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Understanding Supply

• What is the law of supply?

• What are supply schedules and supply curves?

• What is elasticity of supply?

• What factors affect elasticity of supply?


Price

As price

increases…

Supply

Quantity supplied increases

Price

As price falls…

Supply

Quantity supplied

falls

The Law of Supply

• According to the law of supply, suppliers will offer more of a good at a higher price.


Law of Supply

• Quantity Supplied – the amount a supplier is willing and able to supply at a certain price

• As a price rises, the producer will make more in order to earn additional revenue

– New firms will then have an incentive to enter the market to earn profit

• Price falls, the business produces less or drops out completely


Higher Production

• Business that is already making a profit, then an increase in price will increase profits

– The higher revenues encourage them to produce more (supply raises)

• Example

– Making profit at market price and cost of production is low

– Then price of pizza rises a little, raising profits

– Then they will produce more in order to sell more

– If price would fall, they would supply less


Market Entry

• Rising prices draw new people into the market

– If you see a certain type of restaurant doing very well (their prices rising along w/ profits) you want to join in

– So you open that type of restaurant b/c it’s a safe bet

• Grunge music in the 1990s

– Record labels saw the popularity grow, so many more bands joined the market

– Music stores sold more grunge music

– Later, the fad ended


The Supply Schedule

• Supply Schedule – shows the relationship b/w price and quantity supplied for a specific good

– Table compares 2 variables, or factors, that can change

• Price of a slice and the amount supplied

• Lists supply for a very specific set of conditions

– Only price is taken into account (not labor or price of resources)


$.50 1,000

Price per slice of pizza Slices supplied per day

Market Supply Schedule

$1.00 1,500

$1.50 2,000

$2.00 2,500

$2.50 3,000

$3.00 3,500

Supply Schedules


A Change in Quantity Supplied

• Each number of slices supplied at any given price is called the Quantity Supplied

– $.50/slice, there are 100 slices supplied

• We just move from each row when the prices change

• The Supply Schedule never actually changes, only the Quantity Supplied


Market Supply Schedule

• Like the market demand schedule, the Market Supply Schedule shows how much of a good all suppliers will offer at diff. prices

– Important b/c it helps us determine the total supply of a good at a certain price

• Reflects the law of supply


Market Supply Curve

Pri

ce

(in

do

lla

rs)

Output (slices per day)

3.00

2.50

2.00

1.50

1.00

.50

0

0 500 1000 1500 2000 2500 3000 3500

Supply

Supply Curves

• Supply Curve – graph showing quantity supplied of a good at different prices

• X-Axis = Quantity

• Y-Axis = Price

• Rises left to right

• A market supply curve is a graph of the quantity supplied of a good by all suppliers at different prices.


Supply and Elasticity

• Elasticity of Supply – measure of the way suppliers respond to a change in price

– Values of Elasticity of Supply are same as demand


Elasticity of Supply and Time

• Short Term – Orange Grove Example

– Price goes up on oranges, grower can plant more trees to increase supply, but it takes years to grow

– Small steps to increase output, use better pesticide (# of oranges does not increase much)

– This would be inelastic then, supply does not respond much to price change

– Same as if price goes down

• Still grow and sell same number of oranges



• Short Term continued – Haircut Example

– Haircuts can be easily reduced or increased by the hair dresser

– Price rises, hire new workers raise supply

• New shops will open or existing ones stay open later

• Small price raise and supply increases dramatically

– Price falls, supply falls

– Highly elastic



• Long Term – Oranges example

– The grower that planted more trees will, over time, have a higher supply

• Ends up selling many more oranges at the higher market price

– Price falls and stays there for several years

• Orange growers will eventually cut back on growth or grow something diff.

– Becomes elastic over time


Costs of Production

• How do firms decide how much labor to hire?

• What are production costs?

• How do firms decide how much to produce?


Marginal Product of Labor

• Marginal Product of Labor – the change in output from hiring one additional unit of labor

– Shows the change in output at the margin, where the last worker was hired or fired

• First worker hired makes 4 T-Shirts/hour

• 2nd worker raises total to 10 T-Shirts/hour

– Marginal product of labor is 6

• See this in column 3 of the table


Marginal Product of Labor

Labor (number of workers)

Output (T-Shirts per

hour)

Marginal product of labor

0 0 —

1 4 4

2 10 6

3 17 7

4 23 6

5 28 5

6 31 3

7 32 1

8 31 –1

A Firm’s Labor Decisions


Diminishing Marginal Returns

• 4th through the 7th worker – the marginal product of labor is still positive

– It is shrinking though

• Diminishing Marginal Returns – level of production in which the marginal product of labor decreases as the number of workers increases

– Specialization ends when you hire more workers

– Increases total output but at a decreasing rate


Diminishing Marginal Returns

• Business w/ D.M.R. of labor produce less and have less output from each unit of labor added

• Workers are working w/ a limited amount of capital

– Workers now have to wait to use the tools to create w/e product they sell

– They do not increase the speed of making the product

– Add less to the total output of the factory


Increasing Marginal Returns

• Marginal product of labor increases among the first 3 workers b/c there are more than one task to making a T-Shirt

– Adding more workers mean each can specialize in each task

– Specialization increases output per worker

– 2nd worker adds more output than the 1st

– Increasing Marginal Returns – level of production in which the marginal product of labor increases as # of workers increase


Negative Marginal Returns

• Hiring the 8th worker puts the marginal product of labor in the negatives

– Too many workers, everyone in the way of each other

– Businesses work to avoid this problem


Increasing, Diminishing, and Negative Marginal Returns

Labor(number of workers)

Ma

rgin

al

Pro

du

ct

of

lab

or

(be

an

ba

gs

pe

r h

ou

r)

8

7

6

5

4

3

2

1

0

–1

–2

–3

4 5 6 7

Diminishing marginal returns

8 9

Negative marginal returns

Marginal Returns

1 2 3

Increasing marginal returns


Fixed Costs

• Fixed Cost – cost that does not change, no matter how much of a good is produced

– The facility, cost of building the factory (office, store, restaurant etc.)

– Rent, repairs, property taxes, salaries


Variable Costs

• Variable Costs – costs that rise or fall depending on quantity produced

– Company wants to produce more of a product, buy more materials and hire more workers

– Cut costs, then cut back on buying materials and cut workers hours

– Cost of labor is a variable cost

– Electric and Heating bills – turn off electricity and heat when the factory is not in use


Total Cost

• Total Cost – the fixed cost plus the variable cost

– Fixed costs are the building and equipment ($36/hour)

– Variable costs are the fabric, thread, most of the workers

• These rise with number of T-Shirts made/hour


Production Costs

Total revenue

Profit(total revenue –

total cost)

Marginal revenue

(market price)

Marginal cost

Total cost (fixed cost +

variable cost)

Variable cost

Fixed cost

T-Shirts (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

3657

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output


Marginal Cost

• Marginal Cost – the cost of producing one more unit of a good

– If we know the total cost at different levels of output, you can figure out marginal cost

• Not producing a single T-Shirt, they still pay the fixed cost ($36/hour)

• Produce one T-Shirt/hour its total cost rises $36 to $44 ($8 is marginal cost now)

• Total Cost - Fixed Cost = Marginal Cost


Production Costs

Total revenue


total cost)

Marginal revenue

(market price)

Marginal cost


variable cost)

Variable cost

Fixed cost

T-Shirts (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

3657

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output


Marginal Cost

• First 3 T-Shirts, marginal cost falls as output increases

– 2nd T-Shirt = $4, 3rd T-Shirt = $3

– Increasing marginal returns b/c of specialization

• 4th T-Shirt, marginal cost starts to rise

– Reflects diminishing returns to labor

– Benefits of specialization are no longer there

– Diminishing returns set in once workers start to share machines


Production Costs

Total revenue


total cost)

Marginal revenue

(market price)

Marginal cost


variable cost)

Variable cost

Fixed cost

T-Shirts (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

3657

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output


Production Costs

Total revenue


total cost)

Marginal revenue

(market price)

Marginal cost


variable cost)

Variable cost

Fixed cost

T-Shirts (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

3657

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output

• Total Revenue – Total Cost = Profits

• B/w 9 and 10 T-Shirts/hour we see is the highest profit, $98


Marginal Revenue and Marginal Cost

• Marginal Revenue – the additional income from selling one more unit of a good, sometimes equal to price

• If firm has no control over price, marginal revenue = marginal cost

• Each T-Shirt sold at $24 increases the total revenue by $24, so marginal revenue is $24

• At 10 T-Shirts sold, price = marginal cost, so that is the quantity for maximum profit


Production Costs

Total revenue


total cost)

Marginal revenue

(market price)

Marginal cost


variable cost)

Variable cost

Fixed cost

T-Shirts (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

3657

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output

• See why output of 10 T-Shirts is best situation by looking at different levels of output (4, 5, 6, so on…)


Responding to Price Changes

• Price raises to $37 for a T-Shirt

– Firm increases production to 12 T-Shirts

– The new price now = marginal cost

– New levels of profit are available

– Shows law of supply in action (price rises, supply rises)


The Shutdown Decision

• Operating Cost – the cost of operating a facility

• Price of a T-Shirt drops to $7, which means they would produce 5 T-shirts (marginal cost = marginal revenue)

– Total revenue would be $35 and the variable costs are $27

– Total revenue is higher, keep factory open


The Shutdown Decision

• Close the factory, still paying $36/hour in fixed costs

• Stay open, producing 5 T-shirts/hour with total costs at $63/hour (36 in fixed + 27 in variable)

– Losing only $28/hour b/c of the total revenue of $35

• Losing money in both examples, but losing less if they stay open and produce 5 T-shirts


Changes in Supply

• How do input costs affect supply?

• How can the government affect the supply of a good?

• What other factors can influence supply?


Input Costs and Effect of Rising Costs

• Businesses want their price = marginal cost

– Marginal cost includes materials that make the product

– Cost of materials go up, marginal cost does

• Price and Marginal Cost are no longer the same, business not profitable

– The supply curve would shift to the left

• Graph on board.


Technology

• New technology can lower production costs

– Robots in car manufacturers, speed up work and cut down on salaries paid

– Email increasing speed of information being passed throughout the market

• Lowering production costs increase profit and supply curve shifts to the right

• Graph on board.


Subsidies

• Subsidy – govt. payment that supports a business market

– Govt. pays a business a set subsidy for each unit of a good produced

– WWII – European countries subsidized farms b/c of food shortages

• Protected farms in case food imports were cut off

• France – protect small farmers and the French countryside


Subsidies

• Developing countries subsidize businesses to protect growing industries from foreign competition

– Indonesia and Malaysia subsidized national car companies

– Western Europe let their airlines and banks suffer huge losses by assuring them they would cover debts

• Subsidies have slowed to allow for fair competition and free trade


Subsidies

• A controversial subsidy in U.S. are farm subsidies

– Pay farmers to take land out of production in order to keep prices high

– This hurts efficient farmers

– They start to use more pesticides and herbicides to try and produce more on the land they are allowed to plant


Taxes

• Excise Tax – tax on the production or sale of a good

– Increases production cost by adding extra cost for each unit sold

– Decreases supply (supply curve shifts to the left)

– Mainly put on products like cigarettes, alcohol, and high-pollutant gasoline

– Consumers don’t realize they are paying them


Regulation

• Regulation – govt. intervention in a market that affects the production of a good

– Usually raises the price of a good

• 1970s

– Govt put regulations on car emissions

– Cars cost more to make then, supply went down


Supply in the Global Economy

• Imports into the U.S.

– 1. U.S. gets carpets from India

• Wages increase among workers

• Decreases supply to the U.S.

– 2. Phones from Japan

• New technology decreases cost of making them

• Supply imported goes up

– 3. Oil from Russia

• New discovery of oil would increase our supply

• Lower prices


Future Expectations of Prices

• Soybean farmer knows that the price of soybeans will double in a month

– Stores soybeans just harvested and cuts back on supply in short term

– Increase supply in long term

• Price expected to drop in a month

– Sell now and increase supply in short term

– Cut supply in long term



• Inflation is a condition of rising prices

• Businesses hold on to products that can be stored for long periods of time

– Hold on to their goods until the price gets high enough, then sell

– Short term – supply falls drastically



• Civil War

– South faced terrible inflation

– Prices on goods like flour, butter, and salt rose each month

• Shopkeepers would hoard products and wait to sell later at a higher price

• Caused great shortages

– Prices to high for most and riots broke out


Number of Suppliers

• More producers enter a certain market, supply of that good will rise

– Shifting curve to the right

• Suppliers leave the market and stop producing that product

– Supply decreases and curve shifts to the left