Production and Supply

1. Production and Supply

2. When trying to understand the supply decisions of firms, the concept called opportunity cost is important. Here I reproduce an example. Say some guy thinks about collecting cans to recycle. Below is how many total cans he can collect if he puts in different amounts of hours. Search time in hours Total cans found 0 0 1 600 2 1000 3 1300 4 1500 5 1600

3. Note that on the previous slide if the dude searches for 3 hours he will get 1300 total cans. If he searches 4 hours he will get 1500 total cans. Thus, the 4th hour of search leads to 200 additional cans found. Below I add a column to our table from the previous screen and the column is the additional cans obtained from the additional hour of search. Search time in hours Total cans found Additional cans 0 0 ---- 1 600 600 2 1000 400 3 1300 300 4 1500 200 5 1600 100

4. In the example, note as we go down the table the additions to cans diminish. Why do you think this is? Some folks say this is the same idea as the principle of low hanging fruit. When you want to put apples in bushel baskets you get the apples on the ground and low hanging ones first and you do this relatively quickly. But the more bushels you want to get the higher you have to climb and the more careful you have to be so in an additional hour you add less bushels. A similar story is with the cans. Collect the ones out in the open first, then search lower in garbage bins and the like. Additions to output diminish. Now, say this guy who can collect cans can also get paid $6 per hour doing something else – like washing dishes. How many hours would he want to collect cans if he gets paid 3 cents per can?

5. Note the first hour he adds 600 cans. This will mean ($.03)(600) = $18 from cans. This is the benefit from searching an hour. The cost of searching for cans is the $6 he wouldn’t get from washing dishes. DO THE FIRST HOUR OF CANS. The second hour adds 400 cans, or ($.03)(400)=$12. DO THE SECOND HOUR OF CANS. The third hour adds 300 cans, or ($.03)(300) = $9. DO THE THIRD HOUR OF CANS. The Fourth hour adds 200 cans, or ($.03)(200) = $6. He makes as much doing cans as dishes. Say in a tie he goes with the cans. DO THE FOURTH HOUR OF CANS. The fifth hour adds 100 cans, or ($.03)(100) = $3. This has lower pay than the dishes. DO not add THE fifth HOUR OF CANS.

6. When you look at this example more closely you can see the following ideas. The guy is really a supplier of recycled cans! When the price of cans is 3 cents he will search 4 hours and the quantity supplied will be 1500 cans. He doesn’t do more because his opportunity cost is too high (he gets $3 from the cans but gives up $6 from dishes). Note also we doesn’t stop at just 1 or 2 hours, or 600 or 1000 cans, because he benefits from additional cans as much or more than his cost of $6 from dishes. So at a price of 3 cents the quantity supplied is 1500. If the price per can is 4 cents will he do more than 1500? The next hour after the 1500 cans adds 100 cans. But at 4 cents per can this yields only $4 and so dishes is better. Don’t do the cans. The price per can has to get to 6 cents before if makes sense to put in the fifth hour of search.

7. Again, on the last slide we saw that 6 cents is the lowest price per can that would have him work all five hours and thus supply 1600 cans. The supply curve for this guy is

8. Market supply is found from adding the supply from all the separate suppliers. In the graphs below I show just two separate suppliers and add at each price the quantity supplied by each to get the total market supply. (I show the addition at one price – P1) P P P P1 Q Q Q this This + that That Supplier 1 supplier 2 market