Download Chapter 5 Supply_Brown

Chapter 5:
The Law of Supply
(Looking through the eyes of the Producer)
“Quantity Supplied”
Defined:
The Quantity Supplied is the
amount of a good or service that
sellers are willing (motivation) and
able (have resources/factors) to sell .
Law of Supply
Law of supply –
the quantity supplied rises when
the price of the good or service rises.
$
= SUPPLY
– As the price of a product rises,
PRODUCERS will be willing to supply
more.
Supply Curve
Price
(monthly bill)
Supply Curve
140
• Notice how the law of
supply is reflected by
the shape of the supply
curve.
• As the price of a good
rises …
... producers supply more.
120
100
80
60
This is how much they
are willing and able to
sell, not how much
they actually sell
5
10
15
20
25 30
Quantity
(of Cell Phone
Subscribers)
Supply & Costs
Relationship
Role of Costs in Shaping the Supply Curve
To understand the law of supply, we must
recognize that companies need profits.
•Profit occurs when revenues are
greater than all costs (make more
than you spend).
• Revenue- money made from
selling products.
Role of Costs in Shaping the Supply Curve
• Variable cost are cost that CAN change month
to month depending on production
• Ex- changes when production
increases/decreases- hourly wages of workers,
electricity, shipping, gas…
Let us look at some examples of these costs.
VARIABLE
COST
Role of Costs in Shaping the Supply Curve
• Fixed cost- are cost that CANNOT change month
to month. They are steady regardless of the
amount of production.
• Ex- DO NOT change when production increases/
decreases, must be paid even if no production
takes place- rent, manager’s salary.
Let us look at some examples of these costs.
MONTHLY
INSURANCE
PAYMENT
MANAGER’S COMPANY CAR
FIXED
COST
Total Costs
Variable Costs + Fixed
Costs = Total Costs
Review:
•Variable Cost
•Fixed Cost
•Law of Supply
Law of Diminishing
Returns
Law of Diminishing Returns
As production increases, additional costs
increase.
– When benefits > costs: production continues
– When benefits < costs: production ends
Simply put, too much production can be a bad thing.
Every company can reach a point where it cannot supply
any more goods regardless of increases in price.
LET’S LOOK AT AN EXAMPLE
Elasticity of Supply
Elastic and Inelastic Supply
ELASTIC SUPPLY: quantity supplied is SENSITIVE
to small price changes .
 If the marginal costs to make an additional
good are low, then the producer will be more
likely to produce the good if the price changes.
INELASTIC SUPPLY: quantity supplied is NOT
SENSITIVE to small price changes .
 If the marginal costs to make an additional good
are high, then the producer will be less likely to
produce the good if the price changes.
Inelastic and Elastic Supply Curves
$
(per auto)
27,000
Supply for
Camries
24,000
21,000
18,000
Supply for
Corollas
15,000
13,000
Quantity
(per month)
Elastic and Inelastic
• If the market price for
Supply
Curves
motor oil was to rise
from $1.25 to $2.00, the
quantity supplied in the
market increases
insignificantly
$
2.00
1.25
Motor Oil
INELASTIC
(from 7 to 8 units).
• If the market price for
burgers rises from $1.25
to $2.00, the quantity
supplied in the market
increases substantially
$
1 2 3 4 5 6 7 8 9 10
2.00
Burgers
(from 1 to 8 units).
• Burger supply is highly 1.25
sensitive to price changes
and can be described as
elastic; motor oil supply
is insensitive to price
changes and can
be described as inelastic.
Q
ELASTIC
1 2 3 4 5 6 7 8 9 10
Q
Elastic and Inelastic Supply Curves
Price 100,000
Chopper
(per unit)
75,000
1 2 3 4 5 6 7 8 9 10
Price
200
QUANTITY
iPod
(per unit)
125
1 2 3 4 5 6 7 8 9 10
QUANTITY
Elasticity in Short Run and Long Run
Short-Run - Firms don’t have enough
time to adjust production in a short period
of time (ex: stuck with current factory size).
 Supply tends to be inelastic in the short-run .
Long Run - Firms have enough time to
adjust in a longer period of time.
(ex: build a larger factory, thus benefiting from mass producing
a good).
 Supply tends to be more elastic in the long-run.
ELASTICITY and SIZE of a FIRM
If costs rise when they produce more, then why do they produce more.
Which company do you think has a LOWER cost per
unit (thus a larger profit margin)?
OR
Grandma’s Kitchen
What is this called when one benefits from mass production??
ECONOMIES OF SCALE
 The MORE you produce/buy the
LOWER the average cost per item.
Changes in Supply vs. Quantity Supplied
Change in “Supply” - shift OF the supply
curve due to a determinate
change.
A shift to the right =
$ Price
increase in supply
8.00
A shift to the left =
decrease in supply
5.00
1.00
1
5
10
Quantity
Change in “Quantity Supplied” - movement
ON the supply curve in response to a price
change.
$ Price
5.00
1.00
1
5
10
Quantity
THE DETERMINANTS OF SUPPLY
THE ONLY FACTORS THAT CAN
CAUSE A SUPPLY CURVE TO SHIFT
TO THE LEFT (decrease) OR RIGHT
(increase).
$ Price
8.00
5.00
1.00
1
5
10
Quantity
THE DETERMINANTS OF SUPPLY
1. GOVERNMENT ACTIONS
Taxes, Subsidies, Regulations
2. OUTLOOK OF FUTURE (Supplier’s Expectations)
3. SIZE OF INDUSTRY(positive relationship)
4. PRICE OF RELATED PRODUCT LINES
Look at the market price of a good to determine which
one to produce.
5. INPUT COSTS (inverse relationship)
6. TECHNOLOGY(positive relationship)
THE DETERMINANTS OF SUPPLY
Outlook of Future (positive relationship)
A storm is predicted to destroy most of the seaports where most
imported oil is delivered.
 Gas companies, expect that consumer demand after the storm will
increase so they cut back on the current supply (shift left).
 After the storm hits and demand increases, suppliers will increase their
supply until it runs out (usually because they take advantage of the
higher prices).
$ Price
5.00
3.00
5m
10m
Quantity
(gallons)
THE DETERMINANTS OF SUPPLY
PRICE OF RELATED GOODS THAT SHARE
THE SAME RESOURCES
• Look at the market price of a good to determine which one to produce.
 DONUT COMPANY: price of donuts decreases
 Less likely to produce donuts and more likely to use the
dough to produce more donut holes (supply curve for rolls
shifts right)
 THEREFORE, an increase in price of good the resources
could go toward = supply curve of the other good
decreases (shifts left)
SUPPLY
=
$
THE DETERMINANTS OF SUPPLY
RESOURCE PRICES (inverse relationship)
As the price of resources goes $ then a supplier will
the supply of a good and look for something else to make.
As the price of resources goes $ then a supplier will
the supply of a good because he/she is making a profit.
$
LUMBER
=
SUPPLY
HOUSE CONSTRUCTION
THE DETERMINANTS OF SUPPLY
TECHNOLOGY (positive relationship)
Increase in technology = increase in amount supplied (shifts right)
Decrease in technology = decrease in amount supplied (shift left)
=
T
SUPPLY
THE END
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