Chapter 5 Supply

Chapter 5: Supply Lesson 1: What is Supply? Students Will Know: Supply is the amount of a product offered for sale at all possible prices that could prevail in the market The factors that cause a change in supply The three types of supply elasticity Students Will be Able to: Describe the basic differences between supply and demand Explain why supply and demand curves slope in opposite directions List factors that can cause a change in supply Summarize the three cases of supply elasticity

Chapter 5: Supply Lesson 1: What is Supply? SUPPLY -- the amount of a product that would be produced, grown, or acquired and offered for sale at all possible prices that could prevail in the market. LAW OF SUPPLY -- as prices increase, the quantity supplied of a product will increase. There is a direct relationship between price and quantity supplied SUPPLY SCHEDULE -- a listing of the various quantities of a particular product supplied at all possible prices in the market SUPPLY CURVE -- a graph showing the various quantities supplied at all possible prices that might prevail in the market MARKET SUPPLY CURVE -- the supply curve that shows the quantities offered at various prices by all producers that offer the product for sale in a given market

Chapter 5: Supply Lesson 1: What is Supply? Supply Schedule Supply Curve Price 5 4 3 2 1 2 4 6 8 10 Quantity Price Quantity Supplied $5 10 $4 8 $3 6 $2 4 $1 2

Chapter 5: Supply Lesson 1: What is Supply? QUANTITY SUPPLIED -- The amount that a single producer or all producers bring to market at any given price CHANGE IN QUANTITY SUPPLIED -- The change in the amount offered for sale in response to a change in price (Figure 5.2 on page 130) This change is represented by a movement along the existing supply curve A change in quantity supplied only takes place if there is a change in price CHANGE IN SUPPLY -- A situation where suppliers offer different amounts of a product for sale at all possible prices in the market (Figure 5.3 on page 131)

Chapter 5: Supply Lesson 1: What is Supply? Factors that Can Cause a Change in Supply Cost of Resources -- A change in the cost of productive inputs such as land, labor, and capital can cause a change in supply Supply might increase if there is a reduction in the cost of resources, thereby shifting the supply curve to the right Supply might decrease if there is an increase in the cost of resources, thereby shifting the supply curve to the left Productivity -- An increase in output using the same amount of resources. Technology -- The introduction of new machines or industrial processes can lower the cost of production. Taxes -- Taxes are seen as a cost of production for business. A reduction in taxes will reduce the cost of production while a tax increase will increase the cost of production

Chapter 5: Supply Lesson 1: What is Supply? Factors that Can Cause a Change in Supply Subsidies -- A subsidy is a payment to business to encourage or protect a certain type of economic activity, thus reducing the cost of production Government Regulations -- Government mandating that businesses do certain activities that often increase the cost of production Number of Sellers -- Most markets are fairly active with firms entering and leaving all the time. As firms enter supply will increase. As firms leave supply will decrease Expectations -- What firms believe will happen in the future will affect supply today A positive expectation about the future will likely decrease supply today A negative expectation about the future will likely increase supply today

Chapter 5: Supply Lesson 1: What is Supply? Elasticity of Supply How the quantity supplied, the dependent variable, responds to a change in price, which is the independent variable ELASTIC SUPPLY -- (Figure 5.4 on page 134 Panel A) The change in price causes a proportionally larger change in quantity supplied INELASTIC SUPPLY -- (Panel B) The change in price causes a proportionally smaller change in quantity supplied UNIT ELASTIC SUPPLY -- The change in price causes a proportionally equal change in quantity supplied If firms can adjust to new prices quickly, then supply is likely to be elastic. If the nature of production is such that adjustments take much longer, then supply is more likely to be inelastic

Chapter 5: Supply Lesson 2: The Theory of Production Students Will Know: Technological change and investments in capital goods and human capital may increase labor productivity but have significant opportunity costs and economic risks The three stages of production and their characteristics The stages of production determine the most profitable number of workers a firm can hire Students Will Be Able To: Explain how production affects supply elasticity Explain how the production function is used to make business decisions Discuss total and marginal product at different production periods Summarize the three stages of production

Chapter 5: Supply Lesson 2: The Theory of Production Production Function -- a figure that shows how total output changes when the amount of a single variable input (usually labor) changes while all other inputs are held constant. Look at Figure 5.5 Panel A on page 137 for an example of a Production Schedule and Panel B for an example of a Production Function Curve Short Run -- a production period so brief that only the amount of the variable input can be changed. Figure 5.5 reflects the short run because only the total number of workers changes. Long Run -- a production period long enough for the firm to adjust the quantities of all its productive resources, including capital. Total Product -- the total output produced by a firm. Marginal Product -- the extra output or change in total output caused by adding one more unit of variable input.

Chapter 5: Supply Lesson 2: The Theory of Production Marginal Product -- the extra output or change in total output caused by adding one more unit of variable input. In Figure 5.5 we the marginal product of adding the second worker is 13. This is because seven units of output are produced with the first worker and 20 units are produced by adding the second worker. So, the extra or marginal output of adding the second worker is 13. As you look down the schedule you notice that the marginal product is different at each level and even becomes negative at some point. The sum of the marginal products is equal to the total product

Chapter 5: Supply Lesson 2: The Theory of Production Stages of Production -- phases of production that consist of increasing, decreasing, and negative returns. Stage 1 -- Increasing Marginal Returns The marginal product of each additional worker increases. Each additional worker is able to cooperate with existing workers or specialize in certain operations to make better use of existing equipment Each added worker is able to contribute more to total production than the worker before In Figure 5.5, the first five workers added are in stage 1 Stage 2 -- Decreasing Marginal Returns Total production continues to grow, but it does so by smaller and smaller amounts. Diminishing Returns -- the stage of production where output increases at a diminishing rate as more variable inputs are added In Figure 5.5, stage 2 begins with the sixth worker because the 20-unit marginal product of that worker is less than the 28-unit marginal product of the fifth worker Stage 2 continues through the tenth worker but ends with worker number 11

Chapter 5: Supply Lesson 2: The Theory of Production Stages of Production -- phases of production that consist of increasing, decreasing, and negative returns. Stage 3 -- Negative Marginal Return If the firm hires too many workers, they will get in each other’s way or otherwise interfere with production, causing total output to decrease. The marginal product become negative. In Figure 5.5, the 11th worker has a marginal product of minus three, and the 12th worker’s is -10. The number of workers a firm wants to hire will keep the company in stage 2

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization Students Will Know: Marginal product is the extra output or change in total product caused by adding one more unit of variable input The difference between a fixed cost and a variable cost and the effect these costs have on how a business operates How firms determine price and output through marginal analysis Students Will be Able to: Differentiate among fixed, variable, total, and marginal costs Explain the difference in average, total, and marginal revenue Identify the relationship between profit maximization and break-even analysis

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization All businesses, including nonprofit organizations, face the challenge of being successful enough to stay in operation. Most firms hope to operate in a way that maximizes profits Finding Marginal Cost Fixed Costs -- the costs that an organization incurs even if there is little or no activity. Overhead -- costs that occur even if the company is idle Salaries paid to executives Interest charges on bonds Rent payments State and local property taxes Depreciation -- the charge for the gradual wear and tear on capital goods because of their use over time. A machine will not last forever because its parts will wear out slowly and eventually break

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization All businesses, including nonprofit organizations, face the challenge of being successful enough to stay in operation. Most firms hope to operate in a way that maximizes profits Finding Marginal Cost Fixed Costs -- the costs that an organization incurs even if there is little or no activity. Variable Costs -- the cost that changes when the business’s rate of production or output changes Labor -- wage earners may be laid off when production is slow and asked to work overtime when production increases Raw materials Electricity Freight charges on deliveries

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization All businesses, including nonprofit organizations, face the challenge of being successful enough to stay in operation. Most firms hope to operate in a way that maximizes profits Finding Marginal Cost Fixed Costs -- the costs that an organization incurs even if there is little or no activity. Variable Costs -- the cost that changes when the business’s rate of production or output changes Total Costs -- variable costs plus fixed costs; all costs associated with production Marginal Cost -- the extra cost incurred when producing one more unit of output To find marginal cost, we have to divide the additional cost of adding each worker by the additional output the worker generates. In Figure 5.6, the first worker’s additional output is 7 at a cost of $90 for a marginal cost of $12.86. The marginal cost of the second worker is $90 / 13 = $6.92

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization Finding Marginal Revenue Average Revenue -- average price that every unit of output sells for Total Revenue -- total amount earned by a firm from the sale of its products; average price of a good sold times the quantity sold In Figure 5.6, Total Revenue for one worker is 7 units sold X $15 = $105; If 10 workers are hired total revenue is 148 units X $15 = $2,220 Marginal Revenue -- the extra revenue a business receives from the production and sale of one additional unit of output. Marginal Revenue = change in total revenue / change in total output or marginal product In Figure 5.6, when the business employs five workers, it produces 90 units of output and generates $1,350 total revenue. If the sixth worker is added, output increases by 20 units and total revenue increases to $1,650 Change in total revenue = $300; marginal product = 20 $300 / 20 = $15 marginal revenue

Chapter 5: Supply Lesson 3: Cost, Revenue, and Profit Maximization Profit-Maximizing Quantity of Output -- level of production where marginal cost is equal to marginal revenue Break-Even Point -- production level where total cost equals total revenue; production needed if he firm is to recover its costs