The Supply Side of the Market A.S 3.3

Introduction  Supply is the amount of a good or service that a producers is willing and able to offer the market at a range of prices  Key factor affecting supply of a product  Cost of production  Raw materials  Wages  Packaging  Advertising Costs of production are a key determinant of supply

Types of Costs  Two main types  Variable Costs  Costs that change as output changes e.g. wages, electricity, packaging  Fixed Costs  Costs that remain the same regardless of output e.g. rent, insurance Total Costs = Variable Costs + Fixed Costs

Fixed costs are costs that do not vary with output QFCVCTC

QFCVCTC Variable costs are costs that increase as output increases

Fixed costs are costs that do not vary with output QFCVCTC Variable costs are costs that increase as output increases Total costs = Fixed + Variable costs

Relationship between Total costs and output Costs($) OUTPUT TFC TVC TC

The Shape of Average Cost Curves Costs($) Quantity FC FC are constant so AFC will continually decline as FC are spread over increasing output AFC

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Marginal Costs  Marginal cost is the extra cost of the last unit produced  In the short run only changes in variable costs affect marginal costs

The importance of Marginal Cost  Marginal cost is important because a firm will only produce an extra unit if the price that it receives is greater than or equal to marginal cost of producing that unit.  Marginal cost is important in determining if a firm will supply extra units

Example Factory that produces lawn mowers OutputTotal CostMarginal Cost 100$4500$ $ $ $6600 $500 $700 $900 How many units should the firm produce if the price it receives for motor mowers is $500? ___________ $800?___________

Average Costs

Costs Output Total Costs Fixed Costs Variable Costs Average Costs Average variable costs Average fixed costs Marginal Cost N/A

Costs($) Quantity AFC AC The difference between AC and AVC is equal to AFC AVC The Shape of Average Cost Curves

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fig Short-run Time Period In economics we distinguish between various time periods - ie short and long run. The short run, is a period of time in which at least one resource cannot be increased. We usally assume that capital such as machinery is the resource that is fixed in the short run. This means all firms will then be subject to the Law of Diminishing Returns

Diminishing Returns As more of a variable resource (labour) is added to a fixed resource (capital or land), the extra output (Marginal Product) will eventually decrease.

Key Definitions Marginal Product – the extra output from adding one more unit of resource such as labour Increasing returns – occur when a variable resource e.g. labour is added to a fixed resource and marginal product is increasing Constant returns – occur when a variable resource e.g. labour is added to a fixed resource and marginal product increases by a constant amount Decreasing returns – occur when a variable resource e.g. labour is added to a fixed resource and marginal product is decreasing

Example Number of workers Number of haircuts Marginal (extra) Product of extra worker Increasing or Diminishing returns? Increasing Diminishing

Cost Curves and Firms Supply

The Shape of the MC curve Costs($) Quantity MC MC decreases initially because of increasing returns MC increases because of diminishing returns Note: always plot the MC curve at the mid-point!

The Shape of Average Cost Curves Costs($) Quantity AFC AC AC decreases because of increasing returns and increases because of diminishing returns

Costs($) Quantity AFC AC The Shape of Average Cost Curves

Marginal Cost & Average Cost Costs($) Quantity AC MC If MC<AC then AC will be decreasing

Costs($) Quantity AC MC If MC>AC then AC will be increasing Marginal Cost & Average Cost

Costs($) Quantity AC MC MC cuts AC at its minimum point - this is the technical optimum Marginal Cost & Average Cost This is when the firm is using the best mix of resources and is producing maximum output at the least possible cost.

Marginal Cost & Average Variable Cost Costs($) Quantity AC MC MC also cuts AVC at its minimum point AVC

MC, AVC AND AC  Why does MC cut AVC and AC at their lowest points?  Marginal cost is the cost of the last unit produced.  When marginal cost is below the average cost it is pulling the average down.  When it is above the average costs it is pulling them up, therefore it must intersect AC and AVC at their lowest points

Break Even & Shut Down Costs($) Quantity AC MC A firm must cover AC if it is to break even AVC This is the break even point Break even point is where AR=AC. Where the price is enough to cover all costs and the firms make normal profits.

Break Even & Shut Down Costs($) Quantity AC MC In the SR a firm can survive if P > AVC AVC This is the shut down point

The Supply Curve Costs($) Quantity AC MC A firm’s Supply curve is derived from the MC curve above the shut-down point AVC =S The supply curve is upwards sloping because of diminishing returns! Producing higher levels of output results in progressively less efficient resource combinations. Because of this the firm will only supply a larger quantity at higher prices.