Supply and Demand #2

Supply  Quantity supplied - the amount of a good or service that producers are willing and able to offer for sale at a specific price. Supply - the amount of a good or service that producers are willing and able to offer for sale at all prices in a given period.

Price and quantity move in the same direction. The law of supply states that as price increases, the quantity of goods & services supplied also increases.  As the price decreases, the quantity of goods & services supplied also decreases. Price and quantity move in the same direction. Price S Qs

Production decisions by existing producers. Most economists agree that price and quantity move in the same direction for two reasons: Production decisions by existing producers. In a market-based economy, every producer’s primary goal is to maximize profits. Firms earn profits based partly on revenue, the amount of money received in the course of doing business. So when prices increase, the desire to make a profit leads producers to increase their production of goods. They expect their profits to increase as a result. Likewise, when prices fall, producers are likely to cut production.

Market entries and exits. Most economists agree that price and quantity move in the same direction for two reasons: Market entries and exits. When the price of a good or service increases, new firms may enter a market because they see the potential for profit. For example, a building firm might enter the housing construction market to take advantage of rising home prices. Suppose the firm were to build 20 new homes and offer them for sale at $500,000 each. This would increase the quantity of houses supplied at that price. The reverse can also happen when prices drop. Producers may exit the market, decreasing the quantities supplied at certain prices.

So a supply curve is direct, upward sloping or positive curve, due largely to the fact that the higher the price the easier it is for the supplier to cover his costs. Price S Qs

Lets look at the plotted supply schedule which shows how much of a certain product a business will supply at each price. Supply Schedule Price Quantity $2 50 $3 100 $4 150 $5 200 $6 250

Supply Graph S Qs

S is the original supply curve Price s2 S There are six determinants (shifters) that would cause the entire supply curve to shift left (decrease) or right (increase). S1 Qs S is the original supply curve  S1 is the increased supply, to the right is more supplied at each price. S2 is the lesser supply, again left is less supplied at each price

Supply Shifters 1. Input prices change. The greater the cost of inputs into production, the less that can be supplied. Therefore as input prices rise, supply falls. If wheat (input) prices rise, bread companies will not be able to produce as much bread and the supply will decrease.

The supply of bread will decrease and the curve shifts left. Price S1 S left less Qs The supply of bread will decrease and the curve shifts left. Don’t bring demand in yet, we will do that later!  

2. Technology Changes The more technology improves, the less labor or other resources necessary to produce, therefore supply can go up.

Technology change that increases supply Price s s1 Qs

3a. Future expectations As a producer, if you expect that the price of your product will rise in the future you might stockpile your product now and not send it out until the price rises. This means there will be less in the marketplace today.

3b. Change in Price of Alternative Goods Those are the goods that use the same resources as the goods we are analyzing. For example if you make children’s swing sets out of iron, and you realize that iron beds are now selling at a much higher price, it may make it very attractive for you to switch to making iron beds. Therefore the supply of iron beds would increase.

3b. Change in Price of Alternative Goods If you do that… the supply of iron beds will go up, however the supply of children’s swing sets may decrease.

Price S1 S left less Qs

4. Number of sellers If more sellers enter a market, there will be an increase in the supply of the products they sell. This means that the more producers there are, the more product possible.

Price S S1 Qs increase

5. Effects of natural disasters or world events Fires, storms, floods,… can wipe out supplies of materials or products. Political situations or problems around the globe can change supply.

6a. Taxes When the government levies taxes on producers, those are effectively an addition to the cost of production. Therefore, a tax levied on a product will shift the supply curve to the left. So taxes rise, supply will decrease.

6b. Subsidies A subsidy occurs when the government makes a payment to a producer, usually in the form of a cash grant. It is essentially a negative tax paid to the producer by the gov’t. Therefore a subsidy to a producer would have the opposite effect and shift the supply curve to the right.

Time for Practice

Practice High schools and colleges begin in the fall Practice High schools and colleges begin in the fall. What happens to the supply curve for 3 ring binders in February? What supply shifter tells you that? S1 Price S Qs

Practice A mechanic invents a new machine that picks fruit in half the time it takes people. What happens to the supply curve for apples? What supply shifter tells you that? S1 Price S Qs

Practice Government increases taxes on imported foods Practice Government increases taxes on imported foods. What happens to the supply curve for Italian olive oil? What supply shifter tells you that? S1 Price S Qs

Practice A drought has ruined cotton production across the U. S Practice A drought has ruined cotton production across the U.S. What happens to the supply curve for t-shirts? What supply shifter tells you that? S1 Price S Qs

Practice Because of popularity, three new coffee shops have opened in the Town Center area. What happens to the supply curve for lattes? What supply shifter tells you that? S1 Price S Qs

Practice Sugar prices have dropped to their lowest price in four years Practice Sugar prices have dropped to their lowest price in four years. What happens to the supply curve for candy? What supply shifter tells you that? S1 Price S Qs