Download 05--Law of Supply

Supply and Cost
■ Our objectives:
 Explain choices given unlimited wants
in the face of limited resources.
 Develop a theory that helps us
understand what we observe in the
world.
Cost—always an issue in production (supply).
1700: Production of pots in England & China.
Why the different technology? Think about cost.
Supply chains are now very complicated,
so we use a simple model to understand
Opportunity Cost
 The cost of any choice is the best opportunity
not taken (sacrificed). Hence we say
“opportunity cost.” This can only be known by
the individual decision maker. Costs are
subjective.
 When we measure costs, opportunity cost is
the true measure, but we mostly focus on
accounting or objective costs.
Remember: Costs are never fully
known because some are subjective.
Put Theory into Practice
“Opportunity cost is the value of the most
valuable alternative that must be forgone
to undertake a given act. In decision
making, we must look at opportunity cost
rather than book costs. That is, we must
look forward rather than backward.”
 Charles G. Koch, CEO Koch Industries,
p. 33, “The Science of Success”

The (weak) Law of Supply
■ Holding other relevant factors constant,
the higher (lower) the price of a good, the
greater (smaller) will be the quantity
supplied.
▪ Like all scientific propositions, it is a ceteris
paribus (“other things equal”) statement
■ Note the terminology:
- changes in the price of the good lead to
changes in “quantity supplied”
- they do not lead to changes in “supply”
Foundations
■ The principle of Rising Marginal Cost
► As the rate of production rises in a
certain time period, given fixed inputs and
technology, at some point the marginal
cost of producing the next unit rises
► So, in a market, supply usually reflects
the marginal cost (MC) of suppliers as
they evaluate their alternatives.
We Are All Garbage Men
Holding all else constant, the following is true if we
survey a group of possible workers:
Number of Volunteers
1
2
3
4
5
Price Offered
$10/hour
$20/hour
$50/hour
$80/hour
$200/hour
Rising Marginal Cost or
Opportunity Cost of Suppliers
$ Price
200
MARGINAL COST = SUPPLY
80
50
20
10
1
2
3
4
5
Volunteers per time period
The Supply Function
■ S = f (P, I, T, etc.)
Price of the good itself—determines the location
along the supply curve
■ Other factors—determine the placement of the supply curve:
► Prices of inputs (also called “factor prices”)
► Technology (e.g, state of knowledge; regulations)
► Other variables particular to each good, including weather
conditions, etc.
Summarize the Supply Curve
It represents the valuations of many
different existing and potential
suppliers in a market, each making their
own decision.
What is best for me, as I see the world?
As I understand my opportunity costs.
A simple curve to help us sharpen our
thinking about markets.
Change in Price

A change in the price of a good means a
movement along a given supply curve.
Price
Supply
Pa
Pb
Quantity/time
Qb
Qa
Increase in Supply
(A Decrease in Supply Is Opposite)
Price
Sa
Caused by: Lower Factor Prices,
Improvements in Technology; other
changes that lower marginal
costs of production.
Sb
Pa
Not caused by
Change in price
Qa
Qb
Quantity
Question on Supply
In 1998, DVD players cost almost
$1,000. Only a few were sold.
Now DVD players cost as little as $30.
Why can suppliers provide them at such
a lower cost?
What else impacted decision to supply
and the demand?
Opportunity Cost Question:


Suppose average tickets to the
Superbowl usually sell for $1,000, but
can be resold for about $3,000. Suppose
you bought a ticket for $1,000 and can
go to the game.
What is the opportunity cost of going to
the game?
Flat Screen TVs and Movies:
Change in One Market Impact Another



Matsushita invested $1 billion+ in a new flat
screen TV plant. Production over 2.5 million per
year.
Economies of scale allows price to drop while
profits increase due to lower per unit cost
compared to rivals. Some rivals will die.
Thinking about demand: Increase in bandwidth
means cost of delivering movies to a home users
falling rapidly. Value of TV changes. [Who will
lose markets?]
Costs are imperfect but are worth studying
for opportunities: Where is the value for the
demander?
Consider a music CD that retails for $15.99:
24% ($3.83) is retail overhead.
18% ($2.88) is overhead for the label
15% ($2.40) is marketing
11% ($1.76) is label accounting profit
10% ($1.60) is artist royalty
6% ($0.96) is distribution cost
5% ($0.80) is retail accounting profit; 5% manufacturing;
5% publishing accounting royalties
What does the consumer want?
Any wonder this industry is in turmoil?
Book Publishing—Change?
The Associate by John Grisham, $27.95 list:
$3.55, editors, graphic designer, etc.
$2.83, printing costs
$2.00, marketing
$2.80, wholesaler
$4.19, author royalties (high because star author)
$12.58, retailer (45% of list); often discounted
Room for change? Typical best seller author gets 20%;
Amazon offering 45-50%; if self-publish, 75%
Supply and Competition Are
Increasingly Global
Cost of Heart Bypass Operation:
U.S.: $130,000 Singapore: $18,500 India: $10,000
Cost of a Hip Replacement:
U.S.: $43,000 Thailand: $12,000 India: $9,000
Number of “Medical Tourists” to Thailand:
2000: 500,000
2010: 2,000,000
(33% from U.S.; 29% from China; 18% from
Japan; 14% from England)