EconS 451: Lecture #7 Supply Review • Understand the relationship between average and marginal cost curves and supply (both long-run and short-run). • Be able to calculate the elasticity of supply and understand what values indicate Inelastic and Elastic supply. • Understand the relationship between product price and factor price and the quantity produced of a given product. • Be able to understand those factors which shift (or influence) supply……and how. • Describe the concept of “Supply Response”. • Describe…..in detail how changes in marketing margins impact producers relative to consumers. Producer’s Goal Max π s.t. Production Technology Profit Maximization Occurs: MR = MC Cost of Revenue / Unit Cost Curves and Supply Marginal Cost Curve P2 Average Total Cost P1 Average Variable Cost Q1 Q2 Quantity / Unit Time Cost Curves and Supply $ Price Short Run Long Run Quantity / Unit Time Price Elasticity of Supply Percentage change in Quantity Supplied in response to a 1 percent change in price, all other factors held constant. Q P Es P Q Es = 0 0 < Es < 1 Es > 1 Perfectly Inelastic Inelastic Supply Elastic Supply $ Price Changes in Supply Elasticity Quantity / Unit Time Factors influencing Supply • Input prices • Technology • Change in returns from products that compete for productive resources. • Joint products • • Soybean / Soybean Meal Lambs / Wool • Price and Yield Risk • Government Intervention Cost Curves and Supply $ Price S 1 Original Input Price S2 Lower Input Price P1 P2 Q1 Quantity / Unit Time Product – Factor Price Relationship • Producer Optimizes Factor Use: M Px • Pfactor Pproduct Optimum factor use (of input x) will change when relative factor input / product prices change. Factor Price Input Prices and Supply Sx P1 P2 D2 D1 X1 X2 Quantity Input X Factor Price Input Prices and Supply Sx P1 P2 D2 D1 X1 X2 Quantity Input X Supply Changes • Shift • Parallel shifts from changes such as input costs. Q P X • Structural Change • Changes in the parameters or functional form (technology, government programs). Q P X 2 Supply Response Path $ Price S2 Price Increase Response S1 P2 Price Decrease Response P3 P1 Q1 Q3 Q2 Quantity / Unit Time Historical Supply Shifts S1 $ Price S2 P1 P2 Historically, changes in aggregate output have been associated with supply shifts rather than movements along the supply curve. D1 Q1 Q2 Quantity Marketing Margin Changes $ Price Derived Supply 2 (Retail) RP2 Derived Supply 1 (Retail) M2 Primary Supply (Farm) RP1 M1 FP1 FP2 Primary Demand (Retail) Derived Demand 1 (Farm) Derived Demand 2 (Farm) Q2 Q 1 Quantity / Unit Time Methods for Reducing MM • Operational Changes • Reduce # of middlemen. • Reduce risk. • Modify marketing structure / organization. • Change laws for unfair trading practices. • Improve Efficiency • Technological advancements. • # and location of firms. • Economies of size. Short Run Supply Elasticities Crops Elasticity Livestock Elasticity Potatoes .8 Eggs 1.2 Soybeans .5 Poultry Meat .9 Feed Grains .4 Hogs .6 Cotton .4 Beef .5 Tobacco .4 Milk .3 Wheat .3 Fruits .2 Summary Questions • Are agricultural products such as wheat and feed grains generally have inelastic or elastic supply elasticities? • In describing the “supply response”, are the elasticities of supply equal for price increases and decreases? Why? • If output prices drop by 20% and input prices drop by 20%, how much will output change? • At low levels of output, is aggregate (or individual) supply more elastic or inelastic? Why?