aaec 2305 fundamentals of ag economics chapter 4 -continued

AAEC 2305AAEC 2305Fundamentals of Ag Fundamentals of Ag

EconomicsEconomics

Chapter 4 -ContinuedChapter 4 -Continued

SupplySupply

Supply is a direct price and quantity Supply is a direct price and quantity relationship detailing the functional relationship detailing the functional relationship of how suppliers relationship of how suppliers (producers, sellers, & mgrs) of a (producers, sellers, & mgrs) of a product respond to differing price product respond to differing price levels.levels.• It states what suppliers are WILLING It states what suppliers are WILLING

and ABLE to supply at a given price.and ABLE to supply at a given price.

Derivation of Mkt Supply Derivation of Mkt Supply CurvesCurves

Supply curve for the individual firm is Supply curve for the individual firm is based on the cost structure of the firm & based on the cost structure of the firm & how mgrs respond to alternative product how mgrs respond to alternative product prices as they attempt to maximize prices as they attempt to maximize profits.profits.

In chapter 4, we discussed profit In chapter 4, we discussed profit maximization decision rules for the maximization decision rules for the individual firm and said that the MC above individual firm and said that the MC above AVC represented the firm short run supply AVC represented the firm short run supply curve.curve.


In the long run, MC curve above ATC In the long run, MC curve above ATC represents the firm’s long run supply represents the firm’s long run supply curve (remember AVC and ATC are the curve (remember AVC and ATC are the same in the long run).same in the long run).

Additionally, the firm’s supply curve is Additionally, the firm’s supply curve is derived under the assumption that the derived under the assumption that the only economic variable changing is the only economic variable changing is the goods own price. All other factors are goods own price. All other factors are assumed to remain constant.assumed to remain constant.


The industry supply curve is the The industry supply curve is the horizontal summation of all horizontal summation of all individual firms’ supply curves in individual firms’ supply curves in the market.the market.

Ex. - Figure 8.3 - page 207Ex. - Figure 8.3 - page 207

Pc Firm A Firm B Firm C Industry

$30 50 30 20

$60 70 60 100

Ex. - Figure 8.3 - page 207Ex. - Figure 8.3 - page 207

Pc Firm A Firm B Firm C Industry

$30 50 30 20 100

$60 70 60 100 230

Law of SupplyLaw of Supply

The Law of Supply says that the The Law of Supply says that the quantity of goods &/or services offered quantity of goods &/or services offered to a mkt will vary DIRECTLY with the to a mkt will vary DIRECTLY with the price.price.• Price increase will result in an increase in Price increase will result in an increase in

quantity supplied.quantity supplied.• Price decrease will result in a decrease in Price decrease will result in a decrease in

quantity supplied.quantity supplied.• The amt of increase or decrease depends on The amt of increase or decrease depends on

the Elasticity of Supply.the Elasticity of Supply.

Elasticity of Supply (EElasticity of Supply (Ess))

Elasticity (in general) is defined as the Elasticity (in general) is defined as the percentage change in the quantity percentage change in the quantity supplied relative to the percentage supplied relative to the percentage change in price (or other economic change in price (or other economic variable) as we move from one point variable) as we move from one point to another on the supply curve.to another on the supply curve.• It is a measure of responsiveness of It is a measure of responsiveness of

quantity to changes in price (or other eco quantity to changes in price (or other eco variable) variable)


EE = % = % Q / % Q / % P P Elasticity represents movement Elasticity represents movement

along the supply curve and thus along the supply curve and thus elasticity is also a measure of the elasticity is also a measure of the degree of slope of the supply degree of slope of the supply curve. curve.


Classifications:Classifications:• Inelastic supply (EInelastic supply (Ess < 1): a change in price < 1): a change in price

brings about a smaller change in quantity brings about a smaller change in quantity (we are less responsive to price)(we are less responsive to price)

• Unitary Elastic supply (EUnitary Elastic supply (Ess = 1): a change in = 1): a change in price brings about an equivalent change in price brings about an equivalent change in quantity.quantity.

• Elastic supply (EElastic supply (Ess >1): a change in price >1): a change in price brings about a relatively larger change in brings about a relatively larger change in quantity.quantity.


Mgrs & economists are interested in two Mgrs & economists are interested in two types of supply elasticity measures:types of supply elasticity measures:• Own-price elasticity of supply - measures the Own-price elasticity of supply - measures the

repsonsiveness of quantity supplied of a repsonsiveness of quantity supplied of a good to a change in the price of that good.good to a change in the price of that good.

• Cross-price elasticity of supply - measures Cross-price elasticity of supply - measures the repsonsiveness of quantity supplied of a the repsonsiveness of quantity supplied of a good to a change in the price of a related good to a change in the price of a related good.good.


EEss = % = % Q Qss / % / % P <or> P <or>

EEss = ((Q = ((Q22-Q-Q11) / (Q) / (Q22+Q+Q11)) / ((P)) / ((P22-P-P11) / ) / (P(P22+P+P11))))

In class examples**In class examples**

Cross-price elasticityCross-price elasticity

EESSY1Y2Y1Y2 = % = %QQY1Y1 / % / %PPY2Y2

EESSY1Y2Y1Y2 = ((Q = ((QYY1122 – Q – QYY1111) / (Q) / (QYY1122 + Q + QYY1111)) / ((P)) / ((PYY2222

– P– PYY2211) / (P) / (PYY2222 + P + PYY2211)) )) Measures the effect of a change in the Measures the effect of a change in the

price of good Yprice of good Y22 on the quantity supplied on the quantity supplied of Yof Y11..

Read the cross-price of elasticity of Read the cross-price of elasticity of supply for product Ysupply for product Y11 with respect to with respect to product Yproduct Y22..

Classification of Classification of Cross-price elasticity of Cross-price elasticity of

SupplySupply

Complements in production (EComplements in production (ESSY1Y2Y1Y2 > >

0): implies that as the price of Y2 0): implies that as the price of Y2 increases, the quantity of Y1 supplied increases, the quantity of Y1 supplied by the firm will also increase.by the firm will also increase.

Substitutes in production (ESubstitutes in production (ESSY1Y2Y1Y2 < 0): < 0):

implies that as the price of Y2 implies that as the price of Y2 increases, the quantity of Y1 supplied increases, the quantity of Y1 supplied by the firm will decrease.by the firm will decrease.

In class examples** In class examples**

Change in Supply versus Change in Supply versus Change in Quantity Change in Quantity

SuppliedSupplied

Changes in quantity supply result Changes in quantity supply result from changes in the price of the from changes in the price of the product and are movements along product and are movements along the supply curve.the supply curve.

Changes in supply result from Changes in supply result from changes in quantity sold due to changes in quantity sold due to factors other than a change in the factors other than a change in the price of the product.price of the product.

Determinants of Industry Determinants of Industry SupplySupply

Qs = f(own price | input prices, Qs = f(own price | input prices, technology, prices of alternative technology, prices of alternative products, number of sellers, other products, number of sellers, other factors)factors)• States that quantity supplied will States that quantity supplied will

vary with price as long as the vary with price as long as the supply shifters are held constant.supply shifters are held constant.

aaec 2305 fundamentals of ag economics chapter 4 -continued

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