Download (weak) Law of Supply

Lecture 4
The (weak) Law of Supply
■ Our objectives:
► Explain individual choices among unlimited
wants in the face of limited resources
► Develop a theory that satisfies the universal
criteria for theories
► Apply the theory to what we observe around us
The Law of Supply
■ Holding other relevant factors constant, the higher the price of
a good, the greater will be the quantity supplied.
► Like all scientific propositions, it is a ceteris paribus (“other
things equal”) statement about the world
► It is symmetric: a lower price leads to a smaller quantity
supplied
► Note the terminology:
- changes in the price of the good lead to changes in “quantity
supplied”
- they DO NOT lead to changes in “supply”—more on this later
What do we get with
the Law of Supply?
■ It, too, is powerful proposition in economics
► Overtime pay
► Overtime delivery more expensive than second
day air
► The existence of “record-breaking” crowds at
established stadiums
Foundations
■ The principle of Rising Marginal Cost
► As the rate of production rises, the marginal cost the next
unit rises
■ Decision Rule
► Choose a rate of production so that marginal cost of the
last unit equals the price:
MC = P
■ When combined, these yield the Law of Supply
Rising Marginal Cost
Rate of Production
1
2
3
4
5
Marginal Cost
1.00
1.20
1.45
1.75
2.10
Rising Marginal Cost
$$
MARGINAL COST
Adding the Decision Rule MC = P
yields the Law of Supply
Price
MC
The Supply Function
Summarizes the relationship between quantity supplied
and the factors that determine that quantity
■ Price of the good in question—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 matters, particular to each good, including weather
conditions, etc.
The Supply Function
(As we will use it)
■ The rate of production of a good is a function of
►The “own” price of the good
--------------------------------------►The ceteris paribus conditions:
-Prices of inputs
-Technology
-Other factors peculiar to the good
The height of the supply curve shows the
level of marginal costs at the Q
$
Units/time period
Changes in Supply
Price
Decrease
Increase
Output
Increase in Supply
Caused by
-Lower factor prices
-Improvement in technology
-Other charges that
REDUCE marginal costs
Decrease in Supply
Caused by
-Higher factor prices
-Degradation in technology
-Other changes that
RAISE marginal costs
decrease
Terminology
This is important to avoid confusion and reduced wealth
■ Changes in quantity supplied
► Caused by changes in own price of good
► Refer to a movement along a given supply curve
■ Changes in supply
► Caused by changes in ceteris paribus conditions
-Factor prices
-Technology
-Other elements in “Z-vector”
► Refer to a shift of the entire supply curve
■ Be precise and you’ll be richer
Questions on Supply

Suppose a genius writes a new
software program, that is easy to copy,
that doubles the productivity of
computers.
What affect will that have on the supply
of computers?
Supply Question

Suppose 100 million consumers
around the world suddenly decide that
corn is very healthy to eat and will
prevent cancer. How does this affect
the supply of corn?
Question on Supply
In 1998, DVD players cost almost
$1,000. Only a few were sold.
Now DVD players cost about $90.
Why can suppliers provide them at such
a lower cost?
How might this affect demand?
What else would impact demand?
