DOING WELL BY DOING GOOD: THE ECONOMICS OF SUPPLY RANDY RUCKER PROFESSOR DEPARTMENT OF AGRICULTURAL ECONOMICS AND ECONOMICS JUNE 19, 2012

TEENAGE BABY SITTERS (AND OTHER ENTREPRENEURS): WHY DO THEY DO WHAT THEY DO?  Help out Parents and Friends (social responsibility)  Like working with young children (personal satisfaction)  Parents have told them they have to learn responsibility by holding down a job  Earn income (make profits) 2

FIRMS: WHY DO THEY DO WHAT THEY DO?  Make products they believe help people (social responsibility)  Owners and managers enjoy what they do (personal satisfaction)  Produce commodities that meet regulatory standards and legal requirements (obey laws and regulations)  Earn income (make profits) 3

FIRMS: WHAT IS THE MAJOR DRIVING FORCE BEHIND FIRM BEHAVIOR? Profits Note: “Profits” is not a four letter word!! 4

SUPPLY  What commodities will firms produce?  What quantities of those commodities will be produced? 5

WHAT COMMODITIES WILL FIRMS PRODUCE?  Consumer preferences and buying behavior matter.  To sell their goods and make profits, firms will strive to produce goods that consumers want to buy.  John, a Laurel high school student, can make a “Save the Wolves” t-shirt or a “Go Locomotives” t-shirt (with the school logo) with the same amount of effort. 6

WHAT COMMODITIES WILL FIRMS PRODUCE?  Suppose most of John’s potential customers are avid Locomotives fans (who don’t like wolves much).  Which of the two t-shirts will he spend the most time making? 7

THE ROLE OF PROFITS IN FIRM DECISIONS  When an event occurs that increases a firm’s profits, that firm will increase the quantity of the commodity that it produces.  Examples:  An increase in the price of the commodity the firm produces  A decrease in the price of an input 8

THE ROLE OF PROFITS IN FIRM DECISIONS  Alternatively, when an event occurs that decreases a firm’s profits, that firm will decrease the quantity that it produces.  Examples:  A decrease in the price of the commodity the firm produces  An increase in the price of an input 9

WHAT ARE PROFITS? Profit = Total Revenue - Total Cost (TR) (TC) Total Revenue = Price x Quantity (P) (Q) Total Costs = All costs incurred in producing a product 10

EVENTS THAT AFFECT PROFITS AND OUTPUT  Change in the Price of a Commodity  If Price increases, then (at current output levels) Total Revenue (P x Q) increases and profits increase. So the firm will produce more.  Similarly, if the price decreases... 11

EVENTS THAT AFFECT PROFITS AND OUTPUT  Change in Quantity Supplied  When output increases because price has increased, economists say there has been a change in quantity supplied. Similarly if the price decreases...  These are represented as movements along the supply curve. 12

THE CONCEPT OF SUPPLY  What is a supply curve?  This is a curve (or straight line) that shows the relationship between the price of a good and the quantity of the good that firms produce.  Along this curve other factors that affect profit are held constant. 13

THE CONCEPT OF SUPPLY  Based on the preceding discussion, we expect this relationship to be positive.  That is, an increase in output price will lead to an increase in production. Similarly, for a decrease...  This is the “Law of Supply.”  Let’s walk through an example... 14

THE SUPPLY SCHEDULE  At different prices (holding other factors constant), Jenny is willing to provide different amounts of lawn mowing services. (Assume she can mow one lawn per hour.) Price per LawnNumber of Lawns Mowed (Quantity Supplied) $ 40 $ 84 $127 $159 15

THE SUPPLY CURVE 16

CHANGES IN QUANTITY SUPPLIED Once again,  Change in the Price of a Commodity  If Price increases, then (at current output levels) TR (P x Q) increases and profits increase. So the firm will produce more. Similarly, if Price decreases...  Change in Quantity Supplied  When output increases because price has increased, an increase in quantity supplied results. Similarly, if output decreases... 17

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT  Change in Input Prices  If an input price (e.g., gas) falls, then Jenny’s costs of mowing lawns fall and her profits will increase.  So, at any given price she is willing to mow more lawns.  Similarly, if an input price increases...  This is a Change in Supply. 18

A CHANGE IN THE SUPPLY SCHEDULE  At a lower price for gas, Jenny will be willing to mow more lawns. Price Lawns Mowed (Initial Situation: High Gas Price) Lawns Mowed (New Situation: Low Gas Price) $ 402 $ 846 $1279 $

CHANGE (OR SHIFT) IN SUPPLY 20

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT AND CAUSE CHANGES IN SUPPLY  Changes in Technology:  If new technologies enable firms to use resources more efficiently, then  their costs will fall,  their profits will increase,  and (at any given output price) they will produce more output.  That is, Supply will increase. 21

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT AND CAUSE CHANGES IN SUPPLY  Changes in the Number of Sellers:  If more firms enter the market, then at any given price more output will be produced: Supply will increase.  “Supply will increase” means that the supply curve shifts. 22

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT AND CAUSE CHANGES IN SUPPLY  Examples:  The continuing development of farm machinery has decreased the cost of producing corn (and lots of other commodities). This increases the supply of corn.  An import ban on U.S. beef into Japan is lifted. More U.S. sellers now have access to the Japanese beef market. The supply of U.S. beef to Japan increases. 23

OTHER EXAMPLES OF CHANGES IN SUPPLY (WITH GRAPHS)  Examples:  What happens to the world supply of wheat if China and Russia have extremely favorable growing conditions for wheat?  Graphically... 24

The World Supply of Wheat An Increase in the Supply of Wheat due to Favorable Weather in China and Russia Price ($/Q) Q (bushels/year) P0P0 Q0Q0 S0S0 S1S1 Q1Q1 25

Other Examples of Changes in Supply (with Graphs)  Examples:  What happens to the supply of peanuts if there is a drought in the Southeastern United States?  Graphically... 26

The Supply of Peanuts A Decrease in Supply Due to a Drought in Georgia Price ($/Q) Q (Pounds/year) P0P0 Q0Q0 S0S0 Q1Q1 S1S1 27

OTHER EXAMPLES OF CHANGES IN SUPPLY (WITH GRAPHS)  Examples:  What happens to the supply of peanut butter if the price of peanuts goes up?  Graphically...  Note that a change at one level of the production process works its way through to other levels. 28

The Supply of Peanut Butter A Decrease in Supply Due to an Increase in Peanut Prices Price ($/Q) Q (Pounds/year) P0P0 Q0Q0 S0S0 Q1Q1 S1S1 29

SUMMARY  Key Concepts:  Firm objectives, total revenues, total costs, profits, supply schedule, supply curve, and the law of supply  Key Idea:  Firms are primarily motivated by the search for profits. Events that cause profits from producing a commodity to increase cause production of the commodity to increase. Similarly, events that cause profits to decrease... 30

SUMMARY  Change in Quantity Supplied:  A change in the price of a commodity causes a movement along the supply curve, or a change in quantity supplied.  Change in Supply:  An event other than a change in the price of a commodity causes a shift in the supply curve, or a change in supply. − Input prices, technology, the number of firms, etc. 31

QUESTIONS?

COMMENTS:  Doing Well by Doing Good?  Meaning?  Profits is not a four letter word  What is the nature of your relationship with Albertsons (or Town & Country, or Safeway, or...)? 33