Supply Chapter 5

Understanding Supply Chapter 5, Section 1

The Law of Supply  How do producers know how much to produce?  According to the law of supply, the higher the price, the more a firm will produce  This creates more revenue  The amount produced is known as the quantity supplied

Earning a Profit  If a firm is already earning profit, an increase in price will create more profit.  This drives producers and their decisions  Don’t forget ceteris paribus  All things remain constant (except for price) in order to guarantee a change in profit

New Producers  An increase in price will not only cause firms to produce more, but it will encourage the entry of new firms into the market  However, according to the law of supply, this lasts only as price increases  After the price increase stops, new firms may leave the market  Dot Coms

Supply Schedule  Like a demand schedule, a supply schedule is a table that shows how much of a product firms will produce at a given price  In turn, a supply curve is a graphical representation of the supply table $1100 $2150 $3200 $4250

Changes in Supply  Like demand, a change in quantity supplied represents movement along the supply curve.  A change in another variable (besides price) results in a change in supply (whole new curve)

Supply Curve Market Supply Curve Price (in dollars) Output (slices per day) Supply

Change in Supply Price (in dollars) Output (slices per day) Supply

Elasticity of Supply  A measure of the way quantity supplied reacts to a change in price  If supply is elastic, it will react quickly to a change in price  If it is inelastic, it will react slowly

Elasticity of Supply and Time  In the short run, a firm cannot easily change its output so supply is inelastic  In the long run, firms can make greater changes so supply becomes more elastic  Firms that produce products are often inelastic and more effected by time  Firms producing services are more elastic  Ex: Cars vs. Haircuts

Review 1. What is the law of supply?  (a) The lower the price, the larger the quantity supplied.  (b) The higher the price, the larger the quantity supplied.  (c) The higher the price, the smaller the quantity supplied.  (d) The lower the price, the more manufacturers will produce the good. 2. What happens when the price of a good with an elastic supply goes down?  (a) Existing producers will expand and some new producers will enter the market.  (b) Some producers will produce less and others will drop out of the market.  (c) Existing firms will continue their usual output but will earn less.  (d) New firms will enter the market as older ones drop out.

Cost of Production Chapter 5, Section 2

Labor and Output  One question firms need to answer is how many to hire  Output increases with additional labor but to what point?  Marginal Product of Labor...the change in output from hiring one additional worker

Marginal Product of Labor Labor (# of workers) Output (chairs per hr) Marginal Product of Labor

Increasing Marginal Returns  Level of production where the marginal product of labor increases with the number of workers  Results from specialization and efficient use of capital  All workers are efficient and working at a high level  No interruptions at work

Decreasing Marginal Returns  Level of production where the marginal product of labor decreases with the numbers of workers  Output continues to increase but at a slower rate. Benefits of specialization actually end.  Workers become less efficient due to limited capital  Ex…have to borrow equipment, tools, etc.

Negative Marginal Returns  Production actually decreases with the addition of labor  Too many cooks in the kitchen  Ex…workers get in each other’s way, disrupt production, etc.  Very few companies hire SO many workers that MPL becomes negative.

Production Costs  All the costs involved in producing goods and services  Fixed Costs...costs that do not change regardless how much is produced  Rent, machinery, repairs, taxes, salaries  Variable Costs...costs that change with the amount produced  Supplies, electricity, hourly wages  Total Costs...FC+VC

Marginal Cost and Marginal Revenue  The cost of producing one more unit is known as Marginal Cost  The income earned from selling one more unit is know as Marginal Revenue. This is usually equal to the price

Setting Output  Firms set output to maximize profits (profits =Total Revenue-Total Cost)  This happens where Marginal Revenue=Marginal Cost

Review 1. What are diminishing marginal returns of labor?  (a) Some workers increase output but others have the opposite effect.  (b) Additional workers increase total output but at a decreasing rate.  (c) Only a few workers will have to wait their turn to be productive.  (d) Additional workers will be more productive. 2. How does a firm set his or her total output to maximize profit?  (a) Set production so that total revenue plus costs is greatest.  (b) Set production at the point where marginal revenue is smallest.  (c) Determine the largest gap between total revenue and total cost.  (d) Determine where marginal revenue and profit are the same.

Changes in Supply Chapter 5, Section 3

Factors that Affect Supply  Input Costs  Government’s Influence  Supply in the Global Economy  Other Influences

Input Costs  Any change in the cost of an input will affect supply (either up or down)  Raw materials  Machinery  Labor  If the input cost goes up, supply will go down  If the input cost goes down, supply will go up  Technology often causes input costs to go down  Ex…Machines replace humans on assembly lines so firms spend less on salaries

Government’s Influence on Supply  Subsidies  government payment that supports a business or market  Farms to keep producing food  WWII…European countries faced food shortages so gov’ts protected farmers to keep producing  Small companies to prevent foreign producers  Encourage growth in an area

Government’s Influence on Supply  Taxes...Excise taxes are used to reduce production. Built into prices. Supply  Gas, tobacco, alcohol have excise taxes to discourage people from using  Regulation...policies that regulate an industry can eventually change supply  Pollutant producing industries are regulated  1970 – All cars must have pollutant reduction tech.  Release of national reserves after Katrina

Supply in the Global Economy  Supply in other countries can cause a change in imports, which will in turn change our supply  Changes in foreign wages  New discoveries of oil

Supply in the Global Economy  Example  United States imports carpets from India. An increase in the wages of Indian workers would decrease the supply of carpets to the USA. Shift curve to the left.  Example  USA imports oil from Russia. A new discovery of oil in Russia could increase the supply of oil to the USA. Shift supply curve to the right.

Other Influences  Future Expectations  If the seller expects the price of a good to rise, they may store the product for later sales (non-perishables). Cutting back in the short term.  If the price is expected to fall, they may sell immediately. Need to get rid of supplies.  During periods of high inflation, sellers will hold their products because goods keep value and money loses its value.

Other Influences  Number of Sellers  If there are more suppliers in a market, market supply will increase  If suppliers leave a market, the market supply will decrease