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Chapter 5
The Law of Supply
The Law of Supply
 When prices go up, supply goes
up
 When prices go down, supply
goes down
Why Does it Work That
Way?
 Let’s say
you’re selling
ska CDs…
 Ska isn’t very
popular, so
you sell yours
for $8 each
Why Does it Work That
Way?
 Suddenly,
everyone who
is cool is
listening to ska
and wearing
ties to school
 What happens
next?
Why Does it Work That
Way?
 You are now
free to charge
$16.99 for a
CD, and make
a killing
 What happens
next?
Why Does it Work That
Way?
 All sorts of
record labels
start signing
every ska
band there is
 Supply has
gone up!
Why Does it Work That
Way?
 Every company has a certain
amount of resources
 Companies will use the resources
they have to produce the most
profitable goods and services
 If the price goes up and people still
buy it, businesses make more
money!
This reminds
me of when
Saddam tried
to kill my dad.
Like I said
before, “Don’t
Mess with
Texas.”
Supply Schedule
 Works just like a demand
schedule, with a column for price
and a column for quantity
supplied
Supply Curve
 Graphs the
supply
schedule
 The line is
opposite the
demand curve!
Supply Curve
 You can make a
supply curve for
just your
business or for
the entire market
– a market
supply curve
Supply and Elasticity
 Supply is elastic when a small
price change leads to a big
change in quantity supplied
 Supply is inelastic when a big
price change still has little effect
on quantity supplied
Elasticity in the Short Run
 Some business
cannot respond
to price changes
quickly
 Producers of
goods (farmers,
factories, etc.)
Elasticity in the Short Run
 Other business
respond very
quickly to price
changes
 Service industry
can hire more
workers to
produce more
immediately
Elasticity in the Long Run
 When businesses have a long
time to respond to price
changes, supply is even more
elastic
 Time is the most important factor
in determining elasticity of supply
Costs of Production
Labor and Output
 How do companies decide how
many people to hire?
 Marginal Product of Labor – the
change in production output from
hiring one more worker
Marginal Product of Labor
 Let’s say you’re
making delicious
Sweet Onion
Chicken Teriyaki
sandwiches…
 How many
sandwiches can
1 Subway
employee make
in 5 minutes?
Marginal Product of Labor
 Let’s say you’re
making delicious
Sweet Onion
Chicken Teriyaki
sandwiches…
 How many
sandwiches can
2 Subway
employees make
in 5 minutes?
Marginal Product of Labor
 Increasing Marginal Returns –
when adding workers increases
production
Marginal Product of Labor
 Diminishing Marginal Returns –
when adding workers still
increases production, but at a
slower rate
Marginal Product of Labor
 Negative Marginal Returns –
when adding more workers
decreases production
Production Costs
 Production costs are any
expenses that go into making a
product
 Electricity, Worker’s Wages,
Worker’s Benefits, Rent, Gas,
Raw Materials, etc.
Production Costs
 Fixed Cost – does
not change, no
matter how little
or much is
produced
 For example:
machinery
repairs, rent,
salaried
employees
Production Costs
 Variable Costs –
costs that rise or
fall based on
how much is
produced
 For example:
Raw Materials,
Hourly Workers,
Gas, Electricity
Calculating Total Cost
 Total Cost = Fixed Cost + Variable
Cost
 TC = FC + VC
Calculating Average Total
Cost
 Average Total Cost = Total Cost
Total Output
 ATC = TC / Qs
With President George W. Bush
Production Costs
 Marginal Cost – the additional
total cost of producing one more
unit
 So if producing one Sweet
Onion Chicken Teriyaki costs
$1.50, and producing two costs
$2.50, marginal cost is $1.00.
Production Costs
 At first, the more you produce,
the cheaper it is per item to
produce them
 Later on, increasing production
will actually hurt the company’s
profits
That’s Right!
 Because eventually, diminishing
and negative marginal returns
set in when you have too many
workers!
Setting Output
 Businesses, thus, base their
hiring decisions on maximizing
profit – they study marginal cost
How can I line my
pockets with more
indescribable wealth?
Marginal Revenue and
Marginal Cost
 Marginal Revenue is the
additional income from selling
one more product
 Typically, MR = Price
 The best formula for a business
to use is for their marginal
revenue to = their marginal cost
How does this work?
 If it will cost you $.30 to make
another bag of Reese’s Pieces
that you will sell for $.60…
How does this work?
How does this work?
 If it will cost you $.45 to make
another bag of Reese’s Pieces
that you will sell for $.60…
How does this work?
How does this work?
 If it will cost you $.60 to make
another bag of Reese’s Pieces
that you will sell for $.60…
How does this work?
Responding to Price
Changes
 When the price goes up for a
good, how do businesses
respond?
 What if Reese’s Pieces suddenly
cost $1.00?
Responding to Price
Changes
Remember: Your marginal
revenue is now way above
marginal cost
When to Shutdown
 If marginal revenue = marginal
cost and you are still losing
money…
 You are in big trouble!
 Profit is already maximized and
you are still behind!
Changes in Supply
Hey, class! What
kinds of things do
you think might
affect supply?
5 Factors that Shift Supply
 1. Input Costs – costs that go into
producing your good
 The business would naturally produce
less if the product is less profitable
 Higher input costs shift supply left,
lower input costs shift it right
5 Factors that Shift Supply
 2. Technology - can decrease
input costs
 Email has virtually eliminated
many long distance phone bills
and mail delivery charges for
some businesses
 Better technology shifts supply to
the right
5 Factors that Shift Supply
 3. Number of suppliers
 New businesses entering the
market shifts supply to the right
 Businesses closing down and
leaving the market shift supply to
the left
5 Factors that Shift Supply
 4. Government
 Can encourage
or discourage
production of
certain goods
5 Factors that Shift Supply
I want your
 If the government
money!!
wants to shift supply
left, it uses:
Excise Taxes – a
tax on the
production or
sale of a good
5 Factors that Shift Supply
 If the government
wants to shift supply
left, it uses:
 Regulations –
government
intervention that
affects the price,
quantity, or quality
of a good
5 Factors that Shift Supply
 If the government wants to push
the supply curve to the right, it
uses:
 Subsidies- pays the producer a
set amount per good
 Deregulation – gets rid of
existing gov. regulations
5 Factors that Shift Supply
 5. Producer Expectations
 If producers expect prices to
go up in the future, they store
their goods now until they can
sell them for the higher price
 Shifts current supply left
5 Factors that Shift Supply
 5. Producer Expectations
 If producers expect prices to
go down in the future, they
flood the market now to get rid
of them before the price drops
 Shifts current supply right