2. Supply Claudia Garcia-Szekely © 2000 Claudia Garcia-Szekely 1

3. IN A PERFECTLY COMPETITIVE MARKET There are so many buyers that no buyer has the power to affect the price. We say that Buyers are price takers. Buyers “react” to prices

4. IN A PERFECTLY COMPETITIVE MARKET There are so many producers that no producer has the power to affect the price. 3 We say that Producers are price takers too! Producers also “react” to prices

5. Seeds Irrigation Fertilizer Workers

6. 5 Cost of Production $3.25 3 $2.75 $2.25 $1.75 $1.50 4 2 1 0 Quantity Quantity Supplied If Price = Produce= If Price = Cost If Price = 1 2 3 3 4 2 1 0 Produce= Price Supply

7. 6 Increase in Costs $3.25 3 $2.75 $2.25 $1.75 $1.50 4 2 1 0 Quantity Old Quantity Supplied If Price = Produce= If Price = Cost If Price = 0 1 2 0 Price If Price = 3 New Quantity Supplied Supply Decrease Supply Shifts UP/Left

8. 7 Price Q0Q0 Q1Q1 An increase in Costs, Causes a Leftward shift in Supply S0S0 S1S1 Supply Decrease Supply Shifts UP/Left

9. 8 Price Q0Q0 Q1Q1 Bad weather, insect infestation, etc., Causes a Leftward shift in Supply S0S0 S1S1 Weather, Insects, Natural Disasters Supply Decrease Supply Shifts UP/Left

10. More output can be produced from the same amount of inputs 9 Price Q0Q0 Q1Q1 An improvement in technology Causes a Rightward shift in Supply S1S1 S0S0 Technology Supply Increase Supply Shifts DOWN/Right

11. Expectations 10 Price Q0Q0 Q1Q1 Expectation of higher prices in the future, Causes a Leftward shift in Supply TODAY Producers prefer to wait and sell their production in the future, when prices will be higher. S0S0 S1S1

12. Prices of other goods Substitutes in production – goods for which producing more of one implies producing less of the other. o Different crops: opium and rubber, tea and other crops. o Pork can be used to produce bacon or sausage. Complements in production – goods that are produced together. o Beef and leather. o Corn and Ethanol fuel, Ethanol fuel cells for electricity, rocket fuel, Alcoholic beverages, Feedstock, Antiseptic, Antidote 11

13. The Law of Supply True ONLY if the cost of production, weather, Technology, Prices of related goods and Expectations remain the same 12 Price Supply The higher the price The more units will be brought for sale Ceteris Paribus

14. 13 Quantity Supplied The number of units a firm would be willing and able to offer for sale at a given price. Price Supply Is a point on the Supply line Is different for each price Movement alongPrice changes

15. 14 Supply Price Supply Is the entire Supply line The complete set of price and quantity supplied for a firm. Shifts Changes in cost of production, weather, Technology, Prices of related goods and Expectations

16. DA $3.50 $1.50 4 8 Qd 3 $1.50 $3.50 DB Qd P $1.50 $3.50 DC 94Qd 0 P $3.50 $1.50 8 Qd Market Demand = Horizontal Sum of Individual Demands P P From the Individual demand curves to Market demand: 0 20

17. 16 Market Demand 100 80 120 140 ????

18. The Market Supply 17 1 3 2 1030 501002003050100 20 90170330 1 3 2 Is the sum of the quantities supplied by all the firms in the market Is the horizontal sum of the individual firms’ supply curves.

19. 18 Market Supply 100 80 120 ? 60 ???

20. 19 Consider the market for Soybeans P 0 Want to buy Want to sell 35 $3.50 4525 $1.50 $2.50 EQUILIBRIUM Excess Demand Excess Supply 2545 Demand Supply

21. A Shortage 20 Price Quantity Demanded Quantity Demanded Quantity Supplied Quantity Supplied Supply Demand Shortage Po 50 30 20 Shortages occur because the price is “too” low

22. The Effect of a Shortage Quantity Demanded Quantity Supplied S D Po Shortage P1 Q Supplied=Q demanded Q demanded decreases Q supplied increases Shortage eliminated shortage causes a price increase shortage causes a price increase 90 Q Supplied=Q demanded 1206030 Q d drops from 120 units to 60 units: by 60 units Q s increases from 30 units to 60 units: by 30 units -60+30

23. A Surplus 22 Price Quantity Demanded Quantity Demanded Quantity Supplied Quantity Supplied Supply Demand Surplus Po A surplus occurs because the price is “too” high

24. The Effect of a Surplus 23 Quantity Demanded Quantity Demanded Quantity Supplied Quantity Supplied Supply Demand Po Surplus P1 Surplus cause a price drop Surplus cause a price drop Q Supplied=Q demanded Q demanded increases Q supplied decreases Surplus eliminated

25. Market Equilibrium When the quantity firms want to sell is equal to quantity consumers want to purchase. At equilibrium, there is no reason for the market price to change. 24

26. 25 Consider the market for Marijuana. Price 0 quantity D S P0P0 Q0Q0 What will happen to the equilibrium price and quantity? U.S. Government’s efforts to reduce production and trade

27. 26 The War on Drugs 0 D0D0 S0S0 P0P0 Q0Q0 Supply shifts left P1P1 Q1Q1 Shortage A shortage appears Price increases Quantity exchanged decreases SPQ S1S1 A decrease in Supply and a decrease in quantity demanded

28. 27 D S P0P0 The U.S. Government puts into effect a campaign to reduce consumption Q0Q0 Consider the market for Marijuana

29. 0 S Q0Q0 Demand shifts left A surplus appears Price decreases Quantity exchanged decreases D PQ Surplus D1D1 D0D0 D0D0 A decrease in Demand and a decrease in quantity supplied Q1Q1 P0P0 P1P1

30. 29 Consider the market for coffee. D S P0P0 Q0Q0 Unusually good weather increases the size of the crop

31. 30 Unusually Good Weather 0 S0S0 P0P0 Q1Q1 Supply shifts right P1P1 A surplus appears Price decreases Quantity exchanged increases S PQ Q0Q0 D0D0 S1S1 Surplus An increase in Supply and an increase in quantity demanded

32. 31 Consider the market for corn. D S P0P0 Q0Q0 An increase in production of Ethanol (which is made from corn)

33. Increase Demand for corn S P1P1 Q0Q0 Demand shifts right P0P0 A shortage appears Price increases Quantity exchanged increases D PQ Q1Q1 Shortage D1D1 D0D0 D0D0 An increase in Demand and an increase in quantity supplied

34. 33 0 S0S0 P0P0 Q1Q1 P1P1 Q0Q0 D0D0 S1S1 Surplus 0 S0S0 P1P1 Q0Q0 P0P0 Q1Q1 Shortage D1D1 D0D0 S PQ D PQ Effect on price is indeterminate Quantity increases P?Q Surplus Shortage

35. 34 D0D0 D PQ P?Q 0 D S P0P0 Q0Q0 P1P1 Q1Q1 Shortage Effect on price is indeterminate S PQ 0 S P1P1 Q0Q0 P0P0 Q1Q1 Surplus D1D1 Quantity decreases Quantity decreases Surplus Shortage

36. 35 0 S0S0 P0P0 Q1Q1 P1P1 Q0Q0 D0D0 S1S1 Surplus D0D0 D PQ Q?P 0 S P1P1 Q0Q0 P0P0 Q1Q1 Surplus D1D1 S PQ Effect on quantity is indeterminate Price decreases Surplus

37. 36 D S P0P0 Q0Q0 P1P1 Q1Q1 Shortage S PQ S0S0 P1P1 Q0Q0 P0P0 Q1Q1 D1D1 D PQ Price increases P Effect on quantity is indeterminate Q? Shortage

38. Market Demand: Value to Consumer 37 The distance to the Demand curve tells us how much consumers are willing to pay for a given quantity of the good. 10th $10 $1 100th D 1st $11 Willing to pay $10 for the 10 th unit Willing to pay $1 for the 100 th unit 10 th unit is worth at least $10 to consumer

39. Market Supply: Cost of bringing a good to the market 38 The distance to the Supply curve tells us how much it costs to produce the last unit. 100th $10 $1 1000th S Cost $1 Cost $10

40. 100th1000th S (cost) Cost $10$10 $1 Cost $1 100 th unit is worth at least $10 to consumer D (Value given by consumer)Value to consumer =$1 Optimum Output Level

41. S (cost) Optimum Output Level Equilibrium Quantity Produce all units the consumer values enough to pay the cost of bringing them to market Value to consumer Cost Value to consumer > Cost Cost > Value to consumer

42. Willingness to Pay D 1 10 Willingness to pay 23 8 6 $10 for one unit $8 for the second unit $6 for the third unit $24

43. Long Distance Service 42 D 60 0.55 120180 0.45 0.35 Consumer Surplus = 81 – 63= 18 If the price is $0.35 60*0.55=$33 60*0.45=$2760*0.35=$21 $81 Consumer Actually pays $0.35 x 180 = $63 Minutes

44. Consumer Surplus 43 D Willingness to pay 1 Minute intervals 180 minutes Consumer actually pays = 0.35*180 Consumer surplus If the price is $0.35 The area below the demand curve and above the price the consumer pays Consumer surplus = Area of triangle

45. Consumer surplus in a Perfectly Competitive market: D Units of output, Q Supply = Cost Q = 4000 Consumer Surplus 5

46. Producer Surplus 45 S = Cost 2 4 6 123 If The market price is $6 Producer Surplus = 18 – 12 = 6 Cost=12 TR = $6*3 =$18 TR = $6*3 =$18 PS = 6 The area above the supply curve and below the price the producer receives ~ Profit

47. Producer Surplus under Perfect Competition 46 D Supply = Cost 4000 C S P S 10 5 2

48. Consumer surplus in a Perfectly Competitive market: 47 D Supply = Cost Q = 4000 CS = Triangle Area 10 5 2 Triangle Area = Base x Height x ½ Triangle Area = 4000 x (10-5) x 1/2

49. Producer Surplus under Perfect Competition 48 D Supply/Cost 4000 C S Lost CS PS = Triangle Area 10 5 2 Triangle Area = Base x Height x ½ Triangle Area = 4000 x (5-2) x 1/2 Triangle Area = Base x Height x ½ Triangle Area = 4000 x (5-2) x 1/2

50. Perfect Competition D Q Supply/Cost Qe=4000 C S P S 10 5 2

51. When the market is not allowed to clear D Q S 1,000 C S P S Qd =5000 Qs =1000 3,000 2,000 Can’t charge more than $1,000 Price Ceiling All these prices are prohibited Prevents price from reaching equilibrium Shortage

52. Price Ceiling: Consumers May Win or Lose D S 600 3,900 2,200 CS at equilibrium 300 CS after ceiling Gain to consumer Loss to Consumer 7,300 1000 900 CS: Area below Dm Above Price CS: Area below Dm Above Price

53. Price Ceiling: Producers Lose PS at equilibrium D S PS Loss to Producer 3,900 2,200 600 300 1000 7,300 900 PS: Area below Price Above S PS: Area below Price Above S

54. A subsidy to Consumers and a Tax to Producers Loss to Producer D S 600 3,900 2,200 300 PS Gain to consumer D S 600 3,900 2,200 300 CS Tax Subsidy Welfare Loss

55. Welfare Loss From Price Ceiling 54 D Q $ S P=$2 4000 C S P S $1 CS PS Welfare Loss 2000

56. Welfare Loss From Price Ceiling 55 D Q S $6 40 C S P S $4 $8 $10 20 $2

57. When the market is not allowed to clear D Q S 8 C S P S Qd =20,000 Surplus Qs =60,000 40,000 4 Must pay at least Price Floor Prevents price from reaching equilibrium 4 All these prices are prohibited

58. Price Floor: Consumers Lose 57 D S 4 2 CS 2 3 Loss to Consumer CS 6

59. Price Floor: Producers May Win or Lose PS D S 4 2 2 3 Loss to Producer PS Gain to Producer 6

60. A subsidy to Producers and a Tax to Consumers 59 D S 4 2 CS 2 3 PS D S 4 2 2 3 Loss to Consumer Gain to Producer Subsidy Tax

61. Loss of Surplus to Society 60 D S 4 2 CS 2 3 PS D S 4 2 2 3 Loss to Consumer Loss to Producer

62. Welfare Loss from Price Floor 61 D Q $ S P=$2 4 $5 C S Welfare Loss C S P S