Supply & Demand Made Easy The Supply Side

Sorting out Supply In the economist’s view of the supply of goods and services, the key concept is that supplying things is costly, and you have to pay people to supply the things you want. Even more interesting, though, is the fact that the more you want them to supply, the higher their costs of supplying each additional unit. In other words, the first units tend to be relatively inexpensive to produce, while later units become more costly to produce.

Sorting out Supply If you want producers to make more and more, you have to pay them more and more. Rising costs cause supply curves to slope upward and how entire supply curves can shift when the costs of inputs change.

Graphing the Supply Curve A supply curve shows the minimum prices at which someone is willing to sell various amounts of a good or service. Because production costs rise as people make more of something, suppliers insist on more money for larger quantities. That’s why supply curves slope upward.

Graphing the Supply Curve Imagine that a farmer named Babbage likes to grow cabbage. In a few slides, I graph Mr. Babbage’s supply of cabbages and label it S.

Graphing the Supply Curve The horizontal axis gives the number of cabbages supplied, while the vertical axis gives the price per cabbage that you have to pay to get Mr. Babbage to supply you any given number of cabbages. Thus, Point A says that you have to pay Mr. Babbage 50 cents per cabbage if you want him to supply you with five cabbages.

Graphing the Supply Curve Because Mr. Babbage’s production costs rise as he tries to grow more and more cabbages, you have to pay him $1 per cabbage if you want him to grow you ten cabbages, as shown by point B. You have to pay $1.50 per cabbage if you want 15 cabbages, as shown by Point C.

Graphing the Supply Curve Keep in mind that the points on the supply curve don’t represent the prices that Mr. Babbage wants to receive for any given amount of cabbages – obviously, he wants to receive a gazillion dollars for each one. Rather, what each dollar amount on a supply curve represents is the minimum that you could pay him and still get him to produce the desired amount.

Graphing the Supply Curve At Point A, you can get him to produce five cabbages if you pay him 50 cents per cabbage; if you offer him 49 cents per cabbage, he won’t do it. Why not? Because he has costs, and he can cover them at 50 cents per cabbage, but not at 49 cents per cabbage.

Graphing the Supply Curve

Separating sales and price and production cost Economists split all the things that can affect the quantity supplied into two groups: the price and everything else. The things that go into everything else all relate to production costs – the costs of supplying the good in question.

Separating Sales Price and Production Cost When you see a particular supply curve, imagine that it derives from a particular production technology used by the supplier. Because each possible technology creates its own unique relationship between output levels and costs, some technologies give rise to steeply sloped supply curves, while others generate fairly flat supply curves.

Separating Sales Price and Production Cost Regardless of exactly how the curve is sloped or where it’s positioned, the fact that costs increase as output increases means that you need to offer a higher and higher price to the supplier if you want to obtain more units. That’s basically why prices move you along supply curves.

Price Changes: Moving Along the Supply Curve Varying the price of an item moves you along a given supply curve because the supply curve represents the minimum payment you need to give the supplier in order for him/her to supply the amount of output you want.

Price Changes: Moving Along the Supply Curve Suppliers look at whatever price is being offered and make as many units as are profitable but no more. Because costs rise with each additional unit produced, the only way to get suppliers to produce more is to offer them higher prices. Therefore, raising or lowering prices moves you along the supply curve as the suppliers’ quantities supplied respond to changing prices.

Price Changes: Moving Along the Supply Curve To see how this works, consider what happens if you offer to pay Mr. Babbage $1 per cabbage, and then let him choose how many cabbages he wants to produce. Given his supply curve in the supply graph, he’s going to want to produce exactly 10 cabbages and no more. That’s because for cabbage number through cabbage number nine, the cost of production is less than what you’re paying him.

Price Changes: Moving Along the Supply Curve For example, consider Point A from the supply graph. At Point A, his production costs are 50 cents per cabbage. That means that if you’re going to pay him $1 per cabbage, he’ll be making a nice profit. Similarly, because his cost per cabbage for producing six cabbages is also less than $1/cabbage, he’ll also want to make number 6. The same is true of cabbages 7, 8, and 9.

Price Changes: Moving Along the Supply Curve At ten cabbages, Mr. Babbage is indifferent, because his cost per cabbage is $1 and you’re offering him $1. In such cases, economists assume that he’ll produce the tenth just to keep the buyer happy. But notice that Mr. Babbage would not produce at point C if you were offering him $1 per cabbage. That’s because his cost of production is $1.50 per cabbage, and he would lose money.

Cost Change: Shifting the Supply Curve Because a supplier’s production cost determines where his supply curve is located and how it’s sloped, changes in production costs cause changes in the supply curve. Things that make production more costly will shift the supply curve up, and things that lower costs will shift the supply curve down.

Cost Change: Shifting the Supply Curve Suppose Mr. Babbage’s production costs increase because the government imposes a new organic farming law under which he’s required to grow cabbages without using pesticides. In response, he has to hire lots of extra workers to kill pests with tweezers instead of simply spraying cheap chemicals.

Cost Change: Shifting the Supply Curve A few slides from now reflects the change in the supply curve. Because Mr. Babbage’s production costs have increased, the minimum you have to pay him to produce any given level of output goes up. Consequently, he supply curve can be though of as shifting upward vertically from S-0 to S-1.

Cost Change: Shifting the Supply Curve

Cost Change: Shifting the Supply Curve I’ve drawn the shift to show that Mr. Babbage’s cost of production is 50 cents higher for each cabbage, no matter how many cabbages are produced. Compare Points A and A-1. Before the new environmental regulation, Mr. Babbage was willing to produce five cabbages if you paid him 50 cents per cabbage. After the policy change, you have to pay him $1 per cabbage if you want him to grow you five cabbages.

Cost Change: Shifting the Supply Curve Similarly, Points B and B-1 show that before the regulation, he would grow you 10 cabbages if you offered him $1/cabbage. Now you have to offer him $1.50/cabbage if you want him to grow 10.

Cost Change: Shifting the Supply Curve It’s perfectly kosher to think of supply curves as moving left and right when cost structures shift. That is, you can say that the supply curve shifts left when costs increase, and you can quickly extrapolate that a decrease in costs would shift the supply curve to the right.

Cost Change: Shifting the Supply Curve For instance, consider the quantity supplied at a price of $1 both before and after the cost increase. Before the cost increase, Mr. Babbage is willing to supply you ten cabbages for $1, putting you at Point B on the original supply curve. But after the cost increase, he’s willing to supply you only 5 cabbages for $1, putting you at Point A-1 on the shifted supply curve.