1. Lecture 4 The (weak) Law of Supply ■ Our objectives: ► Explain individual choices among unlimited wants in the face of limited resources ► Explain individual choices among unlimited wants in the face of limited resources ► Develop a theory that satisfies the universal criteria for theories ► Apply the theory to what we observe around us

2. The Law of Supply ■ Holding other relevant factors constant, the higher the price of a good, the greater will be the quantity supplied. ► Like all scientific propositions, it is a ceteris paribus (“other things equal”) statement about the world ► Like all scientific propositions, it is a ceteris paribus (“other things equal”) statement about the world ► It is symmetric: a lower price leads to a smaller quantity supplied ► It is symmetric: a lower price leads to a smaller quantity supplied ► Note the terminology: - changes in the price of the good lead to changes in “quantity supplied” - they DO NOT lead to changes in “supply”—more on this later

3. What do we get with the Law of Supply? ■ It, too, is powerful proposition in economics ► Overtime pay ► Overtime delivery more expensive than second day air ► The existence of “record-breaking” crowds at established stadiums

4. Foundations ■ The principle of Rising Marginal Cost ► As the rate of production rises, the marginal cost the next unit rises ► As the rate of production rises, the marginal cost the next unit rises ■ Decision Rule ► Choose a rate of production so that marginal cost of the last unit equals the price: ► Choose a rate of production so that marginal cost of the last unit equals the price: MC = P ■ When combined, these yield the Law of Supply

5. Rising Marginal Cost Rate of Production Marginal Cost 11.00 21.20 31.45 41.75 52.10

6. Rising Marginal Cost MARGINAL COST $$

7. Adding the Decision Rule MC = P yields the Law of Supply MC Price

8. The Supply Function Summarizes the relationship between quantity supplied and the factors that determine that quantity ■ Price of the good in question—determines the location along the supply curve ■ Other factors—determine the placement of the supply curve ► Prices of inputs (also called “factor prices”) ► Technology (e.g, state of knowledge; regulations) ► Other matters, particular to each good, including weather conditions, etc.

9. The Supply Function (As we will use it) ■ The rate of production of a good is a function of ►The “own” price of the good ►The “own” price of the good --------------------------------------- --------------------------------------- ►The ceteris paribus conditions: ►The ceteris paribus conditions: -Prices of inputs -Technology -Other factors peculiar to the good

10. The height of the supply curve shows the level of marginal costs at the Q Units/time period $

11. Changes in Supply Decrease Increase Output Price

12. Increase in Supply Caused by Caused by -Lower factor prices -Lower factor prices -Improvement in technology -Improvement in technology -Other charges that -Other charges that REDUCE marginal costs REDUCE marginal costs

13. Decrease in Supply Caused by Caused by -Higher factor prices -Higher factor prices -Degradation in technology -Degradation in technology -Other changes that -Other changes that RAISE marginal costs RAISE marginal costs decrease

14. Terminology This is important to avoid confusion and reduced wealth ■ Changes in quantity supplied ► Caused by changes in own price of good ► Refer to a movement along a given supply curve ■ Changes in supply ► Caused by changes in ceteris paribus conditions ► Caused by changes in ceteris paribus conditions -Factor prices -Factor prices -Technology -Technology -Other elements in “Z-vector” -Other elements in “Z-vector” ► Refer to a shift of the entire supply curve ► Refer to a shift of the entire supply curve ■ Be precise and you’ll be richer

15. Questions on Supply Suppose a genius writes a new software program, that is easy to copy, that doubles the productivity of computers. Suppose a genius writes a new software program, that is easy to copy, that doubles the productivity of computers. What affect will that have on the supply of computers?

16. Supply Question Suppose 100 million consumers around the world suddenly decide that corn is very healthy to eat and will prevent cancer. How does this affect the supply of corn? Suppose 100 million consumers around the world suddenly decide that corn is very healthy to eat and will prevent cancer. How does this affect the supply of corn?

17. Question on Supply In 1998, DVD players cost almost $1,000. Only a few were sold. In 1998, DVD players cost almost $1,000. Only a few were sold. Now DVD players cost about $90. Why can suppliers provide them at such a lower cost? How might this affect demand? What else would impact demand?