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Economics Chapter 5:Supply

When you look at supply, think like a Business

Owner!!!

What is your ultimate goal as a business owner?

To make a PROFIT

I. What is the Law of Supply?

A. Supply is the amount of a product that would be

offered for sale at all possible prices in the market.

1. There is a direct relationship between price and quantity supplied

B. The Law of Supply states that suppliers will

normally offer more for sale at high prices and less at lower prices.

2. As the price rises for a good, the quantity supplied also rises

3. As the price falls, the quantity supplied also falls

P = Q

P = Q

C. An individual supply curve illustrates how the quantity that a producer will make varies depending on the price that will prevail in the market.

D. A market supply curve illustrates the quantities and prices that all producers will offer in the market for any given product or service.

E. Economists analyze supply by listing quantities and prices in a supply schedule (table). When the supply data is graphed, it forms a supply curve with an upward slope.

II. Change in Quantity Supplied

B. Producers have freedom…

A. A change in quantity supplied is the change in the amount offered for sale in response to a change in price

·Movement is ALONG the curve

If prices fall too low, producers may slow or stop production or leave the market completely. If the price rises, the producer can step up production levels

III. Change in Supply

A. A change in supply is when suppliers offer

different amounts of products for sale at all possible prices in the market This creates a new curve

B. Factors that can cause a change in supply include:Price of inputs (labor, packaging costs for example)

Productivity levels Technology

Taxes or the level of subsidiesPrice expectationsGovernment regulations

Number of sellers

IV. Elasticity of Supply is a measure of the way in which quantity supplied responds to change in

price. A. Supply is elastic when a small increase in price leads to a larger increase in output—and supply.

B. Supply is inelastic when a small increase in price causes little change in supply

C. Supply is unit elastic when a change in price causes a proportional change in supply. D. Determinants of supply elasticity are related to how quickly a producer can act when the change in price occurs.

1. If adjusting production can be done quickly, the supply is elastic

2. If production is complex and requires much

advance planning, the supply is inelastic 3. Another factor is substitution, if substituting for

a given product is easy, the supply is elastic; if it is difficult to substitute, the supply is inelastic.

V. How does elasticity of supply differ from demand?

A. The number of substitutes has no bearing on

elasticity of supply B. The ability to delay the purchase or the portion of income consumers have has no relevance to supply elasticity

CHAPTER 5.2:THEORY OF PRODUCTION

I. Theory of Production = the relationship between the factors of production and the output of goods and services.

A. The short run refers to a period of production that allows producers to only change the variable labor.

B. The long run refers to a period of production that

allows producers to adjust quantities of all their resources, including capital. * adding a factory = long run adjustment

* hiring more workers = short run

II. Law of Variable Proportions A. In the short run, output will change as one variable input is altered, but other inputs are kept constant.Farmer with 30 acres of cultivated

land

Salt added to food = tasty in the right amount BUT at some point it will ruin the taste... taste = output

B. The Law of Variable Proportions looks at how the final product is affected as more units of one variable input or resource are added to a fixed amount of other resources.

C. Economists prefer that only a single variable be

changed at any one time so the impact of this variable on total output can be measured.

III. The Production Function A. This concept illustrates the Law of Variable Proportions within a

production schedule or a graph.

B. Production Function describes the relationship between changes in output to different amounts of a single input while others are held constant (in this case, labor)

C. Total product= the total output the company produces

D. Marginal product = extra output or change in total product caused by adding one more unit of

variable input

a production schedule shows that, as more workers are added, total product rises until a point that adding more workers causes a decline in total product.

IV. Three Stages of Production (figure 5.5 p. 124)

A. In Stage I (increasing returns), marginal

output increases with each new worker. Companies are tempted to hire more

workers, which moves them to Stage II.

B. In Stage II (diminishing returns), total production keeps

growing but the rate of increase is smaller

C. In Stage III (negative returns), marginal product becomes negative, decreasing total plant output.

Each worker is still making a positive contribution to total output, but it is diminishing. Law of Diminishing Returns: after some point, adding units of a factor of production (such as labor) to all the other factors of production (such as equipment) increases total output for a time; after a certain point, the extra output for each additional unit will begin to decrease Workers 11 & 12 would most likely not be hired

Chapter 5.3: Cost, Revenue, and Profit Maximization

I. Measure of Cost A. Fixed costs are those that a

business has even if it has no output. These include management salaries, rent,

taxes, and depreciation on capital goods.

B. Variable costs are those that change when the rate of operation or production changesThese include hourly labor, raw materials, freight charges, and electricity

C. Total cost = the sum of all fixed costs and all variable costs

Increase in Variable Cost ÷

Marginal Product = Marginal Cost

D. Marginal cost = the extra (variable) costs incurred when a business produces one

additional unit of a product.

II. Applying cost Principles

A. A self-service gas station is an example of high fixed costs with low variable costs.

B. E-commerce is an example of an industry with low fixed costs

The ratio of variable to fixed costs is low

III. Measure of Revenue

Profits are maximized when marginal revenue = marginal cost

A. Total revenue = the number of units sold

X the average price per unit. B. Marginal revenue is the extra revenue connected with producing and selling an additional unit of output.

IV. Marginal Analysis A. Marginal analysis is comparing the

extra benefits to the extra costs of a

particular decision.

B. The break-even point is the total output or total product that business needs to sell in order to cover its total costs.

C. Businesses want to find the number of workers and the level of output that

generates maximum profits

The profit-maximizing quantity of output is reached when marginal cost and marginal revenue are equal.