1. 5.0 Product Market Supply

2. 5.1.1 Economists argued for years about the shape of the supply line 1817- David Ricardo – Principles of a Political Economy – argues supply was perfectly elastic – a horizontal line Whatever the cost of production was determined the supply, and therefore the price

3. In the 1870s, Jevons/Menger/Walras all argued Ricardo had it all wrong They said the level of supply was fixed by the quantity available in the market This implies a vertical or perfectly inelastic supply line They said that where demand intersects this line, that will be the price

4. 5.1.2 Alfred Marshall – Principles of Economics Said that these two analyses were just special cases of a larger possible set He called Ricardo ’ s case the long run condition – when the entire scale of production has time to fully adjust

5. He called the Jevons/Menger /Walras case The market period condition – an immediate position where there is a fixed amount of something available Marshall says there is an intermediate case between these two extremes

6. The Short Run Scale of production is fixed, but some factor inputs are variable You can make more things by adding more of the variable factor This implies an upward-sloping supply line Marshall argues it is this intersection of supply and demand that determines price

7. 5.1.3 Diminishing marginal productivity- Holding all other factors constant, as you increase one input, you eventually get less output from each successive unit

9. 5.1.4

10. Unit of laborMP for labor in candy bars 125 2100 3200 4180 5160 6140 7120 8110 9100 1090

11. This is consistent with The shape of the MP curve MP rises, then falls Now, assume a unit of labor costs $20 We can calculate marginal cost

12. Unit of laborMP for labor in candy bars Marginal cost/unit of candy in dollars 125.80 2100.20 3200.10 4180.11 5160.13 6140.14 7120.17 8110.18 9100.20 1090.22

13. Since we pay a constant price for the input, and since output rises then falls, the marginal cost of the output will fall then rise When workers are most productive, the stuff costs less per unit When workers get less productive, the marginal cost begins to rise

15. 5.1.5 The upward sloping segment of the MC curve is the firm ’ s supply line How far do we expand production as MC keeps rising The firm gets the market signal – the price The signal says “ we ’ re willing to pay this much, how many will you produce? ”

17. The firm looks at the market price and its marginal cost curve They can produce up to that point and still cover costs, but to produce more means that rising costs don ’ t make it worthwhile If market price adjusts upward, then they will produce more

18. 5.1.6 Firms consider all costs they incur You have to pay yourself, too Normal return – the amount that covers the opportunity cost of working for yourself

19. 5.1.7 People who run their own business have many skills They could easily work for someone else The normal return might be in cash, pride of ownership, satisfaction, or any combination, but it must exceed the opportunity cost of working for another

20. Normal returns are an essential part of any firm ’ s costs They are built right into the marginal cost curve

21. 5.1.8 A firm ’ s cost structure is based upon The prices of inputs into production Level of technology The Environment of production

22. When one of the changes, it changes the level of the cost structure, and shifts the whole MC line Since the MC line is a firm ’ s supply curve, it is these variables that shift supply

23. Q 1 s = S 1 (p 1 | p I, Tech., Env.) Where: p I is the price of inputs Tech. Is the level of technology Env. Stands for the environment of production

24. 5.1.9 If an input price goes up, the whole cost structure of the firm goes up It costs more to produce at any quantity This increase in input prices will shift the supply curve up Ex. Increase in price of leather shifts supply of gloves up

26. 5.1.10 If a new technique is developed that allows production at a lower cost, the supply line will shift down

27. 5.1.11 If the environment of production deteriorates, supply will shift up Ex. Horrible weather for farmers ruins crops

28. In each of these three cases, What happens to the price and total revenue for the firm depends on the own price elasticity of demand for that product

29. If supply shifts up Total revenue would increase if the demand curve were inelastic Total revenue would decrease if the demand curve were elastic

30. If supply shifts down Total revenue would decrease if the demand curve were inelastic Total revenue would increase if the demand curve were elastic

31. 5.1.12

32. The market supply curve is the sum of individual firms ’ supply curves

33. 5.1.13 Entry and exit of firms shifts the market supply curve Ceteris paribus, More firms, more supply at each price level, supply shifts right Fewer firms, less supply at each price level, supply shifts left

34. 5.1.14 Under the nice assumptions that ensure perfect competition, the market sets the price Firms and households just have to deal with it, as they have no power The firm faces a perfectly elastic demand line The household faces a perfectly elastic supply line

37. Suppose new firms enter the market

38. As market supply expands, price falls Intersection of price and MC for the firm falls down to the left The firm will be at a new position with a lower quantity supplied

39. Suppliers and demanders are constantly responding to the price signal Under the nice assumptions, all these individual behaviors lead to an incredibly efficient outcome