1. Chapter 5: Supply
Economics
Mr. Robinson

2. Section 1: Understanding Supply

3. The law of Supply
According to the law of supply, suppliers will offer more of a good at a higher price.
Price
As price increases…
Supply
Quantity supplied increases
Price
As price increases…
Supply
Quantity supplied increases
Price
As price falls…
Supply
Quantity supplied falls

4. How Does the Law of Supply Work?
Economists use the term quantity supplied to describe how much of a good is offered for sale at a specific price.
The promise of increased revenues when prices are high encourages firms to produce more.
Rising prices draw new firms into a market and add to the quantity supplied of a good.

5. Price per slice of pizza Slices supplied per day
Supply Schedules
A market supply schedule is a chart that lists how much of a good all suppliers will offer at different prices within a given area.
$.50
1,000
Price per slice of pizza
Slices supplied per day
Market Supply Schedule
$1.00
1,500
$1.50
2,000
$2.00
2,500
$2.50
3,000
$3.00
3,500

6. Output (slices per day)
Supply Curves
Market Supply Curve
Price (in dollars)
Output (slices per day)
3.00
2.50
2.00
1.50
1.00
.50
500
1000
1500
2000
2500
3000
3500
A market supply curve is a graph of the quantity supplied of a good by all suppliers at different prices.
Supply

7. Elasticity of Supply
Elasticity of supply is a measure of the way quantity supplied reacts to a change in price.
If supply is not very responsive to changes in price, it is considered inelastic.
An elastic supply is very sensitive to changes in price.

8. Values of Elasticity
If (Es) > 1 we say supply is elastic. Supply is very sensitive to change in price
If (Es) = 1 we say supply is unitary elastic. This means the % change in the Qs is equal to the % change in price.
If (Es) < 1 we say supply is inelastic. Supply is not very responsive to changes in price.

9. What Affects Elasticity of Supply?
Time
In the short run, a firm cannot easily change its output level, so supply is inelastic.
In the long run, firms are more flexible, so supply can become more elastic.

10. Section 2: Costs of Production

11. A Firm’s Labor Decisions
Marginal Product of Labor
Labor (number of workers)
Output (beanbags per hour)
Marginal product of labor
Business owners have to consider how the number of workers they hire will affect their total production.
The marginal product of labor is the change in output from hiring one additional unit of labor, or worker. — 1 4 2 10 6 3 17 7 4 23 6 5 28 31 3 7 32 1 8 –1
When the number of workers is increased from 3 to 4, output increases from 17 beanbags an hour to 23 beanbags an hour. This is an increase in the marginal product of labor of 6

12. Fixed & Variable Inputs
Fixed Input: A fixed input is an input used in production and under the control of the producer that does not change during the time period of analysis (the short run).
Variable Input: A variable input is an input used in production and under the control of the producer that does change during the time period of analysis (the short run).

13. Fixed & Variable Inputs
The variable input used by most producers is more often than not labor. The fixed input for most production operations is usually capital (physical).
The presumption is that the size of a firm's workforce can be adjusted more quickly that the size of the factory or building, the amount of equipment, and other capital.

14. Three Returns: Increasing, Decreasing, and Negative
The addition of a variable input (like labor) to a fixed input (physical capital) can have one of three basic results:
First, production might increase at a increasing rate.
Second, production might increase at a decreasing rate.
Third, production might actually decrease.

15. Increasing Marginal Returns
This occurs if each additional unit of a variable input added to a fixed input causes incremental production to increase.
For example, the one worker contributes 10 units of output to production, the next worker contributes another 12 units, and the subsequent worker contributes 14 units.
With increasing marginal returns, each worker contributes more to production that the previous worker.

16. Decreasing Marginal Returns
This occurs if each additional unit of a variable input added to a fixed input causes incremental production to decrease.
For example, the one worker contributes 10 units of output to production, the next worker contributes another 8 units, and the subsequent worker contributes only 6 units.
With decreasing marginal returns, each worker contributes less to production that the previous worker.

17. Negative Marginal Returns
This results if the addition of a variable input added to a fixed input actually causes the total production to decline.
For example, if 10 workers produce a total of 100 units of output, and 11 workers produce a total of 99 units, then the eleventh worker is said to have negative marginal returns.

18. Law of Diminishing Marginal Returns
This law states that as more and more of a variable input is added to a fixed input in short-run production, then the marginal returns of the variable input eventually declines.

19. Labor (number of workers) Marginal Product of labor
Marginal Returns
Increasing, Diminishing, and Negative Marginal Returns
Labor (number of workers)
Marginal Product of labor
(beanbags per hour) 8 7 6 5 4 3 2 1 –1 –2 –3 1 2 3
Increasing marginal returns 4 5 6 7
Diminishing marginal returns 8 9
Negative marginal returns

20. Production Costs
A fixed cost is a cost that does not change, regardless of how much of a good is produced.
Examples: rent and salaries
Variable costs are costs that rise or fall depending on how much is produced.
Examples: costs of raw materials, some labor costs.
The total cost equals fixed costs plus variable costs.

21. Production Costs Fixed Cost Variable Cost Total Cost + =
Beanbags (per hour)
Fixed cost
Variable cost
Total cost (fixed cost + variable cost)
Marginal cost
Marginal revenue (market price)
Total revenue
Profit (total revenue – total cost)
$ –36
–20 21 40 1 2 3 4 $0 24 48 72 96
$24 — $8 5
$36 44 51 56 8 12 15 20 36 57 72 84 93 5 6 7 8
120
144
168
192 24 9 12 15 63 99 27 36 48 98 92 79
216
240
264
288 24 19 30 37 36 9 10 11 12 82
106
136
173
118
142
172
209

22. Marginal cost
Marginal cost (MC) measures the amount total cost rises when the firm increases production by one unit.
Marginal cost helps answer the following question:
How much does it cost to produce an additional unit of output?
Marginal cost rises with the amount of output produced.

23. Marginal cost
The Marginal cost from producing 1 beanbag per hour to 2 beanbags per hour is $4.
Output increases = Marginal cost rises
Production Costs
Total revenue
Profit (total revenue – total cost)
Marginal revenue (market price)
Marginal cost
Total cost (fixed cost + variable cost)
Variable cost
Fixed cost
Beanbags (per hour)
$ –36
–20 21 40 1 2 3 4 $0 24 48 72 96
$24 — $8 5
$36 44 51 56 8 12 15 20 36 57 84 93 6 7
120
144
168
192 9 63 99 27 98 92 79
216
240
264
288 19 30 37 10 11 82
106
136
173
118
142
172
209

24. Setting Output
Marginal revenue is the additional income from selling one more unit of a good. It is usually equal to price.
To determine the best level of output, firms determine the output level at which marginal revenue is equal to marginal cost.
Production Costs
Total revenue
Profit (total revenue – total cost)
Marginal revenue (market price)
Marginal cost
Total cost (fixed cost + variable cost)
Variable cost
Fixed cost
Beanbags (per hour)
$ –36
–20 21 40 1 2 3 4 $0 24 48 72 96
$24 — $8 5
$36 44 51 56 8 12 15 20 36 57 72 84 93 5 6 7 8
120
144
168
192 24 9 12 15 63 99 27 36 48 98 92 79
216
240
264
288 24 19 30 37 36 9 10 11 12 82
106
136
173
118
142
172
209

25. MC = MR Setting Output Production Costs Total revenue
Profit (total revenue – total cost)
Marginal revenue (market price)
Marginal cost
Total cost (fixed cost + variable cost)
Variable cost
Fixed cost
Beanbags (per hour)
$ –36
–20 21 40 1 2 3 4 $0 24 48 72 96
$24 — $8 5
$36 44 51 56 8 12 15 20 36 57 72 84 93 5 6 7 8
120
144
168
192 24 9 12 15 63 99 27 36 48 98 92 79
216
240
264
288 24 19 30 37 36 9 10 11 12 82
106
136
173
118
142
172
209

26. The Shutdown Decision
Fixed costs must be paid even if all output ceases.
A firm should shut down only if the losses from continuing production exceed fixed costs. (Negative profit > fixed costs)
A firm that can only covers its operating cost is still losing money, but not as great in comparison to shutting down.

27. The Shutdown Decision Variable cost vs. Total Revenue Production Costs
Beanbags (per hour)
Fixed cost
Variable cost
Total cost (fixed cost + variable cost)
Marginal cost
Marginal revenue (market price)
Total revenue
Profit (total revenue – total cost)
$ –36
–37
– 34
– 30
– 48 1 2 3 4 $0 7 14 21 28 $7 — $8 5
$36 44 48 51 56 8 12 15 20 36
– 28 5 35 7 63 27 36

28. Section 3: Changes in Supply

29. Input Costs and Supply
Any change in the cost of an input such as the raw materials, machinery, or labor used to produce a good, will affect supply.
As input costs increase, the firm’s marginal costs also increase, decreasing profitability and supply.
Input costs can also decrease.
New technology can greatly decrease costs and increase supply.

30. Change in Quantity Supplied vs. Change in Supply
Movement along the supply curve.
Caused by a change in the price of the product.
Change in Supply
A shift in the supply curve, either to the left or right.
Caused by a change in a determinant other than the price.
Input prices
Technology
Expectations

31. Result of an increase in the cost of inputs.
Result of a decrease in the cost of inputs.

32. Government Influences on Supply
Subsidies
A subsidy is a government payment that supports a business or market.
Subsidies cause the supply of a good to increase.
Taxes
The government can reduce the supply of some goods by placing an excise tax on them.
An excise tax is a tax on the production or sale of a good.
Regulation
Regulation occurs when the government steps into a market to affect the price, quantity, or quality of a good.
Regulation usually raises costs.

33. Other Factors Influencing Supply
The Global Economy
The supply of imported goods and services has an impact on the supply of the same goods and services here.
Government import restrictions will cause a decrease in the supply of restricted goods.
Future Expectations of Prices
Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect.
Number of Suppliers
If more firms enter a market, the market supply of the good will rise. If firms leave the market, supply will decrease.