Welcome to Supply Chapter 5 Supply and Demand

Welcome to: Supply (Chapter 5)

Supply and Demand n n n Well, demand was only ½ the picture… Both supply and demand influence the price of a good and the quantity produced We’ll generally be looking for the equilibrium (or the market clearing price)

Law of Supply n The law of supply predicts that producers will offer more of a good as the price rises… n n Individual firms will raise their level of production!!! New firms will enter the market!!! If the price goes down, the opposite will be true Discussion regarding costs to enter/exit will occur later… Price Supply As price increases… Quantity supplied increases Price Supply As price falls… Quantity supplied falls

Supply Schedule n Just like demand, there is a supply schedule: n A market supply schedule is a chart that lists how much of a good all suppliers will offer at different prices Price per slice of pizza Slices supplied per day $. 50 1, 000 $1. 00 1, 500 $1. 50 2, 000 $2. 00 2, 500 $2. 50 3, 000 $3. 00 3, 500

Supply Curve n A market supply curve is a graph of the quantity supplied of a good by all suppliers at different prices… Note: Just like demand, a change in price will cause a change along the supply curve Market Supply Curve 3. 00 Supply 2. 50 Price (in dollars) n 2. 00 1. 50 1. 00. 50 0 0 500 1000 1500 2000 2500 3000 3500 Output (slices per day)

Elasticity of Supply n Elasticity of Supply: a measure of the way quantity supplied reacts to a change in price n If supply is not responsive to a change in price, it is inelastic (<1) n If supply is very sensitive to change, it is elastic (>1) n When percent change in supply is equal to percent change in price, it is unitary elastic

Short Run vs. Long Run n Short run: the period of time in which at least one factor of production is fixed n Long run: A period of time in which a firm can vary the quantities of all its inputs. There are no fixed costs in the long run

Elasticity of supply depends on time frame n n For example, NY state apples If the price of apples goes up, what should apple orchards do? n n n Apple trees take a long time to grow It would take years to grow more trees Also hard for new farmers to enter the market n Short run: supply is inelastic n Long run: supply is elastic n Plant more trees, hire more

More Examples? n What are other examples? In the short run, are they elastic or inelastic? n What about the long run? n

Elastic n Supply sensitive to a change in price Supply Price Qty

Inelastic n Supply insensitive to a change in price Supply Price Qty

Perfect Inelasticity n Here, elasticity of supply equals 0 n Supply is fixed Supply Price n Land n Others? Qty

Quick Review 1. What is the law of supply? (a) the lower the price, the larger the quantity supplied (b) the higher the price, the larger the quantity supplied (c) the higher the price, the smaller the quantity supplied (d) the lower the price, the more manufacturers will produce the good 2. What happens when the price of a good with an elastic supply goes down? (a) existing producers will expand some new producers will enter the market (b) some producers will produce less and others will drop out of the market (c) existing firms will continue their usual output but will earn less

Think as a Supplier n n Make chart, then graph it… How many hours of labor a day would you supply if the wage you earned was: n n n n $1/hr? $5/hr? $8/hr? $15/hr? $30/hr? $100/hr? $1, 000/hr? $10, 000/hr?

Marginal Product of Labor n Production of Paper Airplanes n Volunteers: n Time keeper (1) n Counter (1) n Laborers (x), then (x) + (y)

What did we learn? n Marginal product of labor n n Increasing marginal returns n n the change in output from hiring one additional worker a level of production in which the marginal product of labor increases as the number of workers increases Diminishing marginal returns n a level of production in which the marginal product of labor decreases as the number or workers increases

Marginal Product of Labor (number of workers) Output (beanbags per hour) Marginal product of labor 0 0 — 1 2 4 10 4 6 3 17 7 4 23 6 5 6 7 8 28 31 32 31 5 3 1 – 1

Another Way of Saying It… Increasing marginal returns occur when marginal production levels increase with new investment. Increasing, Diminishing, and Negative Marginal Returns 8 7 Increasing marginal returns Diminishing marginal returns occur when marginal production levels decrease with new investment. Negative marginal returns occur when the marginal product of labor becomes negative… Marginal Product of labor (beanbags per hour) 6 5 4 3 Negative marginal returns 2 1 0 – 1 – 2 – 3 1 2 3 8 4 5 6 7 Labor (number of workers) 9

Production Costs n A fixed cost is a cost that does not change, regardless of how much of a good is produced. n n Examples: rent and salaries Variable costs are costs that rise or fall depending on how much is produced. n Examples: costs of raw materials, some labor costs.

Production Costs (cont. ) n The total cost equals fixed costs plus variable cost n The marginal cost is the cost of producing one more unit of a good

How much to produce? n n Marginal revenue is the additional income from selling one more unit of a good. It is usually equal to price. To determine the best level of output, firms determine the output level at which marginal revenue is equal to marginal cost. MR = MC n

Production Costs Beanbags (per hour) Fixed cost 0 $36 1 2 Variable cost Total cost (fixed cost + variable cost) Marginal cost Marginal revenue (market price) Total revenue Profit (total revenue – total cost) $0 $36 — $24 $0 $ – 36 36 8 44 $8 24 24 – 20 36 12 48 4 24 48 0 3 36 15 51 3 24 72 21 4 5 36 36 20 27 56 63 5 7 24 24 96 120 40 57 6 36 36 72 9 24 144 72 7 36 48 84 12 24 168 84 8 36 63 99 15 24 192 93 9 36 82 118 19 24 216 98 10 36 106 142 24 24 240 98 11 36 172 30 24 264 92 12 36 173 209 37 24 288 79

Shutdown Decision n n Operating Cost: the cost of operating a facility such as a store or factory What if a firm can’t reach a point where MR=MC? What if the total revenue is less than total cost? Should the firm shut down? Shut down if: TR-TC< -FC n Stay open if: -FC < TR-TC n Basically you could lose less money by staying open than paying your fixed costs and staying closed n

Quick Review 1. What are diminishing marginal returns of labor? (a) some workers increase output but others have the opposite effect (b) additional workers increase total output but at a decreasing rate (c) only a few workers will have to wait their turn to be productive (d) additional workers will be more productive 2. How does a firm set its total output to maximize profit? (a) set production so that total revenue plus costs is greatest (b) set production at the point where marginal revenue is smallest (c) determine the largest gap between total revenue and total cost (d) determine where marginal revenue and profit are the

Shifts in the Supply Curve (Brainstorm) n Based on your knowledge and previous experiences, what are some ideas you have on what may cause a shift in the supply curve?

Changes in cost affect Supply n Any change in the cost of an input used to produce a good, such as raw materials, machinery, or labor will affect supply

Changes in cost affect Supply n As input costs increase, the firm’s marginal costs also increase, decreasing profitability and supply

Changes in cost affect Supply n Input costs can also decrease. New technology can greatly decrease costs and increase supply

Uncle Sam and Supply n By raising or lowering the cost of producing goods, the government can encourage or discourage an entrepreneur or industry… n Subsidy n Regulation n Taxes

Subsidies n A subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase

Regulation n Regulation occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.

Taxes n The government can reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good.

The Global Economy n n The supply of imported goods and services has an impact on the supply of the same goods and services here Government import restrictions will cause a decrease in the supply of restricted goods

Future Expectations of Prices n Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect.

Number of Suppliers n If more firms enter a market, the market supply of the good will rise n If firms leave the market, supply will decrease

Quick Review What affect does a rise in the cost of raw materials have on the cost of a good? (a) A rise in the cost of raw materials lowers the overall cost of production. (b) The good becomes cheaper to produce. (c) The good becomes more expensive to produce. (d) This does not have any affect on the eventual price of a good. 2. When government actions cause the supply of a good to increase, what happens to the supply curve for that good? (a) It shifts to the left. (b) It shifts to the right. (c) It reverses direction. (d) The supply curve is unaffected. 1.