1. Chapter 5 Section Main
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Understanding Supply
• What is the law of supply?
• What are supply schedules and supply curves?
• What is elasticity of supply?
• What factors affect elasticity of supply?
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Price
As price
increases…
Supply
Quantity
supplied
increases
Price
As price
falls…
Supply
Quantity
supplied
falls
The Law of Supply
• According to the law of supply, suppliers will offer
more of a good at a higher price.
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Law of Supply
• Quantity Supplied – the amount a supplier is willing
and able to supply at a certain price
• As a price rises, the producer will make more in order
to earn additional revenue
– New firms will then have an incentive to enter the
market to earn profit
• Price falls, the business produces less or drops out
completely
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Higher Production
• Business that is already making a profit, then an
increase in price will increase profits
– The higher revenues encourage them to produce
more (supply raises)
• Example
– Making profit at market price and cost of production
is low
– Then price of pizza rises a little, raising profits
– Then they will produce more in order to sell more
– If price would fall, they would supply less
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Market Entry
• Rising prices draw new people into the market
– If you see a certain type of restaurant doing very
well (their prices rising along w/ profits) you want to
join in
– So you open that type of restaurant b/c it’s a safe bet
• Grunge music in the 1990s
– Record labels saw the popularity grow, so many
more bands joined the market
– Music stores sold more grunge music
– Later, the fad ended
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The Supply Schedule
• Supply Schedule – shows the relationship b/w price
and quantity supplied for a specific good
– Table compares 2 variables, or factors, that can
change
• Price of a slice and the amount supplied
• Lists supply for a very specific set of conditions
– Only price is taken into account (not labor or price of
resources)
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$.50 1,000
Price per slice of pizza Slices supplied per day
Market Supply Schedule
$1.00 1,500
$1.50 2,000
$2.00 2,500
$2.50 3,000
$3.00 3,500
Supply Schedules
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A Change in Quantity Supplied
• Each number of slices supplied at any given price is
called the Quantity Supplied
– $.50/slice, there are 100 slices supplied
• We just move from each row when the prices change
• The Supply Schedule never actually changes, only the
Quantity Supplied
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Market Supply Schedule
• Like the market demand schedule, the Market Supply
Schedule shows how much of a good all suppliers will
offer at diff. prices
– Important b/c it helps us determine the total supply
of a good at a certain price
• Reflects the law of supply
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Market Supply Curve
Price(indollars)
Output (slices per day)
3.00
2.50
2.00
1.50
1.00
.50
0
0 500 1000 1500 2000 2500 3000 3500
Supply
Supply Curves
• Supply Curve – graph
showing quantity
supplied of a good at
different prices
• X-Axis = Quantity
• Y-Axis = Price
• Rises left to right
• A market supply curve
is a graph of the
quantity supplied of a
good by all suppliers at
different prices.
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Supply and Elasticity
• Elasticity of Supply – measure of the way suppliers
respond to a change in price
– Values of Elasticity of Supply are same as demand
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Elasticity of Supply and Time
• Short Term – Orange Grove Example
– Price goes up on oranges, grower can plant more
trees to increase supply, but it takes years to grow
– Small steps to increase output, use better pesticide
(# of oranges does not increase much)
– This would be inelastic then, supply does not
respond much to price change
– Same as if price goes down
• Still grow and sell same number of oranges
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Elasticity of Supply and Time
• Short Term continued – Haircut Example
– Haircuts can be easily reduced or increased by the
hair dresser
– Price rises, hire new workers raise supply
• New shops will open or existing ones stay open
later
• Small price raise and supply increases
dramatically
– Price falls, supply falls
– Highly elastic
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Elasticity of Supply and Time
• Long Term – Oranges example
– The grower that planted more trees will, over time,
have a higher supply
• Ends up selling many more oranges at the higher
market price
– Price falls and stays there for several years
• Orange growers will eventually cut back on
growth or grow something diff.
– Becomes elastic over time
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Costs of Production
• How do firms decide how much labor to hire?
• What are production costs?
• How do firms decide how much to produce?
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Marginal Product of Labor
• Marginal Product of Labor – the change in output from
hiring one additional unit of labor
– Shows the change in output at the margin, where the
last worker was hired or fired
• First worker hired makes 4 T-Shirts/hour
• 2nd
worker raises total to 10 T-Shirts/hour
– Marginal product of labor is 6
• See this in column 3 of the table
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Marginal Product of Labor
Labor
(number of
workers)
Output (T-
Shirts per
hour)
Marginal
product
of labor
0 0 —
1 4 4
2 10 6
3 17 7
4 23 6
5 28 5
6 31 3
7 32 1
8 31 –1
A Firm’s Labor Decisions
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Diminishing Marginal Returns
• 4th
through the 7th
worker – the marginal product of labor
is still positive
– It is shrinking though
• Diminishing Marginal Returns – level of production in
which the marginal product of labor decreases as the
number of workers increases
– Specialization ends when you hire more workers
– Increases total output but at a decreasing rate
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Diminishing Marginal Returns
• Business w/ D.M.R. of labor produce less and have less
output from each unit of labor added
• Workers are working w/ a limited amount of capital
– Workers now have to wait to use the tools to create
w/e product they sell
– They do not increase the speed of making the
product
– Add less to the total output of the factory
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Increasing Marginal Returns
• Marginal product of labor increases among the first 3
workers b/c there are more than one task to making a
T-Shirt
– Adding more workers mean each can specialize in
each task
– Specialization increases output per worker
– 2nd
worker adds more output than the 1st
– Increasing Marginal Returns – level of production in
which the marginal product of labor increases as #
of workers increase
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Negative Marginal Returns
• Hiring the 8th
worker puts the marginal product of labor
in the negatives
– Too many workers, everyone in the way of each
other
– Businesses work to avoid this problem
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Fixed Costs
• Fixed Cost – cost that does not change, no matter how
much of a good is produced
– The facility, cost of building the factory (office, store,
restaurant etc.)
– Rent, repairs, property taxes, salaries
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Variable Costs
• Variable Costs – costs that rise or fall depending on
quantity produced
– Company wants to produce more of a product, buy
more materials and hire more workers
– Cut costs, then cut back on buying materials and cut
workers hours
– Cost of labor is a variable cost
– Electric and Heating bills – turn off electricity and
heat when the factory is not in use
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Total Cost
• Total Cost – the fixed cost plus the variable cost
– Fixed costs are the building and equipment
($36/hour)
– Variable costs are the fabric, thread, most of the
workers
• These rise with number of T-Shirts made/hour
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Marginal Cost
• Marginal Cost – the cost of producing one more unit of
a good
– If we know the total cost at different levels of output,
you can figure out marginal cost
• Not producing a single T-Shirt, they still pay the fixed
cost ($36/hour)
• Produce one T-Shirt/hour its total cost rises $36 to $44
($8 is marginal cost now)
• Total Cost - Fixed Cost = Marginal Cost
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Marginal Cost
• First 3 T-Shirts, marginal cost falls as output increases
– 2nd
T-Shirt = $4, 3rd
T-Shirt = $3
– Increasing marginal returns b/c of specialization
• 4th
T-Shirt, marginal cost starts to rise
– Reflects diminishing returns to labor
– Benefits of specialization are no longer there
– Diminishing returns set in once workers start to
share machines
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Marginal Revenue and Marginal Cost
• Marginal Revenue – the additional income from selling
one more unit of a good, sometimes equal to price
• If firm has no control over price, marginal revenue =
marginal cost
• Each T-Shirt sold at $24 increases the total revenue by
$24, so marginal revenue is $24
• At 10 T-Shirts sold, price = marginal cost, so that is the
quantity for maximum profit
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Responding to Price Changes
• Price raises to $37 for a T-Shirt
– Firm increases production to 12 T-Shirts
– The new price now = marginal cost
– New levels of profit are available
– Shows law of supply in action (price rises, supply
rises)
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The Shutdown Decision
• Operating Cost – the cost of operating a facility
• Price of a T-Shirt drops to $7, which means they would
produce 5 T-shirts (marginal cost = marginal revenue)
– Total revenue would be $35 and the variable costs
are $27
– Total revenue is higher, keep factory open
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The Shutdown Decision
• Close the factory, still paying $36/hour in fixed costs
• Stay open, producing 5 T-shirts/hour with total costs at
$63/hour (36 in fixed + 27 in variable)
– Losing only $28/hour b/c of the total revenue of $35
• Losing money in both examples, but losing less if they
stay open and produce 5 T-shirts
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Changes in Supply
• How do input costs affect supply?
• How can the government affect the supply of a good?
• What other factors can influence supply?
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Input Costs and Effect of Rising Costs
• Businesses want their price = marginal cost
– Marginal cost includes materials that make the
product
– Cost of materials go up, marginal cost does
• Price and Marginal Cost are no longer the same,
business not profitable
– The supply curve would shift to the left
• Graph on board.
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Technology
• New technology can lower production costs
– Robots in car manufacturers, speed up work and cut
down on salaries paid
– Email increasing speed of information being passed
throughout the market
• Lowering production costs increase profit and supply
curve shifts to the right
• Graph on board.
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Subsidies
• Subsidy – govt. payment that supports a business
market
– Govt. pays a business a set subsidy for each unit of
a good produced
– WWII – European countries subsidized farms b/c of
food shortages
• Protected farms in case food imports were cut off
• France – protect small farmers and the French
countryside
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Subsidies
• Developing countries subsidize businesses to protect
growing industries from foreign competition
– Indonesia and Malaysia subsidized national car
companies
– Western Europe let their airlines and banks suffer
huge losses by assuring them they would cover
debts
• Subsidies have slowed to allow for fair competition and
free trade
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Subsidies
• A controversial subsidy in U.S. are farm subsidies
– Pay farmers to take land out of production in order
to keep prices high
– This hurts efficient farmers
– They start to use more pesticides and herbicides to
try and produce more on the land they are allowed to
plant
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Taxes
• Excise Tax – tax on the production or sale of a good
– Increases production cost by adding extra cost for
each unit sold
– Decreases supply (supply curve shifts to the left)
– Mainly put on products like cigarettes, alcohol, and
high-pollutant gasoline
– Consumers don’t realize they are paying them
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Regulation
• Regulation – govt. intervention in a market that affects
the production of a good
– Usually raises the price of a good
• 1970s
– Govt put regulations on car emissions
– Cars cost more to make then, supply went down
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Supply in the Global Economy
• Imports into the U.S.
– 1. U.S. gets carpets from India
• Wages increase among workers
• Decreases supply to the U.S.
– 2. Phones from Japan
• New technology decreases cost of making them
• Supply imported goes up
– 3. Oil from Russia
• New discovery of oil would increase our supply
• Lower prices
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Future Expectations of Prices
• Soybean farmer knows that the price of soybeans will
double in a month
– Stores soybeans just harvested and cuts back on
supply in short term
– Increase supply in long term
• Price expected to drop in a month
– Sell now and increase supply in short term
– Cut supply in long term
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Future Expectations of Prices
• Inflation is a condition of rising prices
• Businesses hold on to products that can be stored for
long periods of time
– Hold on to their goods until the price gets high
enough, then sell
– Short term – supply falls drastically
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Future Expectations of Prices
• Civil War
– South faced terrible inflation
– Prices on goods like flour, butter, and salt rose each
month
• Shopkeepers would hoard products and wait to
sell later at a higher price
• Caused great shortages
– Prices to high for most and riots broke out
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Number of Suppliers
• More producers enter a certain market, supply of that
good will rise
– Shifting curve to the right
• Suppliers leave the market and stop producing that
product
– Supply decreases and curve shifts to the left
