Explorations in Economics Alan B. Krueger & David A. Anderson

Chapter 5: Exploring Economics -Module 13: Understanding Supply -Module 14: Shifts of the Supply Curve -Module 15: Production, Cost, and the Profit-Maximizing Output Level

MODULE 13: Understanding Supply KEY IDEA: Producers respond to price changes, offering more goods for sale when prices increase and fewer goods when prices decrease. OBJECTIVES: To explain the concept of supply and the law of supply. To explain the relationship between a supply schedule and a supply curve. To identify the factors that cause the quantity supplied to be more or less responsive to price changes.

Supply This chapter is about supply—firms that sell goods and services. Thinking like a buyer and thinking like a seller are different. Buyers want to maximize their satisfaction; sellers want to earn the greatest profit. To maximize profit, suppliers adjust the quantity of the good or service they produce in response to changes in either the price at which it can be sold or the cost of producing it. 12/12/2015Chapter 5-Mods 13, 14 & 15

Imagine that you are cell phone manufacturers and that the price consumers are willing and able to pay for cell phones begins to rise. How would this affect your production of cell phones? Would you make more or fewer cell phones? – You would want to make more. Why would you want to make more? – To cash in on the rise in prices and make more profit. 12/12/2015Chapter 5-Mods 13, 14 & 15

THE QUANTITY SUPPLIED Profit is the total revenue a firm receives from selling its product minus the total cost of producing it. The quantity supplied is the amount of a good that firms are willing to supply at a particular price over a given period of time.

THE LAW OF SUPPLY According to the law of supply, an increase in the price of a good leads to an increase in the quantity supplied. Price increases the QUANTITY supplied not the supply. Why are firms willing to produce more of a good when its price increases. ceteris paribus.

THE SUPPLY SCHEDULE AND THE SUPPLY CURVE The supply schedule for a good is a table listing the quantity of the good that will be supplied at specified prices.

THE SUPPLY SCHEDULE AND THE SUPPLY CURVE A firm’s supply curve is a graphical representation of the supply schedule, showing the quantity the firm will supply at each price.

THE MARKET SUPPLY CURVE

THE MARKETS WITH SUPPLY CURVES There is perfect competition in a market when there are many firms selling identical goods, firms are free to enter and exit the market, and consumers have full information about the price and availability of goods.

Episode 7 of The Economic Lowdown podcast, “Supply,” discusses the supply side of the market: education_resources/economic- lowdown-podcast-series/supply. 12/12/2015Chapter 5-Mods 13, 14 & 15

THE MARKETS WITH SUPPLY CURVES 1. Every unit of the good sold in the market is identical, regardless of which firm is selling it. 2. The good is produced by many firms, none of which is large enough to influence the price of the good. 3. New firms that want to supply the good are free to enter the market, and existing firms that want to stop supplying it are free to exit the market. 4. Consumers are aware of the price charged by the various firms and have the opportunity to buy from whichever firm they choose. There is perfect competition among firms when:

Perfect Competition Identical products like corn or wheat NO price control—Small firms in very large markets with many, many sellers; they are price takers who accept the market price. NO barriers to entry or exit. Perfect information for buyers means awareness of the market price. 12/12/2015Chapter 5-Mods 13, 14 & 15

MODULE 13 REVIEW What is… A. Profit? B. Quantity supplied? C. Supply schedule? D. Supply curve? E. Market supply curve? F. Law of supply? G. Perfect competition?

MODULE 14: SHIFTS OF THE SUPPLY CURVE KEY IDEA: The supply curve can shift because of changes in the cost of inputs, government policies, the number of firms, technology, weather, and expectations about future prices. OBJECTIVES: To differentiate between a movement along the supply curve and a shift of the supply curve. To explain how changes in factors other than price cause the supply curve to shift. To recognize which types of changes cause the supply curve to shift to the left or to the right.

WHEN OTHER FACTORS CHANGE A shift of the supply curve is the result of a change in the quantity supplied at every price, not to be confused with a movement along the supply curve, which is the result of a change in the price.

Shifts of the Supply Curve The price of milk goes up 30 cents a gallon. Decrease in supply of ice cream at all prices (cost of inputs). The government raises the minimum wage to $8 an hour. Decrease in supply of ice cream at all prices (government regulation). A hurricane wipes out the sugar crop in Hawaii. Decrease in supply of ice cream at all prices (availability of inputs). New regulations from the government mandate that they use specific cleaning tools more often in the factory. Decrease in supply of ice cream at all prices (government regulations). 12/12/2015Chapter 5-Mods 13, 14 & 15

FACTORS THAT SHIFT THE SUPPLY CURVE The cost of inputs Government policies Taxes Regulations Subsidies The number of firms Technological change Natural disasters and weather Expectations about future prices

The cost of inputs Government policies Taxes Regulations Subsidies The number of firms Technological change Natural disasters and weather Expectations about future prices FACTORS THAT SHIFT THE SUPPLY CURVE

MODULE 14 REVIEW What is… A. Change in supply? B. Technological progress? C. Change in the quantity supplied? D. Inventory? E. Subsidy?

MODULE 15: PRODUCTION, COST & THE PROFIT- MAXIMIZING OUTPUT LEVEL KEY IDEA: Firms can maximize their profit by producing the quantity that equates marginal revenue and marginal cost. OBJECTIVES: To explain the components of total cost. To identify the condition for profit maximization. To explain how a profit-maximizing entrepreneur decides whether to open a new firm and whether to shut down an existing firm.

UNDERSTANDING PRODUCTION The short run is the period of time during which the quantity of at least one input is fixed. The long run is the period of time in which the quantities of all inputs are variable.

Short Run verses Long Run This is important because it determines the use of space in the short run. If a restaurant wants to serve more people in the short run, it buys more advertising, and more food to prepare. More labor is hired. In the long run, if business is good, they can build a bigger restaurant or more locations. They can add more stoves, and tables. Long run means that capital purchases can increase production, but short run means only labor, and materials. 12/12/2015Chapter 5-Mods 13, 14 & 15

Short Run versus Long Run Don’t be confused by the terms short run and long run. It boils down to this: in the short run, the quantity of at least one input is fixed, whereas in the long run the quantities of all inputs are variable. The inputs with fixed quantities in the short run are called fixed inputs. In the long run, even fixed inputs become variable inputs. 12/12/2015Chapter 5-Mods 13, 14 & 15

UNDERSTANDING PRODUCTION A production schedule indicates the inputs needed to produce different quantities of output. Ask at what point do we stop hiring workers?

UNDERSTANDING PRODUCTION The marginal product of labor is the amount by which total output increases when one more worker is hired. – Increasing marginal return is usually high in the beginning due to specialization of resources. Diminishing marginal productivity describes the decrease in the marginal product of a variable input, such as labor, as more and more of it is combined with a fixed input, such as equipment.

Diminishing Marginal Productivity Too many workers can actually reduce output. – volunteers clogging up a kitchen – each additional worker contributes less to total output than the worker before because additional workers have less equipment to work with. visually that the point of diminishing returns is a downturn in the graph. 12/12/2015Chapter 5-Mods 13, 14 & 15

Negative Marginal Product 12/12/2015Chapter 5-Mods 13, 14 & 15 It’s easy to confuse diminishing marginal product with a negative marginal product, but they are very different. When marginal product is decreasing but still positive, hiring additional workers causes total out to rise. But when marginal product is negative, employing more workers actually causes total output to fall.

THE COST OF PRODUCTION Fixed cost is the cost of inputs that do not vary with the amount of output produced. Variable cost is the cost of inputs that do vary with the amount of output produced.

Fixed Cost versus Variable Cost 12/12/2015Chapter 5-Mods 13, 14 & 15 Fixed cost: (short run) include rent paid for buildings, the cost of equipment, and fees for operating licenses. Does not increase as output increases. Ex. Stays the same regardless of the number of lawn that are mowed.. Variable cost changes with the number of units of output produced. Variable costs: payments for wages, electricity, and raw material.

Variable Cost and Total Cost Calculation In the table 15.1, the daily wage of each worker is $60, so the variable cost is $ 60 X ( the number of workers hired) Example: to mow 21 lawns, Blade Runner hires 4 workers, so the variable cost is $ 60 X 4 = $240 Total Cost: is the entire amount the firm must spend to produce a specified amount of output. – Add Fixed Cost + Variable Cost 12/12/2015Chapter 5-Mods 13, 14 & 15

THE COST OF PRODUCTION Marginal cost is the additional cost of producing one more unit of output. Marginal cost is calculated as the change in total cost divided by the change in output.

PROFIT MAXIMIZATION AND MARGINAL ANALYSIS The profit maximizing output level is the amount of output that gives a firm as much profit as possible. Marginal revenue is the additional revenue a firm receives from selling another unit of output.

Calculations profit maximizing firm looks for where MR=MC. 1.how is marginal revenue calculated? For every lawn, $20 is charged. 2. Total Revenue is Price x output 3. Total Revenue — Total cost = profit. 4.Total Cost = Fixed Cost + Variable cost 5.Marginal cost = change in total cost/change in output 12/12/2015Chapter 5-Mods 13, 14 & 15

PROFIT MAXIMIZATION AND MARGINAL ANALYSIS Firms will produce where MR=MC. That is the profit maximizing output.

MODULE 15 REVIEW What is… A. Short run? B. Marginal product of labor? C. Long run? D. Marginal revenue? E. Law of diminishing returns? F. Fixed cost? G. Variable cost? H. Profit- maximizing output level? I. Total cost? J. Output? K. Diminishing marginal Productivity? L. Cost minimization?