benefit Firms | IB Economics Supply

Why Higher Prices Make Firms Rub Their Hands Together

Let’s face it: supply isn’t exactly the Beyoncé of Economics topics, right? It’s more like that quiet kid in class who always turns in solid work but never gets invited to the party. Still, this little concept pulls a lot of weight in markets - and once you understand it properly, a lot of economics starts to click into place.

So, let’s give supply its moment in the spotlight - with a few stories along the way to make it worth your while.

A little reminder: What is Supply?

Supply is the amount of a good or service that firms are willing and able to offer at different prices over a given period.

Think of a bakery on a Saturday morning. If cupcakes are selling for £3 each, the bakery might bake 100. But if the price jumps to £6 (maybe a TikTok influencer declared them the new avocado toast), that same bakery might bake 300. Why? You don’t need to be Steve Ballmer (former Microsoft CEO) to know why, simply because higher prices = higher potential profit.

That’s the core of the Law of Supply:

As the price of a product rises, the quantity supplied rises too ceteris paribus (that’s Latin for “as long as everything remains the same”).

Why are firms like this?

Two big reasons:

1. Profit motive – Businesses aren’t charities or non-profit entities. If the price is high, they see pound signs and produce more.

2. New firms enter the market – High prices can attract new producers who previously couldn’t afford to compete. (Imagine how many Chinese electric vehicle start-ups showed up once Tesla started making billions…)

The Supply Curve: The only time we like things that slope upwards

On a graph, the supply curve is upward sloping. As price increases, so does the quantity supplied. But this isn’t just because businesses are greedy - it’s also about costs.

Let’s bring in a little HL into the conversation:

As firms produce more, marginal costs (the cost of making one more unit) usually rise due to the Law of Diminishing Marginal Returns.

Marginal cost represents the expense of producing one more unit of output. You calculate it by dividing the change in total cost by the change in total output or production.

MC = ∆TC ÷ ∆Q.

Picture a pizza restaurant. The first few chefs work great. But as the owner squeezes 10 people into a tiny kitchen, they start bumping elbows and dropping pepperoni. More workers = less efficiency = higher costs per pizza. So, if the price of pizza doesn’t go up, the restaurant won’t want to make more. Simple as that.

The law of diminishing marginal returns applies only in the short run, because all factors of production become variable in the long run.

Shifts vs Movements: A Classic IB Scaramouche!

• A movement along the supply curve happens when the price of the good changes.

• A shift of the supply curve happens when a non-price factor changes.

Let’s run through those non-price factors using the trusty CISTERN acronym:

1. Costs of production (e.g. energy prices go up? Supply shifts left!)

2. Indirect taxes (like VAT - firms produce less if it costs more to produce)

3. Subsidies (government help = more supply)

4. Technology (robots don’t need coffee breaks and perform like Jack Reacher)

5. Expectations of future prices (will prices rise or fall?)

6. Related goods (beef and leather, smartphones and smartwatches)

7. Number of firms in the market (more firms = more supply)

Real-World Example Time

• iPhones: When Apple expects a spike in demand for new models, it ramps up production early. If supply of key components like chips is limited, prices go up, but so do efforts to supply more.

• Wheat & War: After Russia invaded Ukraine, global wheat supply dropped dramatically. Ukraine is a major supplier - and disruptions shifted the supply curve left, leading to higher prices globally.

• Taylor Swift Tickets: Yes, she’s back again. When ticket resale prices surge, more resellers (a.k.a. firms?) enter the market - shifting “supply” of available tickets right on secondary markets. (Whether this is fair is another blog entirely…)

Common Misconceptions (A little exam help)

“If demand rises, supply increases and prices fall.”

Wrong! Demand increasing causes price to rise and then supply expands (a movement along the supply curve), not a shift in supply.

“Taxes reduce demand.”

Partially true - but in most cases, indirect taxes reduce supply, by increasing production costs. A key exam ambush!

Final Thought

The concept of supply might not grab headlines like inflation or unemployment, but it’s the quiet engine behind every business decision. Whether it’s Nike dropping limited trainers, Amazon shifting warehouse operations, or your local coffee shop hiring extra staff - supply decisions are everywhere.

Understand this basics quickly, and you’ll be a step ahead not just in your IB exams, but in understanding how the real world ticks.

Subscribe to the IB Trainer Newsletter

“Want IB tips straight to your inbox? Join our mailing list - no spam, just smart stuff.”