SupplyUnderstandingEconomics,Chapter5

WhatisSupply?Chapter5,Lesson1

WhatisSupply?

!  Supply–theamountofaproductaproducerorsellerwouldbewillingtoofferforsaleatallpossiblepricesatagivenpointintime!  Thehigherthepriceis,themoresellerswillwant

tosell.

!  LawofSupply–rulestatingthatmorewillbeofferedforsaleathigherpricesandlessatlowerprices

!  Supplyschedule–listingshowingtheamountofaproductaselleriswillingtosellatallpossibleprices!  Seethesupplyscheduleforasellerforburritos.

SupplyCurve

!  Supplycurve–graphshowingthequantitiessuppliedateverypossibleprice!  Noticethatsupplycurvesarealways

upwardsloping.!  Ahigherpriceisanincentiveforsellers

tosellmore.Alowerpricemotivatesthemtosellless.

!  Thesupplycurveisformedbyplottingthecombinationsofpriceandquantitysuppliedfromasupplyschedule.

!  Seeasupplyscheduleforasellerofburritosatright.

!  Interesting–Youareasellerwhenyoulookforajob.Yourproductisyourlabor.

MarketSupply

!  Marketsupplycurve–supplycurvethatshowsthequantitiesofferedatvariouspricesbyallfirmsthatsellthesameproductinagivenmarket.!  Addtheindividualsupplycurvestogetherbyaddingthequantitiesforeachateach

price.!  Thereareusuallymanysellersinagivenmarket,notjusttwo.

ChangeinQuantitySupplied

!  Quantitysupplied–specificamountofferedforsaleatagivenprice;apointonthesupplycurve

!  Changeinquantitysupplied–movementalongthesupplycurveshowingthatadifferentquantityisofferedinresponsetoachangeinprice.!  Ifthepriceofburritosgoesupfrom$5to

$7,thenthequantitysuppliedgoesupfrom24millionto36million

!  Thisisaslidealongthesupplycurvefrompointatopointb.

!  Ifthepricedrops,asellermaynotofferasmuchforsaleormayevenleavethemarketaltogether.

!  Ifthepricegoesup,asellerwilloffermoreforsaletotakeadvantageofthehigherprices.

ChangeinSupply

!  Changeinsupply–differentquantitiesofaproductareofferedforsaleateveryprice,causingthesupplycurvetoshifttotheleftortotheright.!  Thisiscausedbyfactorsinthemarketotherthanprice.!  Ashifttotherightisanincreaseinsupply.!  Ashifttotheleftisadecreaseinsupply.

ChangeinSupply(Shift)

Factorscausingachangein

supply(shiftofcurve)

CostofResources

Productivity

Technology

TaxesonBusinesses Subsidies

GovernmentRegulations

NumberofSellers

SellerExpectations

fortheFuture

ChangeinSupply(Shift)

CostofResources

• Thecostofland,laborandcapitalimpactssupply

• Adecreaseinthecostofresourcesmeansthatsupplierscanproducemoreateveryprice.Thismeansanincreaseinsupplyandashiftright.

• Anincreaseinthecostofresourcesmeansadecreaseinsupplyandashiftleft.

Productivity

• Productivityincreaseswhenevermoreproductsareproducedwiththesameamountofresources.

• Anincreaseinproductivitymeansthesuppliercanproducemorewiththesameresources.Thisisanincreaseinsupplyorashiftright.

• Adecreaseinproductivitymeansadecreaseinsupplyandashiftleft.

Technology

• Animprovementintechnologycanlowerthecostofproduction,whichincreasesproductivity.

• Animprovementtotechnologythatreducescostsleadstoanincreaseinsupplyandashiftright.

• Inreality,newtechnologiesdonotgettakenaway,butsometimesthereisalearningcurvewithanewtechnology,whereitislessproductiveasworkersgetusedtoit.Thismeansadecreaseinsupplyandashiftleft.

ChangeinSupply(Shift)

TaxesonBusinesses

• Taxesareacostforbusinessesjustlikerawmaterialsandlabor.Lowertaxesmeanslowercostsandbusinessescanproducemoreateveryprice.

• Lowertaxesleadtoanincreaseinsupplyandashiftright.

• Highertaxesonbusinessesleadstoadecreaseinsupplyandashiftleft.

Subsidies

• Subsidy–governmentpaymenttoencourageorprotectaneconomicactivity.

• Manyfarmersreceivegov’tsubsidiesfortheircropstoensurethatfarmerscontinuetogrowthosecrops.

• Agov’tsubsidyreducescostsforthesupplierandleadstoanincreaseinsupplyorashiftright.

• Ifasubsidyisrepealed,thisleadstoadecreaseinsupplyorashiftleft.

GovernmentRegulations

• Itcostsbusinessesmoneytocomplywithgovernmentregulations.

• Example:Governmentregulationsonvehiclesafetymeanscarsaremoreexpensivetoproduce.

• Anincreaseinregulationsrepresentsanincreaseincostsforasupplierandadecreaseinsupplyorashiftleft.

• Adecreaseinregulationsleadstoanincreaseinsupplyandashiftright.

ChangeinSupply(Shift)

NumberofSellers

• Mostmarketsarefairlyactivewithfirmsenteringandleavingallthetime.

• Whenanindustrygrowsbecausemorefirmsareenteringthemarket,supplyfortheindustryincreases(shiftsright)

• Iftheindustryisshrinkingbecausefirmsareleavingthemarket,supplyfortheindustrydecreases(shiftsleft)

ChangeinSellers’ExpectationsfortheFuture

• Expectationsforthefutureaffectsthedecisionsbusinessesmake.Thiscanaffectcosts.

• Tobeabletomakepredictionsabouttheaffectofsellers’expectationsforthefuture,weneedmorespecificsaboutthoseexpectations.

• Forexample,manybusinesseswereuneasyabouthavingObamaasapresidentbecausetheyfearedhighertaxesandmoreregulations.Asaresult,theydidnotgrowtheirbusinessesastheydecidedtowaitouthispresidency.Thisledtoadecreaseinsupplyorashiftleft.

SupplyElasticity

!  Supplyelasticity–ameasureofthedegreetowhichthequantitysuppliedchangesinresponsetoachangeinprice.!  Elastic–whenthechangeinpricecausesa

proportionallylargerchangeinthequantitysupplied(flatsupplycurve)

!  Inelastic–whenthechangeinpricecausesaproportionallysmallerchangeinthequantitysupplied(steepsupplycurve)

!  Unitelastic–whenachangeinpricecausesaproportionalchangeinthequantitysupplied.

!  Supplyelasticityisdeterminedbyhowlongittakesforthebusinesstochangeitsproduction.!  Ifabusinesscanchangeproductionquicklyinresponse

toachangeinprice,supplyismoreelastic.!  Ifabusinesscannotchangeitsproductionquicklyin

responsetoachangeinprice,supplyismoreinelastic.(Ex:nuclearpowerplant)

TheTheoryofProduction

Chapter5,Lesson2

TheProductionFunction

!  Productionfunction–graphshowinghowachangeinasinglevariableinputaffectstotaloutput!  Allothervariablesareheldconstantexceptone.!  Theproductionfunctiononthenextslideshowshowoutputwillchangeasthenumberof

workersincreasesfrom0to12.

!  Shortrun–productionperiodsoshortthatonlyvariableinputscanbechanged!  Variableinputs–inputsintoproductionthatcanbeeasilychangedtochangetheamountof

outputproduced–likelaborandrawmaterials!  Theproductionfunctiononthenextsliderepresentstheshortrun.

!  Longrun–productionperiodlongenoughtochangetheamountvariableandfixedinputsusedinproduction!  Fixedinputs–inputsthatdonotoftenchangetoproduceachangeinoutputproduced–like

machinery,technologyandbuildings

TheProductionFunction

TheProductionFunction

!  Totalproduct–totaloutputproducedbyabusiness

! Marginalproduct–theextraoutputproducedduetotheadditionofonemoreunitofinput!  Themarginalproductofthethirdworkeristhetotalproductfor3workersminus

thetotalproductfor2workers(38–20=18)!  Noticethatthemarginalproductforeachworkerisdifferent.Thisisnormal.

!  Stagesofproduction–phasesofproduction(ontheproductionfunction)thatconsistofincreasing,decreasingandnegativereturns.!  Thisiswheremarginalproductionisincreasingwitheachworkeradded,

decreasingwitheachworkeraddedandnegativewitheachworkeradded.!  Decreasingmarginalproduct–notethatyouarestillgettingmoreoutputwith

eachadditionalworker–justthemarginalproductisdecreasing.

StagesofProduction

StageI–IncreasingMarginalReturns

• Wherethemarginalproductforeachadditionalunitofoutput(worker)isincreasing

• Thishappensbecauseasworkersareadded,theycooperateorspecializetomakebetteruseoftheirequipment.

• Inourexample,thefirst5workersareinstageI.

• BusinessesdonotknowinglyproduceinStageI.TheywillkeepaddingworkersuntiltheyareinStageII.

StageII–DecreasingMarginalReturns

• Totalproductionkeepsgrowingbutbysmallerandsmalleramounts.

• Eachworkerismakingadiminishing,butpositivecontributiontototaloutput.

• Diminishingreturns–stageofproductionwhereoutputincreasesatadecreasingrateasmoreunitsofavariableinputareadded

• Inourexample,StageIIgoesfromthe6thworkerthruthe10thworker.

• ThegoalofbusinessesistooperateinStageII.

StageIII–NegativeMarginalReturns

• Themarginalproductofeachworkerisnegative.

• Asmoreworkersareadded,thefirmproduceslessoutput.

• Eachworkerdecreasestotaloutputbecauseinthisstagetherearetoomanyworkersandtheyaregettingineachothers’wayorotherwiseinterferingwithproduction.

• BusinessesdonotproduceinStageIII.TheywillletworkersgountiltheyareinStageII.

Cost,RevenueandProfitMaximization

Chapter5,Lesson3

Production,Cost,RevenuesandProfits

FindingMarginalCost

!  Fixedcosts–costsofproductionthatdonotchangewhenoutputchanges!  Thebusinessincursthesecostsevenifthereislittletonoproduction.!  Overhead–anothernameforfixedcosts!  Includessalariesforexecutives,interestcostondebt,rentormortgagepayments,property

taxes,depreciation…!  Depreciation–thechargeforgradualwearandtearonmachinery

!  Variablecosts–productioncostthatvariesasoutputchanges!  Includeslabor,rawmaterials,electricpowertorunmachines!  Inourexample,thevariablecostisforlaborat$90perworkerperday.

!  Totalcost–allofthecostsassociatedwithproduction(variablecostsplusfixedcosts)

!  Marginalcost–theextracostofproducingoneadditionalunitofoutput!  Themarginalcostforthe5thworkeristotalcostfor5workersminustotalcostfor4workers

dividedbythemarginalproductofthe5thworker:(500–410)/28=$3.21

FindingMarginalRevenue

!  Averagerevenue–theaveragepricethateveryunitofoutputsellsfor

!  Totalrevenue–totalamountearnedbyafirmfromthesaleofitsproducts.!  Also,averagepriceofagoodtimesthequantitysold!  Inourexample,eachunitsellsfor$15.Totalrevenueiscalculatedas$15timestotal

product.

! Marginalrevenue–theextrarevenuefromthesaleofoneadditionalunitofoutput.!  Calculatedasthechangeintotalrevenue÷marginalproduct.!  Forthe5thworker,thisis(1350–930)÷28!  Noticethatsinceallofourunitsofproductinourexamplesellfor$15,ourmarginal

productisalso$15.Inreality,firmschargedifferentpricesfortheproduct,sothesewillnotbethesame.

ProfitMaximizationandBreakEven

!  Totalprofit–totalrevenueminustotalcosts!  Businessesseektoproducethequantitythatmaximizesprofit.!  Inourexample,thefirmswouldhire8or9workersbecausethatcorresponds

tothequantitythatmaximizesprofitsat$1300.

!  Profit-maximizingquantityofoutput–levelofproductionwheremarginalcost=marginalrevenue!  Inourexample,thisoccursat9workers.

ProfitMaximizationandBreakEven

!  Sometimesafirmmaynotbeabletosellenoughproducttomaximizeprofits,soitneedstoknowhowmuchitneedstoselltocoveritscosts(notlosemoney).!  Break-evenpoint–thelevelofproductionthatgeneratesjustenoughrevenuetocoverits

operatingcosts.!  Thisisthepointwheretotalcost=totalrevenue!  Inourexample,withoneworker,totalrevenueis$105andtotalcostis$140andcosts

wouldnotbecovered.!  Withtwoworkers,totalrevenueis$300andtotalcostis$230.Sincethisisjustenoughto

covercosts,thebreak-evenpointforthisfirmisforthemtohire2workers.

!  E-commerce–electronicbusinessorbusinessconductedovertheinternet!  Thishasbecomeverypopularwithbusinessesbecauseitismuchlessexpensive.Businesses

donothavethecostsofoperatingastore.!  Assuch,thebreak-evenpointofsalesismuchlower.