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Chapter 5

Supply. Chapter 5. The Law of Supply. Supply is the amount of goods available According to the law of supply, producers offer more of a good as its price increases and less as its price falls Quantity supplied describes how much of a good is willing to sell at a specific price

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Chapter 5

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  1. Supply Chapter 5

  2. The Law of Supply • Supply is the amount of goods available • According to the law of supply, producers offer more of a good as its price increases and less as its price falls • Quantity supplied describes how much of a good is willing to sell at a specific price • A producer is called the supplier if they supply a product to the market • As prices increase, firms will produce more to make additional revenue and incentive to earn profit • As prices fall, some firms will produce less or drop out of the market

  3. The Law of Supply • Higher Production • If a firm is earning profit by selling a good, an increase in price (ceteris paribus) will increase profits • The promise of high revenue encourages a firm to produce more • Refer to example on page 111 • The search for profit drives the supplier’s decision • If prices fall, firms may look to produce something else

  4. The Law of Supply • Market Entry • Profits appeal to producers in the market and who may decide to join the market • If the price of pizza rises and you want to start your own restaurant, a pizzeria would be a safe bet • In the music business in the 1970’s, disco became popular and many people from other genres joined disco music to take advantage of the potential profits

  5. The Supply Schedule • The supply schedule shows the relationship between price and quantity supplied for a specific good, or how much a good a supplier will offer at various prices • The table will show two variables, or factors that can change • Variables are the two factors listed on the axis's • Usually price and the product supplied • Supply schedule lists supply for a very specific set of conditions and other factors are assumed to remain constant

  6. The Supply Schedule • A Change In Quantity Supplied • Economists use the word supply to refer to the relationship between price and quantity supplied • The number of slices that a pizzeria offers at a specific price is called the quantity supplied • A rise or fall in the price of pizza will cause the quantity supplied to change, not the supply schedule

  7. The Supply Schedule • Market Supply Schedule • All of the supply schedules of individual firms in a market can be added up to create the market supply schedule • Shows prices and quantities by all firms in a particular market • Important when we want to determine the total supply of pizza at a certain price in a large area

  8. The Supply Schedule • The Supply Graph • When the data points in the supply schedule are graphed, they create a supply curve • The horizontal axis now measures the quantity of the good supplied, not the demand • Market supply curve are from the market schedule • Key feature is the supply curve will rise from left to right • This illustrates the law of supply, high prices lead to higher output

  9. Supply and Elasticity • Elasticity of supply measures how firms will respond to changes in the price of a good • When elasticity is very sensitive to changes in price, it is considered elastic • If supply is not very responsive to price changes, it is considered inelastic • When percentage change in price is perfectly matched by an equal percentage change, elasticity is exactly one or unitary elastic

  10. Supply and Elasticity • Elasticity and Time • Elasticity in the short run is inelastic and in the long run is elastic • Elasticity of Supply in the Short Run • An orange groove is a good example because orange trees take several years to mature • The short run a orange grower can use more effective pesticides to increase output, but not very much • In the short run supply is inelastic whether the prices increase or decrease • A business that would be more elastic would be the hair cutting business

  11. Supply and Elasticity • Elasticity in the Long Run • Supply will become more elastic over time • The orange grower can plant more trees with the hopes of making more profits in the future • If prices drop for a number of years, the orange growers that survived might start growing something else

  12. Labor and Output • Business owners have to answer the question of how many workers to hire • The number of workers hired will affect total production • Ex. At the bean bag company • 1 person = 4 bags per hour • 2 people = 10 bags per hour • 3 people = 17 bags per hour • 7 people = 32 bags per hour ***PEAK*** • 8 people = 31 bags per hour

  13. Labor and Output • Marginal Product of Labor • The change in output from hiring one more worker • Called marginal product because it measures the change in output at the margin, where the last worker is hired or fired

  14. Labor and Output • Marginal Product of Labor – Beanbags

  15. Labor and Output • Increasing Marginal Returns • The marginal product of labor increases with the first 3 workers because there are three jobs involved in making beanbags • Cutting cloth into correct shape, stuff with beans, and sewing the bag • Because specialization increases output per worker, the second worker adds more to output then the first, or increasing marginal returns

  16. Labor and Output • Chart Questions • In this example, why does the marginal product of labor increase with the first three workers? • Why does the marginal product of labor decrease with more than four workers in this example?

  17. Labor and Output • Diminishing marginal returns • Though workers 4-7 output increases, the marginal product of labor shrinks • The benefits of specialization ends after the hiring of the first 3 workers • Adding more workers increases total output but at a decreasing rate, or diminishing marginal return • Limited amount of capital makes the firm suffer • One sewing machine, one pair of scissors,

  18. Production Costs • Fixed Costs • A fixed cost is a cost that does not change, no matter how much of a good is produced • Most involve cost of building or equipment • Ex. Is rent, machinery repairs, property taxes, and salaries • Variable Cost • Variable costs are costs that rise or fall depending on the quantity produced • Includes raw materials and labor • Depends on if the firm wants to produce more or less • Ex. Also include electricity and heating bills

  19. Production Costs • Total Cost and Marginal Cost • Fixed cost + variable cost = total cost • Marginal cost is the additional cost of producing one more unit

  20. Setting Output • Marginal Revenue and Marginal Output • Another way to find the best level of output is to find the output level where marginal revenue is equal to marginal cost • Marginal revenue is the additional income from selling one unit of a good • If firm has no control over market price then marginal revenue = marginal cost • We can also determine profit by comparing price and average cost • Average cost is total cost divided by quantity produced

  21. Setting Output • Responding to Price • What would happen if the price of a beanbag rises from $24 to $37? • Firm would increase to 12 beanbags/hr. • Marginal cost is equal to the new higher price • This is an example shows the law of supply in action

  22. Input Costs • Any change in the cost of input, such as raw materials, machinery, or labor will affect supply • Effect of Rising Costs • If the costs of labor or raw materials rise, marginal cost will rise • If the costs of inputs increases enough, marginal cost may become higher than the price, which means no profit • If the firm has no control over price, the only solution is to cut production and lower marginal cost • The supply curve would shift to the left

  23. Input Costs • Technology • Advances in technology can lower the production costs in many industries • Automation like robotic tools save in labor costs • Computers have simplified tasks • Email saves paper • Technology lowers costs and increases supply at all levels • This would cause a shift to the right on the supply curve

  24. Government Influence • The government has the power to affect supplies of many types of goods • Subsidies • A subsidy is a government payment that supports a business or a market • Subsidies generally lower costs, allowing a firm to produce more goods • European governments protect farms so that some will be available to grow food in case cheaper imports are ever restricted

  25. Government Influence • Subsidies • Governments in developing countries often subsidize manufacturers to protect young, growing industries from strong foreign competition • Indonesia and Malaysia subsidize cars as a source of pride • In many countries governments have stopped subsidizing in the interest of free trade and competition • Subsidizing can shift the supply curve to the right

  26. Government Influence • Taxes • A government can reduce the supply of some goods by placing an excise tax • A tax on the production or sale of a good • An excise tax increases production costs by adding an extra cost for each unit sold • Alcohol, cigarettes, and high-pollutant gasoline • Usually built into prices • Increase in cost cause a decrease in supply • Shifts the supply curve to the left

  27. Government Influence • Regulation • Government regulation often has the effect of raising costs • Regulation is government intervention in a market that affects the price, quantity, or quality of good • Regulation like reducing exhaust and using lead-free gas increase cost and reduces supply • The supply shift shifts to the left

  28. Other Influences on Supply • Changes in the Global Economy • The U.S. imports carpets from India. An increase in the wages of Indian workers would decrease the supply of carpets to the U.S. market, shifting the supply curve to the left • The United States imports oil from Russia. A new oil discovery in Russia could increase the supply of oil to the U.S. market and shift the supply curve to the right.

  29. Other Influences on Supply • Future Expectations of Prices • If a seller expects a price of a good to rise in the future, the seller will store the goods now in order to sell more in the future • If prices are expected to fall, the seller will market the product immediately • During rising inflation, the value of money decreases but a good will still hold its value if it is stored for a long period

  30. Other Influences on Supply • Number of Suppliers • The number of suppliers in a market affects supply • If more suppliers enter the market to produce a certain good, the market supply of the good will rise –supply curve shifts right • If suppliers stop producing the good and leave the market

  31. Where Do Firms Produce? • Key factor for many firms is transportation • Transporting inputs to a production facility and transporting the finished product to consumers • Some firms locate themselves near raw materials if inputs are costly to transport • Some firms will locate close to consumers when output in more costly to transport

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