social studies department economics mr. j. ochoa & …€¦ · mr. j. ochoa & mr. r....

SOCIAL STUDIES DEPARTMENTECONOMICS

MR. J. OCHOA & MR. R. VANNEST

Chapter 5: Supplynetw rks

NAME ________________________________________ DATE _______________ CLASS _________

Lesson 2 The Theory of Production

Reading Essentials and Study Guide

ESSENTIAL QUESTIONWhy is the production function useful for making business decisions?

Reading HELPDESKAcademic Vocabularyhypothetical assumed but not provencontributes gives time, money, or effort

Content Vocabularyproduction function graphic portrayal showing how a change in the amount of a single variable

input affects total outputshort run production period so short that only variable inputs (usually labor) can be changedlong run production period long enough to change amount of variable and fixed inputs used in

productiontotal product total output or production by a firmmarginal product extra output due to the addition of one more unit of inputstages of production phases of production that consist of increasing, decreasing, and negative

returnsdiminishing returns stage of production where output increases at a shrinking rate as more units

of variable input are added

TAKING NOTES: Key Ideas and DetailsUse a graphic organizer like the one below to describe production function.

Production Function

production time

measurements

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NAME ________________________________________ DATE _______________ CLASS _________

Chapter 5: Supplynetw rksReading Essentials and Study Guide

Lesson 2 The Theory of Production, Continued

Companies change the mix of their productive inputs all the time—and you may have been part of this without even knowing it! For example, have you or one of your friends ever worked in the fast food industry? How many times have you or your friend been called in to work when the business got busy, or been sent home when sales slowed?

The Production FunctionGuiding Question Why is marginal product an important concept for business owners to understand?Production is usually illustrated with a production function. A production function is a figure that shows how total output changes when the amount of a single variable input (usually labor) changes while all other inputs stay the same. The single variable input is usually labor, or workers. A schedule can show the production function, such as the one in columns one and two of Panel A of Figure 5.5. A graph like the one in Panel B can also show the production function.

Both panels show hypothetical output as the number of workers changes from zero to 12. According to the numbers in Panel A, if a firm hires no workers, output is zero. If the number of workers goes up by one, output rises to seven. Add another worker, and total output rises to 20. Use three workers, and total output rises to 38, and so on. Next, we use this information to make the production function that appears as the graph in Panel B. In this graph, the number of variable inputs is on the horizontal axis. Total production is on the vertical axis.

The Production Period When economists analyze production, they focus on the short run. The short run is a production period so short that only the amount of the variable input can be changed. The production function in Figure 5.5 reflects the short run because only the total number of workers changes. There are no changes in the amount used of machinery, technology, or land. So any change in output must be the result of a change in the number of workers.

Other changes happen in the long run. The long run is a production period long enough for the firm to change the quantities of all its productive resources, including capital. For example, a firm that reduces its labor force today may also have to close down some factories later on. These factory closings are long-run changes because the amount of capital used for production changes slowly.

Total Product The second column in Panel A of Figure 5.5 shows total product, or the total output produced by the firm. As you read down the column, you will see that zero workers produce zero units of total output, one worker produces seven, and so on.

Again, this is a short-run relationship because it only shows that the amount of labor changes while the amount of other resources used stays the same. Now that we have total product, we can easily see how we get our next measure.

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Lesson 2 The Theory of Production, Continued

Marginal Product The measure of output shown in the third column of Panel A in Figure 5.5 is an important concept in economics. The measure is marginal product. Marginal product is the extra output or change in total product caused by adding one more unit of variable input.

As we see in the figure, the marginal product, or extra output, of adding the first worker is 7. Likewise, the marginal product of adding the second worker is 13. So, the total extra or total marginal output of adding both workers is 20. If you look down the column, you will see that the marginal product for every additional worker is different. Some marginal products are even negative.

Finally, notice that the sum of the marginal products is equal to the total product. For example, the marginal product of the first and second workers is 7 plus 13, or 20—the same as the total product for two workers. Likewise, the sum of the marginal products of the first three workers is 7 plus 13 plus 18, or 38—the total output for three workers.

Reading Progress CheckAnalyzing Why does the production function represent short-run production?

Stages of ProductionGuiding Question How do companies use the stages of production to determine the most profitable number of workers to hire?In the short run, every firm faces the question of how many workers to hire. To answer this question, let us take another look at Figure 5.5. Figure 5.5 shows three separate stages of production:

• Stage I, which is called increasing returns;• Stage II, which is called diminishing returns; and• Stage III, which is called negative returns.

Each of these stages gets its name from the way marginal product changes as a firm adds moreworkers.

Stage I—Increasing Marginal ReturnsStage I of the production function is when the marginal product grows for each new worker. This happens because the added workers can work together or specialize in certain jobs to make better use of their equipment.

As we see in Figure 5.5, the first worker produces 7 units of output. The second is even more productive, with a marginal product of 13 units. This brings the total production to 20. As long as each new worker contributes more to total output than the worker before, total output rises at a growing rate.

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NAME ________________________________________ DATE _______________ CLASS _________

Chapter 5: SupplyReading Essentials and Study Guide

Lesson 2 The Theory of Production

According to the figure, the first five workers are in Stage I. This is because these are the workers with increasing marginal returns.

When a firm sees that each new worker increases output more than the last, it wants to hire more workers. As a result, the firm soon begins producing in the next stage of production, Stage II.

Stage II—Decreasing Marginal Returns In Stage II, the total production keeps growing, but by less and less. Each additional worker is still making a positive contribution to total output, but that contribution is shrinking.

Stage II shows the principle of decreasing or diminishing returns. Diminishing returns is the stage of production where output grows at a smaller and smaller rate as a firm adds more variable inputs. In Figure 5.5, Stage II begins when the firm hires the sixth worker. This sixth worker has a marginal product of 20. But the fifth worker had a marginal product of 28. You can see that total output is still growing, but now each new worker contributes less than the one before. In other words, marginal products are shrinking. The stage ends when the firm hires the tenth worker because marginal products are no longer positive after that point.

Exploring the Essential Question Most firms operate within Stage II, but is this always the best choice? How would the diminishing returns of adding each extra employee affect what the business must charge for each item or service?

Stage III—Negative Marginal Returns If a firm hires too many workers, the workers will get in each other’s way or hold back production. This would cause total output to fall. Stage III, then, is where the marginal product of each additional worker is negative. For example, the eleventh worker has a marginal product of minus three, and the twelfth’s is minus ten. This causes output to fall.

The number of workers a firm hires is usually only found in Stage II. This is because most companies would not hire more workers if their negative marginal return brought down the company’s total production. As we will see in the next section, the exact number of workers to hire also depends on the revenue from the sale of the output. But for now, we can say that the firm with the production function shown in Figure 5.5 will hire between six and ten workers.

Reading Progress CheckAnalyzing Why would a firm be motivated to hire more workers than are found in Stage I of the production function?

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NAME ________________________________________ DATE _______________ CLASS _________


Lesson 3 Cost, Revenue, and Profit Maximization

ESSENTIAL QUESTIONHow do companies determine the most profitable way to operate?

Reading HELPDESKAcademic Vocabularygenerates produces or brings into beingconducted handled by way of

Content Vocabularyfixed costs costs of production that do not change when output changesoverhead broad category of fixed costs that includes interest, rent, taxes, and executive salariesvariable cost production cost that varies as output changes; labor, energy, raw materialstotal cost variable cost plus fixed cost; all costs associated with productionmarginal cost extra cost of producing one additional unit of productionaverage revenue average price that every unit of output sells fortotal revenue total amount earned by a firm from the sale of its products; average price of goods

sold times quantity soldmarginal revenue extra revenue from the sale of one additional unit of outputprofit-maximizing quantity of output level of production where marginal cost is equal to

marginal revenuebreak-even point production level where total cost equals total revenue; production needed if

the firm is to recover its costse-commerce electronic business or exchange conducted over the Internet

TAKING NOTES: Key Ideas and DetailsUse a graphic organizer like the one below to describe information business people must gather in order to balance costs and revenue.

Costs Revenue

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Lesson 3 Cost, Revenue, and Profit Maximization, Continued

All businesses, including nonprofit organizations, face the challenge of being successful enough to stay in operation. Even better, most hope to operate in a way that maximizes profits. What information does a business need to achieve these goals?

1. What is the cost of the lease, the utility bills, the purchase and repair of equipment, and other daily expenses for doing business?

2. What is the cost of paying employee salaries and benefits?3. What is the cost of producing each good or providing each service?

Finding Marginal CostGuiding Question What is the difference between a fixed cost and a variable cost? Businesses need to think about several measures of cost if they want to produce efficiently. But which measure is the most useful if they want to maximize profits? Let’s take a look at measures of cost one by one to find out.

Fixed Costs The first measure is fixed costs. Fixed costs are the costs that an organization experiences even if there is little or no activity. With fixed costs, it makes no difference whether the business produces nothing, very little, or a large amount. Total fixed costs, sometimes called overhead, stay the same.

Fixed costs include salaries paid to executives, interest charges on bonds, rent payments on leased properties, and state and local property taxes. Fixed costs also include depreciation. Depreciation is the charge for the gradual deterioration, or wear and tear, on capital goods because of their use over time. A machine, for example, will not last forever because its parts will wear out slowly and eventually break.

Suppose fixed costs are $50 for the firm with the hypothetical production function shown in Figure 5.5 in the previous lesson. To keep all of our numbers together, Figure 5.6 shows the same production function in the first three columns, along with total fixed costs in column four. As you can see, the total fixed cost is $50 for every level of output, even if nothing is produced.

Variable CostsThe second measure is variable cost. Variable cost is the cost that changes when the business’s rate of operation or output changes. While fixed costs are generally related to machines and other capital goods, variable costs are usually related to labor and raw materials. For example, wage-earning workers may be laid off or asked to work overtime as output decreases or increases. Other examples of variable costs include electric power to run machines and shipping charges to deliver the final product.

For most businesses, the largest variable cost is labor. Let’s say that a business wants to hire one worker to produce seven units of output per day. If the worker costs $90 per day, the total variable cost is $90. If the business wants to hire a second worker to produce additional units of output, then its total variable cost is $180, and so on. These are the numbers shown in column five of the figure.

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Total Cost Figure 5.6 shows the total cost of production. The total cost of production is the sum of the fixed and variable costs. Total cost includes all the costs a business has in its operations. Suppose the business decides to use six workers costing $90 each to produce 110 units of total output. Then its total cost will be $590. This is the sum of $50 in fixed costs plus $540 (or $90 times six) of variable costs.

Marginal Cost We need to know variable, fixed, and total costs to figure out the most useful measure of cost, marginal cost. Marginal cost is the extra cost of producing one more unit of output.

To find marginal cost, we have to divide the additional cost of each worker by the additional output the worker makes. Let’s find the marginal cost of the first worker. To do this, divide the additional cost of $90 by the additional output of 7. The answer is $12.86. To find the marginal cost of the second worker, divide the additional cost of $90 by the additional output of 13 to get $6.92, and so on. You can see all of these values in column seven of Figure 5.6.

As we will see next, marginal revenue is the most useful measure of revenue. This is because it helps a firm maximize profit.

Reading Progress CheckAnalyzing If a firm’s total output increases, will the fixed costs increase? Explain.

Finding Marginal RevenueGuiding Question Why is marginal revenue more important than the average revenue?The second important measure a business needs to find is its marginal revenue. But before we get to it, we’ll look at two other measures of revenue.

Average RevenueThe average revenue is simply the average price that every unit of output sells for. For example, if the company in Figure 5.6 sells every unit of output for $15, its average revenue is $15. This $15 would stay the same if it sold 10, 100, or 1000 units. Although average revenue is easy to understand, it is the least useful of all the revenue measures. This is why the table in Figure 5.6 does not have a column for average revenue.

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Total Revenue The total revenue is all the revenue that a business receives. For the firm in Figure 5.6, total revenue is shown in column eight. It is equal to the number of units sold multiplied by the average price of $15 per unit. Imagine the firm hires one worker who produces seven units, which are sold at $15 each. The total revenue is $105. Now imagine the firm hires 10 workers who produce 148 units of total output that sell for $15 each. The total revenue would be $2,220. The calculation is the same for any level of output in the table. Column eight in Figure 5.6 shows total revenue.

Marginal Revenue The most important measure of revenue is marginal revenue. Marginal revenue is the extra revenue a business receives from the production and sale of one additional unit of output. You can find the marginal revenue in Figure 5.6 by dividing the change in total revenue by the change in total output. Remember, the change in total output is also called the marginal product.

For example, imagine the business employs five workers who produce 90 units of output. This generates $1,350 of total revenue at an average price of $15 per unit. If it hires a sixth worker, output increases by 20 units and total revenues increase to $1,650. If we divide the change in total revenue ($300) by the marginal product (20), we have marginal revenue of $15.

As long as every unit of output sells for $15, the marginal revenue earned by the sale of one more unit will always be $15. For this reason, the marginal revenue appears to be constant at $15 for every level of output in Figure 5.6. In reality, this is not always the case. Businesses often find that marginal revenues change, especially if they sell some of their output at different prices.

Reading Progress CheckExplaining What does the word “marginal” in the term “marginal revenue” stand for?

Profit Maximization and Break-EvenGuiding Question What cost advantage does e-commerce offer businesses?Profits are affected by both cost and the revenue from sales. That is why owners have to consider both when they think about profitability.

Exploring the Essential Question Imagine you run a company that manufactures widgets. Last week you had $1,000 in total costs and revenue of $1,000. If you want to hire 10 more workers at $110 a day, what would happen to your total fixed cost?

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Profit Maximization Suppose the firm in Figure 5.6 wanted to experiment to try to find the level of output that maximized profits. The business would hire the sixth worker, for example, because the extra output would cost only $4.50 to produce, and it would generate $15 in new revenues. This means that each of the 20 additional units produced would generate $10.50 of profit. This would increase total profits from $850 to $1,060.

Based on this, the business would then hire a seventh and eighth worker. But it would find that hiring the ninth worker neither adds to nor takes away from total profits. And the firm would have no reason to hire the tenth worker. If it did, it would find that profits went down, and it would go back to using nine workers.

Eventually, the firm would reach the profit-maximizing quantity of output. This is the volume of production where marginal cost and marginal revenue are equal. You can see this in the last column in Figure 5.6. Other levels of output may generate equal profits, but none will be more profitable.

The firm in Figure 5.6 found this level of output by using trial and error, or experimenting. But it could have saved some time by looking for the level of output where marginal cost (in column seven) is exactly equal to marginal revenue (in column nine). This is 144 units using nine workers. This is why we computed the marginal cost and revenue measures in the first place.

Break-Even Analysis Sometimes a firm may not be able to sell enough to maximize its profits right away. Then it may want to know how much it must sell just to cover its costs. This is when the firm needs to find its break-even point. This is the level of production that generates just enough revenue to cover total operating costs.

For example, the firm in Figure 5.6 could not cover all its costs if it employed one worker and produced 7 units. This is because total costs would be $140, while total revenue is only $105. But if it employed two workers and could sell 20 units, the company would cover all of its costs. This means that the firm has to hire two workers to break even.

The break-even point only tells the firm how much it has to produce to cover its costs. Most businesses want to do more. They want to maximize the amount of profits they can make, not just cover their costs. To do this, they would have to figure out their marginal costs and marginal revenues to find the level of output where they are equal.

Costs and Business Operation Many stores are opening on the Internet, mostly because overhead costs are so low. This is why the Internet is one of the fastest-growing areas of business today. Remember that overhead is the fixed costs of operation. Another good thing about doing business on the Internet is that a firm does not need as much inventory. And if a business can lower its fixed or variable costs, this also helps its break-even point. It helps by lowering the amount of sales the company needs to cover its total costs.

Businesses do not need to spend a large sum of money to rent a building and stock it with inventory if they use e-commerce. E-commerce is electronic business done over the Internet. For just a fraction of the cost of a typical store, the e-commerce business owner can buy Web access along with an e-commerce software package. The package provides everything from Web catalog pages to ordering, billing, and accounting software. Then, the owner of the e-commerce business store puts in pictures and descriptions of the products for sale into the software and loads the program.

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Lesson 3 Cost, Revenue, and Profit Maximization

When customers visit the “store” on the Web, they see a variety of goods for sale. In some cases, the owner has the merchandise in stock. In other cases, the merchant simply forwards the orders to a distribution center that handles the shipping. Either way, the fixed costs of operation are significantly lower than they would be in a typical retail store. And the break-even point of sales is much lower.

Reading Progress CheckContrasting What are the differences between an e-commerce store and a traditional business?

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NAME ________________________________________ DATE _______________ CLASS _________

Lesson 1 What Is Supply?


ESSENTIAL QUESTIONWhat are the basic differences between supply and demand?

Reading HELPDESKAcademic Vocabularyvarious different

Content Vocabularysupply amount of a product offered for sale at all possible prices in a market at a given point in timeLaw of Supply principle that more will be offered for sale at high prices than at lower pricessupply schedule a table showing the quantities produced or offered for sale at each and every

possible price in the market at a given point in timesupply curve a graph that shows the quantities supplied at each and every possible price in the

marketmarket supply curve supply curve that shows the quantities offered at various prices by all firms

that sell the product in a given marketquantity supplied amount offered for sale at a given price; point on the supply curvechange in quantity supplied change in amount offered for sale in response to a price change;

movement along the supply curvechange in supply different amounts offered for sale at each and every possible price in the

market; shift of the supply curvesubsidy government payment to encourage or protect a certain economic activitysupply elasticity responsiveness of quantity supplied to a change in price

TAKING NOTES: Key Ideas and DetailsUse a graphic organizer like the one below. In the Effect column, explain how supply and price react to demand.

Cause Effect

Demand increases

Demand decreases

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Lesson 1 What Is Supply?, Continued

Supply is the amount of a product that would be produced or grown and offered for sale at all possible prices that could prevail in the market. Demand is how much buyers want an item or service. Sometimes, though, other factors influence production.

Suppose that as a Student Council officer, your job is to obtain custom logo T-shirts for every member of your class. Because you want to get the best possible price, you plan to make inquiries, meet with suppliers, and finally ask for bids. You are also going to ask for quotes at three different price levels, but you want the same quality shirt to be supplied at each price. You haven’t done the work yet, and you only have a $1,000 budget, but the more you think about it, the more you think that you can predict the outcome.

On the basis of what you know about the Law of Supply, write a brief essay explaining the economic principles occurring here.

An Introduction to Supply Guiding Question Why do supply and demand curves slope in opposite directions?All producers must decide how much of a product to offer for sale at various prices. Each producer makes this decision according to what is best for him or her. What is best depends upon the cost of producing the goods or services and the consumer’s demand for them. A table or a graph can show the concept of supply, like it can for demand.

The Supply Schedule The supply schedule is a list of the various quantities, or amounts, of a particular product a producer would supply at all possible prices in the market. Panel A of Figure 5.1 shows a hypothetical, or imaginary, supply schedule for burritos at a certain price. It shows the quantities of burritos that will be supplied at various prices, if other things are equal. If you compare it to the demand schedule in Panel A of Figure 4.1, you will see that the two are very similar.

The main difference between Figure 5.1 and Figure 4.1 is that for supply, the quantity goes up when the price goes up—rather than down as in the case of demand. This is because a high price is a reason for a producer to offer more. But the same high price is a reason for a buyer to buy less.

The Individual Supply Curve We can also show the data in the supply schedule as the upward-sloping line in Panel B of Figure 5.1. To draw it, all we do is move each combination of price-quantity data in the schedule over to the graph. Then we connect the points to form the curve. The result is a supply curve, a graph showing the various quantities supplied at all possible prices that might succeed in the market at any particular time. Of course the prices and quantities in Figure 5.1 are a bit unlikely, but the numbers keep the graph simple.

The main thing to remember is that all normal supply curves have a positive slope, which means that it goes up when you read the diagram from left to right. This shows that if the price goes up, the quantity supplied will go up too.

The supply schedule and curve in Figure 5.1 show the voluntary decisions of one imaginary burrito producer. But remember that supply is a very general concept. In fact, you are a supplier whenever you look for a job and offer your services for sale. Your economic product is your labor. You would probably be willing to supply more labor for a high wage than you would for a low one.


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The Market Supply Curve The supply schedule and curve in Figure 5.1 show the information for a single producer. But often we are more interested in the market supply curve. This is the supply curve that shows the quantities offered at different prices by all producers that sell the product in a particular market.

It is simple to get the data for the market supply curve. First add the number of burritos that each business would produce. Then place those numbers on a separate graph. In Figure 5.2, point a’’ on the market supply curve represents three burritos that are for sale at a price of $2. The three burritos are two from the first company and one from the second company. In the same way, point b’’ on the curve represents a total of five burritos for sale at a price of $4.

Of course, two producers rarely represent all of the producers in a market. But if we could add all producers together, we might have a much more typical market supply curve like the one in Figure 5.2A. This figure has a wider range of prices and quantities because it represents all the producers in the market, not just two as in Figure 5.2.

A Change in Quantity Supplied The quantity supplied is the amount that a single producer or all producers bring to market at any one price. A change in quantity supplied is the change in the amount offered for sale in response to a change in price. In Figure 5.2, the supply curve S shows that producers supply 24 million burritos when the price is $5, and 36 million when the price goes up to $7. These changes show a change in the quantity supplied. This change appears as a movement along the supply curve, just like demand.

Notice that the change in quantity supplied can be an increase or a decrease. This depends on whether there is more or less of a product offered. For example, the movement from a to b in the final panel of Figure 5.2 shows an increase. It shows an increase because the number of products offered for sale goes from 24 million to 36 million when the price goes up. If the movement along the supply curve had been from point b to point a, there would have been a decrease in quantity supplied. The decrease in quantity supplied would have been because the number of products offered for sale went down.

In a market economy, producers react to changing prices in just this way. Take oil as an example. If the price of oil falls, producers may offer less for sale. They may even leave the market altogether if the price goes too low. If the price rises, producers may offer more for sale to take advantage of the better prices.

It makes no difference whether we are talking about an individual supply curve or a market supply curve. In either case, a change in quantity supplied only happens if there is a change in price. Also, a change in quantity supplied will not shift the supply curve to the left or the right. The change in price only affects the amount offered for sale along an unmoving supply curve.

Reading Progress CheckSynthesizing How might a producer of bicycles adjust the quantity supplied when prices decrease?

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Change in Supply Guiding Question What might happen to make a producer decrease the supply of a product? Sometimes something happens to cause a change in supply. This is when suppliers offer different amounts of a product for sale at all possible prices in the market.

Comparing a Change in Quantity Supplied to a Change in Supply The change in quantity supplied in Figure 5.2 is not the same as the change in supply shown in Figure 5.3. This is because the change in quantity supplied happens only when there is a change in price. When we have a change in supply, all quantities change even though the selling price stays the same.

For example, the supply schedule in Figure 5.3 shows that producers are now willing to offer more burritos for sale at every price. Before, producers offered 24 million burritos at a price of $5, and now they offer 36 million. If producers offered 36 million at a price of $7 before, they now offer 50 million, and so on.

When you put on a graph both old and new quantities supplied, it appears as if the supply curve has shifted to the right. This shows an increase in supply. For a decrease in supply to occur, producers would offer fewer products for sale at all possible prices. Then the supply curve would shift to the left.

Factors that Can Cause a Change in Supply Changes in supply can be increases or decreases. These changes can occur for the reasons shown below.

• Cost of Resources A change in the cost of producing a product can cause a change in supply. Production costs can include land, labor, and capital. Supply might increase because of a lower cost of production, such as labor or packaging. This would allow suppliers to produce more at every price. This would then shift the supply curve to the right.

An increase in production cost has the opposite effect. A higher production cost would force producers to offer fewer products for sale at every price. This would shift the supply curve to the left.

• Productivity Productivity is how many goods workers produce over a period of time. Productivity goes up whenever workers produce more with the same amount of resources. When management trains or motivates its workers, productivity usually goes up. This results in a supply curve that shifts to the right.

But if workers become less motivated, untrained, or unhappy, then productivity could go down. They would produce fewer goods at every possible price. This would shift the supply curve to the left.

• Technology Using a new machine or industrial process can lower the cost of production and increase productivity. For example, improvements in jet aircraft fuel have lowered the cost of air passenger service. When production costs go down, a firm can produce more at every possible price. This shifts its supply curve to the right.

New technologies do not always work at first, of course. In the beginning, the supply curve may briefly shift to the left. But companies expect new technologies to help over time, or they would not use them in the first place.


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• Taxes Firms consider most taxes to be a cost of production, just like raw materials and labor. This is one reason why businesses almost always lobby for lower taxes. If a company pays fewer taxes, it can produce more at each possible price. This would shift its supply curve to the right.

However, if taxes go up, its production costs go up and it will produce less at each and every price. This would shift its supply curve to the left.

• Subsidies A subsidy is a payment to an individual, business, or other group to encourage or protect a certain type of economic activity. Today many farmers in the milk, cotton, corn, wheat, sugar, and soybean industries receive subsidies to support their incomes. This shifts the supply curves of their products to the right.

When a government removes subsidies, production costs go up. Then companies either leave the market entirely or produce less at each possible price. This shifts their supply curves to the left.

• Government Regulations If government lessens its regulations on business, production costs go down and firms are able to produce more at all possible prices. This shifts individual supply curves to the right.

But more often, government increases its regulations. This raises a typical business’s cost of production. For example, when the government requires new auto safety features such as air bags, emission controls, or higher collision safety standards, cars cost more to produce. Producers then adjust to the higher production costs by producing fewer cars at every possible price. This shifts the market supply curve to the left.

Exploring the Essential Question How do government regulations affect supply and demand? Explain how a government regulation to increase bicycle safety might affect supply and demand. The new government regulation requires bicycle manufacturers to put a chain guard on bicycles they make. Would that affect the supply of bicycles? Give reasons for your answer.

• Number of Sellers Most markets are fairly active, with firms entering and leaving all the time. You may see this where you live, especially when one store closes and another opens in its place. Whenever an industry grows because more firms are coming in, the market supply curve shifts to the right.

Or, if the industry is shrinking because firms are leaving, there are fewer products at the same prices as before. This shifts the market supply curve to the left.

• Expectations Expectations—that is, what a firm thinks will happen in the future—can also affect the decisions a firm makes. These expectations may affect anything from the cost of production to the demand for the firm’s products. But unless we know more about these expectations, it is not possible to make any simple statements about the way they affect a firm’s supply curve.

As you can see, there are many factors that can cause a change in supply and so cause the market supply curve to shift to the left or to the right. But, only a change in price—which we learned in the previous section—can cause a change in quantity supplied, shown by a movement along a stationary, or nonmoving, supply curve.

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Reading Progress CheckExplaining Why do factors that cause a change in individual supply also affect the market supply curve?

Elasticity of Supply Guiding Question How does the production of a product affect the elasticity of supply?Just as demand has elasticity, so does supply. Supply elasticity is how much the quantity supplied responds to a change in price.

As you might imagine, there is very little difference between supply and demand elasticities. Demand elasticity relates to the buying of quantities of a product. Supply elasticity relates to the producing and offering for sale quantities of a product.

Three Cases of Supply Elasticity Figure 5.4 shows three examples of supply elasticity. In each case, we look at how the quantity supplied responds to a change in price. The quantity supplied depends on the change in price, which is the independent variable.

• Elastic Supply The supply curve in Panel A is elastic because the change in price causes a proportionally larger change in quantity supplied. Doubling the price from $1 to $2 causes the quantity supplied to triple from two to six units. Again, the prices and numbers are very simple, but it makes the diagrams easier to understand.

• Inelastic Supply Panel B shows an inelastic supply curve. In this case, a change in price causes a proportionally smaller change in quantity supplied. When the price doubles from $1 to $2, a 100 percent increase, the quantity supplied goes up only 50 percent, or from two units to three units.

• Unit Elastic Supply Panel C shows a unit elastic supply curve. Here a doubling, or a 100 percent change in price, causes an equally proportional change in the quantity supplied. As the price goes from $1 to $2, the quantity supplied also doubles.

What Determines Supply Elasticity? The elasticity of a producer’s supply curve depends on the type of production. If a firm can adjust to new prices quickly, then supply is likely to be elastic. If production needs more time to adjust to changes, then supply is more likely to be inelastic.

For example, the supply curve for nuclear power is inelastic in the short term. No matter what price is being offered, it is hard for electric utilities to increase nuclear power output. This is because of the huge amount of capital and technology needed. There is also the issue of extensive government regulation to consider.


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Lesson 1 What Is Supply?

However, the supply curve is likely to be elastic for many toys, candy, and other products that can be made quickly without huge amounts of capital and skilled labor. If consumers are willing to pay more for any of these products, most producers will be able to quickly prepare to greatly increase production.

Unlike demand elasticity, only production issues determine supply elasticity. If a firm can react quickly to a changing price, then supply is likely to be elastic. If the firm takes longer to react to a change in price, then supply is likely to be inelastic.

Reading Progress CheckComparing How are the elasticities of supply and demand similar? How do they differ?

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