Chapter 5

CHAPTER 5Supply

The Law of Supply Supply is the amount of goods available

According to the law of supply, producers offer more of a good as its price increases and less as its price falls

Quantity supplied describes how much of a good is willing to sell at a specific price

A producer is called the supplier if they supply a product to the market

As prices increase, firms will produce more to make additional revenue and incentive to earn profit

As prices fall, some firms will produce less or drop out of the market

The Law of Supply Higher Production

If a firm is earning profit by selling a good, an increase in price (ceteris paribus) will increase profits

The promise of high revenue encourages a firm to produce more

Refer to example on page 111The search for profit drives the supplier’s

decisionIf prices fall, firms may look to produce

something else

The Law of Supply Market Entry

Profits appeal to producers in the market and who may decide to join the market

If the price of pizza rises and you want to start your own restaurant, a pizzeria would be a safe bet

In the music business in the 1970’s, disco became popular and many people from other genres joined disco music to take advantage of the potential profits

The Supply Schedule The supply schedule shows the relationship

between price and quantity supplied for a specific good, or how much a good a supplier will offer at various pricesThe table will show two variables, or factors that

can changeVariables are the two factors listed on the axis'sUsually price and the product suppliedSupply schedule lists supply for a very specific

set of conditions and other factors are assumed to remain constant

The Supply Schedule A Change In Quantity Supplied

Economists use the word supply to refer to the relationship between price and quantity supplied

The number of slices that a pizzeria offers at a specific price is called the quantity supplied

A rise or fall in the price of pizza will cause the quantity supplied to change, not the supply schedule

The Supply Schedule Market Supply Schedule

All of the supply schedules of individual firms in a market can be added up to create the market supply schedule

Shows prices and quantities by all firms in a particular market

Important when we want to determine the total supply of pizza at a certain price in a large area

The Supply Schedule The Supply Graph

When the data points in the supply schedule are graphed, they create a supply curve

The horizontal axis now measures the quantity of the good supplied, not the demand

Market supply curve are from the market schedule

Key feature is the supply curve will rise from left to right

This illustrates the law of supply, high prices lead to higher output

Supply and Elasticity Elasticity of supply measures how firms

will respond to changes in the price of a goodWhen elasticity is very sensitive to changes in

price, it is considered elasticIf supply is not very responsive to price

changes, it is considered inelasticWhen percentage change in price is perfectly

matched by an equal percentage change, elasticity is exactly one or unitary elastic

Supply and Elasticity Elasticity and Time

Elasticity in the short run is inelastic and in the long run is elastic

Elasticity of Supply in the Short RunAn orange groove is a good example because orange

trees take several years to matureThe short run a orange grower can use more effective

pesticides to increase output, but not very muchIn the short run supply is inelastic whether the prices

increase or decreaseA business that would be more elastic would be the

hair cutting business

Supply and Elasticity Elasticity in the Long Run

Supply will become more elastic over timeThe orange grower can plant more trees

with the hopes of making more profits in the future

If prices drop for a number of years, the orange growers that survived might start growing something else

Labor and Output Business owners have to answer the

question of how many workers to hireThe number of workers hired will affect total

productionEx. At the bean bag company

○ 1 person = 4 bags per hour○ 2 people = 10 bags per hour○ 3 people = 17 bags per hour○ 7 people = 32 bags per hour ***PEAK***○ 8 people = 31 bags per hour

Labor and Output Marginal Product of Labor

The change in output from hiring one more worker

Called marginal product because it measures the change in output at the margin, where the last worker is hired or fired

Labor and Output Marginal Product of Labor – Beanbags

Labor (number of workers)

Output (beanbags

per/hr.)

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

Labor and Output Increasing Marginal Returns

The marginal product of labor increases with the first 3 workers because there are three jobs involved in making beanbags○ Cutting cloth into correct shape, stuff with

beans, and sewing the bagBecause specialization increases output per

worker, the second worker adds more to output then the first, or increasing marginal returns

Labor and Output Chart Questions

In this example, why does the marginal product of labor increase with the first three workers?

Why does the marginal product of labor decrease with more than four workers in this example?

Labor and Output Diminishing marginal returns

Though workers 4-7 output increases, the marginal product of labor shrinks

The benefits of specialization ends after the hiring of the first 3 workers

Adding more workers increases total output but at a decreasing rate, or diminishing marginal return

Limited amount of capital makes the firm suffer○ One sewing machine, one pair of scissors,

Production Costs Fixed Costs

A fixed cost is a cost that does not change, no matter how much of a good is produced

Most involve cost of building or equipmentEx. Is rent, machinery repairs, property taxes, and

salaries Variable Cost

Variable costs are costs that rise or fall depending on the quantity produced

Includes raw materials and labor○ Depends on if the firm wants to produce more or less

Ex. Also include electricity and heating bills

Production Costs Total Cost and Marginal Cost

Fixed cost + variable cost = total cost

Marginal cost is the additional cost of producing one more unit

Beanbags(per hour)

Fixed Cost

VariableCost

Total Cost(FC+VC)

Marginal Cost

MarginalRevenue

TotalRevenue

Profit(TR-TC)

0 $36 $0 $36 ______ $24 $0 $ -36

1 36 8 44 $8 24 24 -20

2 36 12 48 4 24 48 0

3 36 15 51 3 24 72 21

4 36 20 56 5 24 96 40

5 36 27 63 7 24 120 57

6 36 36 72 9 24 144 72

7 36 48 84 12 24 168 84

8 36 63 99 15 24 192 93

9 36 82 118 19 24 216 98

10 36 106 142 24 24 240 98

11 36 136 172 30 24 264 92

12 36 173 209 37 24 288 72

Setting Output Marginal Revenue and Marginal Output

Another way to find the best level of output is to find the output level where marginal revenue is equal to marginal cost

Marginal revenue is the additional income from selling one unit of a good

If firm has no control over market price then marginal revenue = marginal cost

We can also determine profit by comparing price and average cost○ Average cost is total cost divided by quantity produced

Setting Output Responding to Price

What would happen if the price of a beanbag rises from $24 to $37?○ Firm would increase to 12 beanbags/hr.○ Marginal cost is equal to the new higher price○ This is an example shows the law of supply in

action

Input Costs Any change in the cost of input, such as raw

materials, machinery, or labor will affect supply Effect of Rising Costs

If the costs of labor or raw materials rise, marginal cost will rise

If the costs of inputs increases enough, marginal cost may become higher than the price, which means no profit

If the firm has no control over price, the only solution is to cut production and lower marginal cost○ The supply curve would shift to the left

Input Costs Technology

Advances in technology can lower the production costs in many industries

Automation like robotic tools save in labor costsComputers have simplified tasksEmail saves paperTechnology lowers costs and increases supply

at all levels○ This would cause a shift to the right on the supply

curve

Government Influence The government has the power to affect

supplies of many types of goods Subsidies

A subsidy is a government payment that supports a business or a market

Subsidies generally lower costs, allowing a firm to produce more goods

European governments protect farms so that some will be available to grow food in case cheaper imports are ever restricted

Government Influence Subsidies

Governments in developing countries often subsidize manufacturers to protect young, growing industries from strong foreign competition

Indonesia and Malaysia subsidize cars as a source of pride

In many countries governments have stopped subsidizing in the interest of free trade and competition○ Subsidizing can shift the supply curve to the right

Government Influence Taxes

A government can reduce the supply of some goods by placing an excise tax

A tax on the production or sale of a goodAn excise tax increases production costs by

adding an extra cost for each unit soldAlcohol, cigarettes, and high-pollutant gasolineUsually built into pricesIncrease in cost cause a decrease in supply

○ Shifts the supply curve to the left

Government Influence Regulation

Government regulation often has the effect of raising costs

Regulation is government intervention in a market that affects the price, quantity, or quality of good

Regulation like reducing exhaust and using lead-free gas increase cost and reduces supply○ The supply shift shifts to the left

Other Influences on Supply Changes in the Global Economy

The U.S. imports carpets from India. An increase in the wages of Indian workers would decrease the supply of carpets to the U.S. market, shifting the supply curve to the left

The United States imports oil from Russia. A new oil discovery in Russia could increase the supply of oil to the U.S. market and shift the supply curve to the right.

Other Influences on Supply Future Expectations of Prices

If a seller expects a price of a good to rise in the future, the seller will store the goods now in order to sell more in the future

If prices are expected to fall, the seller will market the product immediately

During rising inflation, the value of money decreases but a good will still hold its value if it is stored for a long period

Other Influences on Supply Number of Suppliers

The number of suppliers in a market affects supply

If more suppliers enter the market to produce a certain good, the market supply of the good will rise –supply curve shifts right

If suppliers stop producing the good and leave the market

Where Do Firms Produce? Key factor for many firms is

transportationTransporting inputs to a production facility

and transporting the finished product to consumers

Some firms locate themselves near raw materials if inputs are costly to transport

Some firms will locate close to consumers when output in more costly to transport