© 2010 Pearson Education CanadaChapter 3 - 1 Chapter 3 Show Me the Money © 2010 Pearson Education...

© 2010 Pearson Education CanadaChapter 3 - 1

Chapter 3

Show Me the Money

© 2010 Pearson Education Canada


Show Me the MoneyThe Law of Supply


LEARNING OBJECTIVES

3.1 Explain why marginal costs are ultimately opportunity costs

3.2 Define sunk costs and explain why they do not influence smart, forward-looking decisions

3.3 Describe the relationship between price and quantity supplied, and identify the roles of higher profits and marginal opportunity costs of production


LEARNING OBJECTIVES

3.4 Explain the difference between a change in quantity supplied and a change in supply, and list five factors that change supply

3.5 Explain elasticity of supply and how it helps businesses avoid disappointed customers


WHAT DOES IT REALLY COST? COSTS ARE OPPORTUNITY COSTS

Businesses must pay higher prices to obtain more of an input because opportunity costs change with circumstances.

Marginal costs of additional inputs are ultimately opportunity costs — best alternative use of the input.


COSTS ARE OPPORTUNITY COSTS

• Marginal cost additional opportunity cost of increasing quantity supplied– changes with circumstances

• Marginal cost increases as you increase quantity supplied

• To buy inputs, business must pay price matching best opportunity cost of input owner


FORGET IT, IT’S HISTORY SUNK COSTS DON’T MATTER FOR FUTURE

CHOICES

Sunk costs that cannot be reversed are not part of opportunity costs. Sunk costs do not influence smart,

forward-looking decisions.


SUNK COSTS DON’T MATTER FOR FUTURE CHOICES

• Sunk costs past expenses that cannot be recovered– same no matter which fork in the road you

take, so no influence on smart choices– not part of opportunity costs


MORE FOR MORE MONEY: THE LAW OF SUPPLY

If the price of a product/service rises, quantity supplied increases.

Businesses increase production when higher prices either create higher profits or cover higher marginal opportunity costs of production.


LAW OF SUPPLY

• Quantity suppliedquantity you actually plan to supply at a given price

Figure 3.1 Your Supply of Hours WorkedPrice (minimum willing to accept)

Quantity Supplied(hours)

$ 10 10 - 20$ 20 35$ 30 55

continued…


• Supply businesses’ willingness to produce a particular product/service because price covers all opportunity costs

• Increasing marginal opportunity costs arise because inputs not equally productive in all activities

continued…


Figure 3.3 PPF Parlour Maximum Combinations & Marginal Opportunity Costs

Combination

Fingernails

Piercings

Marginal Opportunity Cost(fingernails given up)

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

(15 – 14)1

= 1

(9 – 5)1

= 4

(12 – 9)1

= 3

(5 – 0)1

= 5

(14 – 12)1

= 2


Figure 3.4 Increasing Marginal Opportunity Cost


Figure 3.5 PPF Parlour’s Supply of Piercings

Price(marginal opportunity cost orminimum willing to accept)

Quantity Supplied

$ 20 1

$ 40 2

$ 60 3$ 80 4

$ 100 5


• Market supply sum of supplies of all businesses willing to produce a particular product/service

• Law of supplyif the price of a product/service rises, quantity supplied increases


Figure 3.6 Market Supply of Piercings

Price(marginal opportunity cost orminimum willing to accept)

Quantity Supplied

$ 20 100

$ 40 200

$ 60 300$ 80 400

$ 100 500


CHANGING THE BOTTOM LINE:WHAT CAN CHANGE SUPPLY?

Quantity supplied is changed only by a change in price.

Supply is changed by all other influences on business decisions.


WHAT CAN CHANGE SUPPLY?

• Supply changes with changes in – technology– prices of inputs – prices of related products/services

produced– expected future prices– number of businesses

continued…


• Supply increases with– improvement in technology– fall in price of an input– fall in price of a related product/service– fall in expected future price– increase in number of businesses


Figure 3.7 Market Supply of Piercings Before & After a Technology Improvement

Price(marginal opportunity cost or minimum willing to accept)

Quantity Supplied(before improvement)

Quantity Supplied(after improvement)

$ 20 100 200$ 40 200 400$ 60 300 600$ 80 400 800$ 100 500 1,000


Figure 3.8 Market Supply of Piercings with More Businesses

Price(marginal opportunity cost or minimum willing to accept)

Quantity Supplied(100 businesses)

Quantity Supplied(200 businesses)

$ 20 100 200$ 40 200 400$ 60 300 600$ 80 400 800$ 100 500 1,000


HOW FAR WILL YOU JUMP FOR THE MONEY?

PRICE ELASTICITY OF SUPPLY

Elasticity of supply measures how responsive quantity supplied is to a change in price, and depends on the difficulty, expense, and time involved in increasing production.



• Elasticity of supply measures how much quantity supplied responds to a change in price

• Elasticity of supply =% change in quantity supplied

% change in price

continued…


• Inelastic supply small response in quantity supplied when price rises– example — supply of mined gold– elasticity of supply < 1

• Elastic supplylarge response in quantity supplied when price rises– example — snow shovelling services– elasticity of supply > 1

continued…


• Elasticity of supply influenced by– availability of additional inputs —

more available inputs, more elastic supply – time production takes —

less time, more elastic supply• Elasticity of supply allows accurate

projections of future outputs and prices, helping businesses avoid disappointed customers


Chapter 3Refresh Slides


COSTS ARE OPPORTUNITY COSTS

1. What is the real cost to a business of hiring or purchasing any input?

2. Microsoft released a limited supply of Xbox 360s in 2005 with a list price — or “real” price — of $400. The units immediately started selling on eBay and other auction websites for far more than $400. What do you think determined the “real” price of an Xbox?

continued…


1. If a recession makes it much harder for workers to find better-paying jobs, what might happen to Paola’s labour costs?


SUNK COSTS DON’T MATTER FOR FUTURE CHOICES

1. Why aren’t sunk costs part of the opportunity costs of forward-looking decisions?

2. Suppose you have just paid your bus fare. A friend in a car pulls up offers you a ride. Explain how you would decide between staying on the bus or taking the ride, and the influence of the paid fare.

3. If you bought a $100 textbook for a course, and then dropped out after the tuition refund date, is that $100 a sunk cost? Explain your answer.


LAW OF SUPPLY

1. Why does Paola need a higher price to be willing to supply more body piercings?

2. If you could spend the next hour studying economics or working at your part-time job, which pays $10 an hour, what is your personal opportunity cost, in dollars, of studying?

continued…


1. Suppose the PPF Parlour was producing only piercings and no fingernail sets. If Paola wanted to start producing some fingernail sets, which staff person would she switch to fingernails first? Who would she switch last? Explain your answers.


WHAT CAN CHANGE SUPPLY?

1. Explain the difference between a change in quantity supplied and a change in supply, and distinguish the five factors that can change supply.

2. Suppose you are working at two part-time jobs, babysitting and pizza delivery. After many younger babysitters start offering to work for less, your babysitting clients will now pay only $6 per hour instead of $8 per hour. What will happen to your supply of hours for delivering pizzas? Explain.

continued…


1. When the price of nail sets falls, none of Paola’s hard dollar costs (like wages, rent, or stud costs) change. Is there an effect on the quantity of piercings Paola chooses to supply.



1. Explain the relationship between price & quantity supplied for inelastic supply and for elastic supply.

2. If your boss offers you a 20% raise, and in response you work 10% more hours, how would you describe your price elasticity of labour supply?

3. Your business is about to launch an advertising campaign, boasting about your current low prices. You are hoping the ads will bring in many more customers. Explain why you need to be concerned about your elasticity of supply.

© 2010 Pearson Education CanadaChapter 3 - 1 Chapter 3 Show Me the Money © 2010 Pearson Education...

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