CHAPTER 5: SUPPLY HOW DO SUPPLIERS DECIDE WHAT GOODS AND SERVICES TO OFFER?

CHAPTER 5

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SECTION 1: UNDERSTANDING SUPPLY

Objectives:

Explain the law of supply.

Interpret a supply schedule and a supply graph.

Examine the relationship between elasticity of supply and time.

THE LAW OF SUPPLY Supply

the amount of goods available

Law of Supply

producers offer more of a good as its price increases and less as its price falls

Quantity Supplied

the amount that a supplier is willing and able to supply at a specific price

THE LAW OF SUPPLY

Higher Production

higher prices = more production

lower prices = less production

Market Entry

SUPPLY AND DEMAND

Price DemandSupply

THE SUPPLY SCHEDULE Supply Schedule

a chart that lists how much a good a supplier will offer at various prices

Variables

a factor that can change

A Change in Quantity Supplied

Relationship between price and quantity (supply)

Market Supply Schedule

Chart that lists how much of a good all suppliers will offer at various prices

The Supply Graph

supply curve – a graph of the quantity supplied of a good at various prices

always rises from left to right

SUPPLY AND ELASTICITY Elasticity of Supply

measure of the way quantity supplied reacts to a change in price

Elasticity of Supply and Time

will a good be elastic or inelastic?

Elasticity in the short run

- an orange grove

- inelastic…why?

Elasticity in the long run

- overtime supply becomes more elastic if the supplier has a longer time to respond to change

REVIEW – CHAPTER 5, SECTION 1

SECTION 2: COSTS OF PRODUCTION

Explain how firms decide how much labor to hire in order to produce a certain level of output.

Analyze the production costs of a firm.

Explain how a firm chooses to set output.

Identify the factors that a firm must consider before shutting down an unprofitable business.

According to some reports, supermarkets make a profit of three to six cents for every dollar of revenue. Where does the rest of the money go?

LABOR AND OUTPUT

Marginal Product of Labor The change in output from hiring one additional unit of labor

Output at the margin = hired or fired

Increasing Marginal Returns Level of production in which the marginal product of labor

increases as the number of workers increases The role of specialization

Increases productivity

Diminishing Marginal Returns A level of production at which the marginal product of labor decreases as

the number of workers increases

Negative Marginal Returns When adding an extra worker actually decreases marginal return

PRODUCTION COSTS

Fixed CostsCost that does not change EX: rent, machinery repairs, salaries, property taxes

Variable CostsCosts that rise and fall depending on the quantity produced EX: cost of workers, electricity, heating

GETTING STARTED

Your family is having guests over. Create columns that would show fixed cost and variable costs of having the guest stay for a week.

Total CostThe sum of the fixed cost and variable cost

Marginal Cost The additional cost of adding one more unit

SETTING OUTPUT

Marginal Cost and Marginal Revenue

Marginal Revenue – additions income from selling one more unit of a good; sometimes equal to the price

Average Cost – total cost divided by the quantity produced

EX: 10 beanbags

Average Cost = $14.20 ($142/10 )

Profit is the difference between the market price and the average cost $24 - $14.20 = $9.80 x the quantity (10) = $98

Responding to Price Change

What happens if the price of beanbags rises from $24 to $37

- Increase quantity supplied!

The Shutdown Decision

Most profitable level of output = Marginal Revenue = marginal cost

TO MAXIMIZE PROFIT

M A N A G I N G L A B O R

Increased marginal return

Look for highest marginal return

Buy capital to increase marginal return

S E T T I N G O U T P U T

Set output where marginal revenue equals marginal cost

SECTION 3:

Explain how factors such as input costs creates changes in supply.

Identify three ways that the government can influence the supply of goods.

Analyze the other factors that affect supply.

Explain how firms choose a location to produce goods.

INPUT COSTS

Effect of Rising Costs Price = marginal cost (most profitable level ) Remember marginal cost…raw materials, labor etc.

Rising costs?Cut production – that will lower marginal cost until it equals cost of production

Technology Can lower production costs Lower costs and increase in supply

GOVERNMENT’S INFLUENCE ON SUPPLY

Subsidies A government payment that supports a business or market

Producer is paid for each unit Lower costs Allows a firm to produce more EX: Developing companies in underdeveloped countries

Taxes Excise tax - A tax on the production or sale of a good

Increase production costs Can be used to discourage sale

Tobacco, alcohol, high pollutant gasoline

Regulation The government intervention in a market that affects the production of a good

EX: Pollution

OTHER INFLUENCES ON SUPPLY

Changes in the Global Economy EX: The US imports carpets from India. An increase in the wages of Indian workers would decrease the supply of carpets to the US market, shifting the supply curve to the left.

EX: The US imports oil from Russia. A new oil discovery in Russia could increase the supply of oil in the US market and shift the supply curve to the right.

Future Expectation of Prices

Number of Suppliers

WHERE DO FIRMS PRODUCE?

Location. Location. Location. Transporting goods Closer to suppliers? Raw materials are expensive to transport

Closer to consumers? Output is expensive to transport