Download 100 - Gore High School

The Supply Side
of the Market
A.S 3.3
Introduction
 Supply
is the amount of a good or service that a
producers is willing and able to offer the market at a
range of prices
 Key

factor affecting supply of a product
Cost of production
 Raw
materials
 Wages
 Packaging
 Advertising
Costs of production are a key determinant of supply
Types of Costs
 Two
main types
 Variable

Costs that change as output changes e.g. wages,
electricity, packaging
 Fixed

Costs
Costs
Costs that remain the same regardless of output
e.g. rent, insurance
Total Costs = Variable Costs + Fixed Costs
Fixed costs are costs that
do not vary with output
Q
FC VC
0 100
1 100
2 100
3 100
TC
Fixed costs are costs that
do not vary with output
Variable costs are costs
that increase as output
increases
Q
FC
VC TC
0
100
1
100 30
2
100 50
3
100 80
0
Fixed costs are costs that
do not vary with output
Q
FC
VC TC
Variable costs are costs
that increase as output
increases
0
100
1
100 30 130
Total costs = Fixed +
Variable costs
2
100 50 150
3
100 80 180
0 100
Relationship between Total costs
and output
TC
Costs($)
TVC
TFC
OUTPUT
The Shape of Average Cost
Curves
Costs($)
FC are constant so AFC will
continually decline as FC are
spread over increasing output
FC
AFC
Quantity
http://www.youtube.com/wat
ch?v=nQ5APwtBig&safe=active
Marginal Costs

Marginal cost is the extra cost of the last
unit produced

In the short run only changes in variable
costs affect marginal costs
The importance of Marginal Cost
 Marginal
cost is important because a firm
will only produce an extra unit if the price
that it receives is greater than or equal to
marginal cost of producing that unit.
 Marginal
cost is important in determining if
a firm will supply extra units
Example Factory that
produces lawn mowers
Output
Total Cost
Marginal Cost
100
$4500
$430
101
$5000
102
$5700
$500
$700
103
$6600
$900
How many units should the firm produce if the price it receives
for motor mowers is
101
$500? ___________
102
$800?___________
Average Costs

Average Total costs = Total Cost ÷ Output

Average Variable costs = Total Variable costs ÷ Output

Average Fixed Costs = Total Fixed Costs ÷ Output

Average Total Costs= Average Variable costs + Average Fixed Costs

Average Total costs = Total Cost ÷ Output

Average Variable costs = Total Variable costs ÷ Output

Average Fixed Costs = Total Fixed Costs ÷ Output

Average Total Costs= Average Variable costs + Average Fixed Costs
Costs
Output
Total
Costs
Fixed
Costs
0
1
2
3
4
5
100
100
100
135
160
180
192
250
Variable Average Average
Costs
Costs
variable
costs
0
N/A
N/A
35
60
135
80
35
30
80
60
26.66
100
92
48
23
100
150
50
30
100
100
Average Marginal
fixed
Cost
costs
N/A
N/A
100
50
33.33
25
20
35
25
20
12
58
The Shape of Average Cost Curves
Costs($)
The difference
between AC
and AVC is
equal to AFC
AC
AVC
AFC
Quantity
Workbooks page 123
 http://www.youtube.com/watch?v=S3iLM
fm6CGY&safe=active
 http://www.youtube.com/watch?v=UI-
LL8-dVAs&safe=active
Short-run Time Period
In economics we distinguish between various time periods
- ie short and long run.
The short run, is a period of time in which at least one
resource cannot be increased.
We usally assume that capital such as machinery is the
resource that is fixed in the short run.
This means all firms will then be subject to the Law of
Diminishing Returns
fig
Diminishing Returns
As more of a variable resource (labour) is added to a
fixed resource (capital or land), the extra output
(Marginal Product) will eventually decrease.
Key Definitions
Marginal Product – the extra output from adding one
more unit of resource such as labour
Increasing returns – occur when a variable resource e.g.
labour is added to a fixed resource and marginal product
is increasing
Constant returns – occur when a variable resource e.g.
labour is added to a fixed resource and marginal product
increases by a constant amount
Decreasing returns – occur when a variable resource e.g.
labour is added to a fixed resource and marginal product
is decreasing
Example
Number of
workers
Number of
haircuts
Marginal (extra) Increasing or
Product of
Diminishing
extra worker
returns?
1
10
10
Increasing
2
30
20
Increasing
3
70
40
Increasing
4
130
60
Increasing
5
160
30
Diminishing
Cost Curves and Firms Supply
The Shape of the MC curve
Costs($)
MC decreases
initially because
of increasing
returns
MC increases
because of
diminishing
returns
MC
Note: always
plot the MC
curve at the
mid-point!
Quantity
The Shape of Average Cost Curves
Costs($)
AC
decreases
because of
increasing
returns and
increases
because of
diminishing
returns
AC
AFC
Quantity
The Shape of Average Cost Curves
Costs($)
AC
AFC
Quantity
Marginal Cost & Average Cost
Costs($)
MC
AC
If MC<AC
then AC will
be decreasing
Quantity
Marginal Cost & Average Cost
Costs($)
MC
AC
If MC>AC
then AC will
be increasing
Quantity
Marginal Cost & Average Cost
MC cuts AC
at its
minimum
point - this is
the technical
optimum
This is when the firm
is using the best mix
of resources and is
producing
maximum output at
the least possible
cost.
Costs($)
MC
AC
Quantity
Marginal Cost & Average Variable Cost
Costs($)
MC also cuts
AVC at its
minimum
point
MC
AC
AVC
Quantity
MC, AVC AND AC

Why does MC cut AVC and AC at their lowest
points?

Marginal cost is the cost of the last unit
produced.
When marginal cost is below the average
cost it is pulling the average down.


When it is above the average costs it is pulling
them up, therefore it must intersect AC and
AVC at their lowest points
Break Even & Shut Down
A firm must
cover AC if it
is to break
even
Costs($)
MC
AC
AVC
Break even point
is where AR=AC.
Where the price is
enough to cover
all costs and the
firms make
normal profits.
This is the break
even point
Quantity
Break Even & Shut Down
Costs($)
In the SR a
firm can
survive if
P > AVC
MC
AC
AVC
This is the shut
down point
Quantity
A firm’s Supply
curve is derived
from the MC
curve above the
shut-down point
The Supply Curve
Costs($)
The supply curve is
upwards sloping
because of diminishing
returns!
Producing higher levels
of output results in
progressively less
efficient resource
combinations. Because
of this the firm will
only supply a larger
quantity at higher
prices.
MC =S
AC
AVC
Quantity