Chapter 5: The Law of Supply

(Looking through the eyes of the Producer)

able (have resources/factors) to sell

“Quantity Supplied”Defined:

.

The Quantity Supplied is the

amount of a good or service that

sellers are willing (motivation) and

Law of supplyLaw of supply – –

the quantity supplied the quantity supplied risesrises when when

the price of the good or servicethe price of the good or service risesrises..

$$ =SUPPLYSUPPLY

Law of Supply

– As the price of a product As the price of a product risesrises, , PRODUCERS PRODUCERS will be willing to supplywill be willing to supply moremore..

Supply CurvePrice

(monthly bill)

Quantity(of Cell Phone Subscribers)

140

120

100

80

60

5 10 15 20 25 30

• Notice how the law of supply is reflected by the shape of the supply curve.

• As the price of a good rises … ... producers supply more.

Supply Curve

This is how much they are willing and able to sell, not how much they actually sell

Supply & Costs Supply & Costs RelationshipRelationship

•ProfitProfit occurs when occurs when revenuesrevenues are are greater than all costs greater than all costs ((make more make more than you spendthan you spend).).

• RevenueRevenue- - money made from money made from selling products.selling products.

To understand the law of supply, we must To understand the law of supply, we must recognize that companies need profits.recognize that companies need profits.

Role of Costs in Shaping the Supply CurveRole of Costs in Shaping the Supply Curve

Role of Costs in Shaping the Supply CurveRole of Costs in Shaping the Supply Curve

Let us look at some examples of these costs.Let us look at some examples of these costs.

•Variable costVariable cost are cost that are cost that CANCAN change change month to month depending on productionmonth to month depending on production

• ExEx- changes when production - changes when production increases/decreases- hourly wages of increases/decreases- hourly wages of workers, electricity, shipping, gas…workers, electricity, shipping, gas…

VARIABLE VARIABLE COSTCOST

Let us look at some examples of these costs.Let us look at some examples of these costs.

Role of Costs in Shaping the Supply CurveRole of Costs in Shaping the Supply Curve

MONTHLY MONTHLY INSURANCE INSURANCE PAYMENTPAYMENT

MANAGER’S COMPANY CARMANAGER’S COMPANY CAR

FIXED FIXED COSTCOST

• Fixed cost- Fixed cost- are cost that are cost that CANNOTCANNOT change change month to month. They are month to month. They are steady steady regardless of the amount of productionregardless of the amount of production..

• ExEx- DO NOT change when production - DO NOT change when production increases/ decreases, must be paid even if increases/ decreases, must be paid even if no production takes place- rent, no production takes place- rent, manager’s salary.manager’s salary.

Total Costs

Variable Costs + Fixed Costs = Total Costs

Law of Diminishing Law of Diminishing ReturnsReturns

Review:•Variable Cost

•Fixed Cost•Law of Supply

As production increases, additional costs As production increases, additional costs increase.increase.– When When benefitsbenefits >> costscosts: production continues : production continues

– When When benefitsbenefits << costscosts: production ends: production ends

Simply put, too much production can be a bad Simply put, too much production can be a bad thing. thing.

Every company can reach a point where it cannot Every company can reach a point where it cannot supply any more goods regardless of increases in supply any more goods regardless of increases in

price.price.

LET’S LOOK AT AN EXAMPLELET’S LOOK AT AN EXAMPLE

Law of Diminishing ReturnsLaw of Diminishing Returns

ElasticityElasticity of Supply

Elastic and Inelastic SupplyELASTIC SUPPLY:ELASTIC SUPPLY: quantity supplied is quantity supplied is SENSITIVESENSITIVE

to small price changesto small price changes

If the If the marginal costsmarginal costs to make an additional to make an additional good are good are lowlow, then the producer will be , then the producer will be more more likelylikely to produce the good if the price changes. to produce the good if the price changes.

If the If the marginal costsmarginal costs to make an additional good to make an additional good are are highhigh, then the producer will be , then the producer will be less likelyless likely to to produce the good if the price changes.produce the good if the price changes.

INELASTIC SUPPLY:INELASTIC SUPPLY: quantity supplied is quantity supplied is NOTNOT SENSITIVESENSITIVE to small price changes to small price changes

..

..

Inelastic and Elastic Supply Curves

$ $ (per auto)(per auto)

Quantity(per month)

27,000

24,000

21,000

15,000

13,000

5,000

10,000

15,000

20,000

25,000

Supply for Supply for CamriesCamries

Supply for Supply for CorollasCorollas18,000

Elastic and Inelastic Supply Curves

2.00

1.25

2.00

1.25

1 2 3 4 5 6 7 8 9 10

• If the market price for motor oil was to rise from $1.25 to $2.00, the quantity supplied in the market increases insignificantly (from 7 to 8 units).

• If the market price for burgers rises from $1.25 to $2.00, the quantity supplied in the market increases substantially (from 1 to 8 units).

• Burger supply is highly highly sensitivesensitive to price changesand can be described as elasticelastic; motor oil supplyis insensitive to price changes and can be described as inelasticinelastic.

INELASTIC

ELASTIC

Motor Oil

Burgers

Q

$

$

Q1 2 3 4 5 6 7 8 9 10

Elastic and Inelastic Supply Curves

100,000

75,000

200

125

1 2 3 4 5 6 7 8 9 10

1 2 3 4 5 6 7 8 9 10

Chopper

iPod

QUANTITY

QUANTITY

Price(per unit)

Price(per unit)

Elasticity in Short Run and Long Run

Short-RunShort-Run - Firms don’t have enoughdon’t have enough time to adjust production in a short period of time (ex: stuck with current factory size). Supply tends to be inelasticinelastic in the short-run

Long RunLong Run - Firms have enough timehave enough time to adjust in a longer period of time. (ex: build a larger factory, thus benefiting from mass producing a good).

Supply tends to be more elasticelastic in the long-run

.

.

ELASTICITY and SIZE of a FIRMELASTICITY and SIZE of a FIRM

Which company do you think has a LOWER cost per unit (thus a larger profit margin)?

ECONOMIES OF SCALE The MORE you produce/buy the

LOWER the average cost per item.

OR

Grandma’s Kitchen

What is this called when one benefits from mass production??

If costs rise when they produce more, then why do they produce more.

Changes in Supply vs. Quantity SuppliedChanges in Supply vs. Quantity SuppliedChange in “Supply”Change in “Supply” - shift - shift OFOF the supply the supply

curve due to a determinate change.curve due to a determinate change.

Change in “Quantity Supplied”Change in “Quantity Supplied” - movement - movement ONON the supply curve in response to a price the supply curve in response to a price change. change.

11 55

$ Price$ Price

QuantityQuantity1010

1.001.00

5.005.00

8.008.00

A shift to the left = A shift to the left = decreasedecrease in supply in supply

A shift to the right A shift to the right = = increaseincrease in in

supplysupply

11 55

$ Price$ Price

QuantityQuantity1010

1.001.00

5.005.00

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

THE THE ONLYONLY FACTORS THAT CAN FACTORS THAT CAN CAUSE A SUPPLY CURVE TO SHIFT CAUSE A SUPPLY CURVE TO SHIFT TO THE TO THE LEFTLEFT ( (decreasedecrease) OR ) OR RIGHTRIGHT

((increaseincrease).).

11 55

$ Price$ Price

QuantityQuantity1010

1.001.00

5.005.00

8.008.00

5. INPUT COSTS 5. INPUT COSTS (inverse relationship)(inverse relationship)

3. SIZE OF INDUSTRY3. SIZE OF INDUSTRY(positive relationship)(positive relationship)

6. TECHNOLOGY6. TECHNOLOGY(positive (positive relationship)relationship)

4. PRICE OF RELATED PRODUCT LINES4. PRICE OF RELATED PRODUCT LINES

2. OUTLOOK OF FUTURE2. OUTLOOK OF FUTURE (Supplier’s Expectations) (Supplier’s Expectations)

Taxes, Subsidies, RegulationsTaxes, Subsidies, Regulations

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

““GO SPIT”GO SPIT”

1. GOVERNMENT ACTIONS1. GOVERNMENT ACTIONS

Look at the market price of a good to determine which Look at the market price of a good to determine which one to produce. one to produce.

Outlook of FutureOutlook of Future (positive relationship)(positive relationship)

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

Gas companies, expect that consumer demand after the storm will Gas companies, expect that consumer demand after the storm will increase so they cut back on the current supply increase so they cut back on the current supply (shift left).(shift left).

After the storm hits and demand increases, suppliers will increase their After the storm hits and demand increases, suppliers will increase their supply until it runs outsupply until it runs out (usually because they take advantage of the (usually because they take advantage of the higher prices).higher prices).

A storm is predicted to destroy most of the seaports where most A storm is predicted to destroy most of the seaports where most imported oil is delivered.imported oil is delivered.

$ Price$ Price

QuantityQuantity

(gallons)(gallons)

3.003.00

5m5m 10m10m

5.005.00

PRICE OF RELATED GOODS THAT SHARE PRICE OF RELATED GOODS THAT SHARE THE SAME RESOURCESTHE SAME RESOURCES• Look at the market price of a good to determine which one to produce.Look at the market price of a good to determine which one to produce.

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

DONUT COMPANY:DONUT COMPANY: price of donuts price of donuts decreasesdecreases

Less likelyLess likely to produce donuts and to produce donuts and more likelymore likely to to use the dough to produce more donut holes use the dough to produce more donut holes (supply curve for rolls shifts right)(supply curve for rolls shifts right)

THEREFORE, anTHEREFORE, an increaseincrease in price of good the in price of good the resources could go toward = supply curve of the resources could go toward = supply curve of the other good other good decreasesdecreases (shifts left)(shifts left)

$$==SUPPLYSUPPLY

As the price of resources goes then a supplier will As the price of resources goes then a supplier will

the supply of a good and look for something else to make.the supply of a good and look for something else to make.

RESOURCE PRICES RESOURCE PRICES (inverse relationship)(inverse relationship)

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

$$

As the price of resources goes then a supplier will As the price of resources goes then a supplier will

the supply of a good because he/she is making a profit. the supply of a good because he/she is making a profit.

$$

LUMBERLUMBER

$$ ==SUPPLYSUPPLY

HOUSE CONSTRUCTIONHOUSE CONSTRUCTION

TECHNOLOGY TECHNOLOGY (positive relationship)(positive relationship)

THE DETERMINANTS OF SUPPLYTHE DETERMINANTS OF SUPPLY

IncreaseIncrease in technology = in technology = increaseincrease in amount supplied in amount supplied (shifts right)(shifts right)DecreaseDecrease in technology = in technology = decreasedecrease in amount supplied in amount supplied (shift left)(shift left)

TT==

SUPPLYSUPPLY

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