SUPPLY

Chapter 5

What is Supply?

• Supply is the quantities that would be offered for sale and all possible prices that could prevail in the market.

Figure 5.1Figure 5.1

The Law of Supply

• The quantity supplied, or offered for sale, varies directly with its price.

• If prices are high, suppliers will offer greater quantities for sale. If prices are low, suppliers will offer smaller quantities for sale.

• A change in overall supply will cause the Demand curve to shift.

• A change in quantity demanded will move along the original curve.

Supply Curve

• Individual Curve– Illustrates how the quantity that a producer makes

varies depending on the price that will prevail in the market

• Market Curve – Illustrates the quantities and prices that all

producers will offer in the market for any given product or service

• Economist analyze supply – by listing quantities and prices in a supply

schedule – Forms supply curve with and UPWARD slope

Figure 5.2Figure 5.2

• Quantity supplied:– The amount that producers bring to the

market at any given price

• Change in Quantity Supplied;– The change in the amount offered for sale

in response to a change in price

Change in Quantity Supplied

Quality Supplied

• Illustrates a change in quantity supplied – Shows as a

movement along the line

– Can increase or decrease amount of the product (movement from a to b)

Figure 5.1Figure 5.1

• Situation where suppliers offer different amounts of products for sale at all possible prices

Change in Supply

Figure 5.3Figure 5.3

Change in Supply(cont)

• Supply Curves can also shift in response to the following factors:– Resource costs: cost to purchase factors of

production will influence business decisions– Productivity: increases whenever more output is

produced with the same amount of inputs– Technology: improvements in production increase

ability of firms to supply– Taxes: firms view taxes as a cost of production and

lobby for lower taxes

Change in Supply (cont)

– Subsidies: government subsides encourage production, while taxes discourage production

– Government regulations: if government decides to reduce its regulations on business, production costs go down and firms produce more output at all possible prices

– Number of sellers: how many firms are in the market

– Expectations: businesses consider future prices and economic conditions

Elasticity of Supply

• Supply Elasticity: a measure of the way in which a quantity supplied responds to a change in price

• Elastic – Small increase in price leads to a larger increase

in output—supply • Inelastic

– Mall increase in price causes little change in supply

• Unit Elastic – A change in price causes a proportional change in

supply

Figure 5.4aFigure 5.4a Figure 5.4bFigure 5.4b

Figure 5.4cFigure 5.4c

Figure 5.4dFigure 5.4d

Determinants of Supply Elasticity

• How quickly a producer can act when a change in price occurs:– Adjust quickly = elastic – Complex/advance planning = inelastic

• Factor of Substitution:– Easy = elastic – Difficult = inelastic

The Law of Variable Proportions

• Short Run:– Output will change as one variable input is

altered, but other inputs are kept constant – i.e.: salting a meal (amount of input –salt- varies;

so does the output – quality of the meal) • Final Product is affected

– How is the output of the final product affected as more units of one variable input or resources are added to a fixed amount of other resources?

– i.e.: farmer may have all the land, machines, workers, and other items needed to produce a crop, but may have questions about the use of fertilizers ,

The Production Function

• Concept that describes the relationship between changes in output to different amounts of a single input while others are constant

• Possible to vary all the inputs at the same time – Economist prefer only a single variable be

changed at a time – b/c more than one = harder to gauge the

impact of a single variable

The Law of Variable Proportions

• Total product is the total output the company produces – Total Product Rises

• As more workers are added, total product rises until a point that adding more workers causes a decline in total product

– Total product Slows• As more workers are added output continues

to rise = it does so at a slower rate until ti can grow no further

– More workers “get in the way”

The Production Function

• Marginal Product is the extra output or change in total product caused by adding one more unit of variable output– i.e.: worker 1’s output is 7; worker 2’s

output is 13 together their output is 20 (figure 5.5)

The Production Function

Figure 5.5aFigure 5.5a

Figure 5.5bFigure 5.5b

Three Stages of Production

• Stage I: increasing returns – Marginal output increases with each new worker – Companies are tempted to hire more workers

(moves them to stage II)• Stage II: diminishing returns

– Total production keeps growing but the rate of increase is smaller

– Each worker is still making a positive contribution to total output (but diminishing)

• Stage III: negative returns – Marginal product becomes negative – Decreasing total plant output

Cost, Revenue and Profit Maximization

What kinds of cost do you have to consider?

• Fixed Cost – the cost that a business incurs even if the plant idle and output is zero.– Salaries– Rent– Property Taxes– Variable Cost – cost that does change when the

business rate of operation or output changes– Electric power– Shipping charges

What kinds of cost do you have to consider?

• Variable Cost – cost that does change when the business rate of operation or output changes– Electric power– Shipping charges

• Total Cost – Sum of the fixed and variable costs

• Marginal Cost – Extra cost incurred when a business produces one additional unity of a product.

Figure 5.6Figure 5.6

Measure of Revenue

• Average Revenue=

-The average price that every unit of

output sells for

Total revenue = – Number of units sold multiplied by the average

price per unit

• Marginal Revenue =– The extra revenue connected with producing

and selling an additional unit

Marginal Analysis

• Profit maximization quantity of output is reached when marginal cost and marginal revenue are equal

• Break-even point is the total output or total product the business needs to sell in order to cover its total cost

Applying Cost Principles

• Self-service Principles – Gas station is an example of high fixed

cost with low variable cost– Ration of variable to fixed cost is low

• E-Commerce – An industry with low fixed cost