2. Chapter 5: The Law of Supply (Looking through the eyes of the Producer)

3. able (have resources/factors) to sell “Quantity Supplied” Defined:. The Quantity Supplied is the amount of a good or service that sellers are willing (motivation) and

4. There are 4 concepts (two are laws) that help explain why the supply curve has a positive slope. Shape of the Supply Curve? 1. Law of Supply 2. Law of Diminishing Returns 3. Supply & Costs Relationship 4. Elasticity of Supply 5. Determinates of Supply

5. Law of supply is the claim that, other things staying constant (ceteris paribus), the quantity supplied of a good or service rises when the price of the good or service rises. $= SUPPLY Law of Supply –As the price of a product rises, producers will be willing to supply more.

6. Supply Curve Price (monthly bill) Quantity (of Cell Phone Subscribers) 140 120 100 80 60 5 1015 2025 30 Notice how the law of supply is reflected by the shape of the supply curve. As the price of a good rises …... producers supply more. Supply Curve This is how much they are willing and able to sell, not how much they actually sell

7. Supply & Costs Relationship

8. Profit occurs when revenues are greater than all costs (variable and fixed). Let us look at some examples of these costs. To understand the law of supply, we must recognize that companies need profits. Variable Cost (VC) are cost that CAN change month to month depending on productionVariable Cost (VC) are cost that CAN change month to month depending on production Fixed Cost (FC) are cost that CANNOT change month to month. They are steady regardless of the amount of production.Fixed Cost (FC) are cost that CANNOT change month to month. They are steady regardless of the amount of production. VC+FC= TOTAL COSTS Role of Costs in Shaping the Supply Curve

9. Let us look at some examples of these costs. Variable cost are cost that CAN change month to month depending on productionVariable cost are cost that CAN change month to month depending on production Ex- changes when production increases/decreases- hourly wages of workers, electricity, shipping, gas…Ex- changes when production increases/decreases- hourly wages of workers, electricity, shipping, gas… VARIABLE COST

10. Let us look at some examples of these costs. Role of Costs in Shaping the Supply Curve MONTHLY INSURANCE PAYMENT MANAGER’S COMPANY CAR FIXED COST Fixed cost- are cost that CANNOT change month to month. They are steady regardless of the amount of production.Fixed cost- are cost that CANNOT change month to month. They are steady regardless of the amount of production. Ex- DO NOT change when production increases/ decreases, must be paid even if no production takes place- rent, manager’s salary.Ex- DO NOT change when production increases/ decreases, must be paid even if no production takes place- rent, manager’s salary.

11. Variable & Fixed Costs and the Supply Curve Let’s look at these costs as totals. $Price/Cost Quantity $14.00 $12.00 $4.00 $2.00 1520253035 Total Fixed Cost Supply Curve (total revenue) Total Cost Total Variable Cost $6.00 PROFIT D1 B.E. POINT 4045 $8.00 $10.00 D2 D3 Cost per unit Price per unit Notice at a price of $10 they make $80 profit.

12. Law of Diminishing Returns Review: Variable Cost Fixed Cost Law of Supply

13. As production increases, additional costs increase. –When benefits > costs: production continues –When benefits < costs: production ends Simply put, too much production can be a bad thing, especially if the company cannot provide products and services quick enough or if resources are stretched thin. Every company can reach a point where it cannot supply any more goods regardless of increases in price. LET’S LOOK AT AN EXAMPLE This law also happens to explain why the curve slopes upward. Law of Diminishing Returns

14. Output Workers 12 11 10 2 1 123456 Workers Total Product 0 Marginal returns diminish as more inputs are introduced into any production process. Marginal Returns (Mowed lawns) 1 2 3 4 5 6 7 LAWN CARE SERVICE (only 2 lawn mowers) 7 0 2 7 10 12 13 10 - 2 5 3 2 1 0 -3 3 4 5 6 7 8 9 13

15. As production increases, additional costs increase. Price (monthly bill) Quantity (of Cell Phone Subscribers) 140 120 100 80 60 5 1015 20 2530Supply Benefits > costs Benefits < costs (no more production) Basically for each additional unit produced the company had to hire more people and use more capital, which costs money.Basically for each additional unit produced the company had to hire more people and use more capital, which costs money. Therefore,Therefore, even though the company is taking in more money, the returns on each item decrease as a result of increased costs. Law of Diminishing Returns

16. Elasticity Elasticity of Supply (how do costs effect production)

17. Elastic and Inelastic Supply  ELASTIC SUPPLY: quantity supplied is SENSITIVE to small price changes  If the marginal costs to make an additional good are low, then the producer will be more likely to produce the good if the price changes. Products that are cheap & mass produced have more elasticity than expensive products...

18. Elastic and Inelastic Supply  If the marginal costs to make an additional good are high, then the producer will be less likely to produce the good if the price changes.  INELASTIC SUPPLY: quantity supplied is NOT SENSITIVE to small price changes.. Products that are expensive and more specialized are more inelastic.

19. Elastic and Inelastic Supply Curves 2.00 1.25 2.00 1.25 12345678910 If the market price for motor oil was to rise from $1.25 to $2.00, the quantity supplied in the market increases insignificantly (from 7 to 8 units). If the market price for burgers rises from $1.25 to $2.00, the quantity supplied in the market increases substantially (from 1 to 8 units). highly sensitive elastic inelastic Burger supply is highly sensitive to price changes and can be described as elastic; motor oil supply is insensitive to price changes and can be described as inelastic. INELASTIC ELASTIC Motor Oil Burgers Q $ $ Q 12345678910

20. Elastic and Inelastic Supply Curves 100,000 75,000 200 125 12 3 45 6 78910 1 2 3 4 5 6 7 89 Chopper iPod QUANTITY Price (per unit) Price (per unit)

21. Elasticity in Short Run and Long Run Short-Run Short-Run - Firms don’t have enough time to adjust production in a short period of time (ex: stuck with current factory size).  Supply tends to be inelastic inelastic in the short-run Long Run Run - Firms have enough time time to adjust in a longer period of time. (ex: build a larger factory, thus benefiting from mass producing a good).  Supply tends to be more elastic elastic in the long-run..

22. Elasticity and the Size of the Firm Which company do you think has a LOWER cost per unit (thus a larger profit margin)? ECONOMIES OF SCALE TThe MORE you produce/buy the LOWER the average cost per item. OR Grandma’s Kitchen What is this called when one benefits from mass production?? If costs rise when they produce more, then why do they produce more.

23. As companies grow larger their costs rise, but they can spread that increased cost over more goods produced. ECONOMIES OF SCALE OR Grandma’s Kitchen One machine can produce 500 snacks in 1 hour OR 12,000 in a day. One grandma can produce 12 in 1 hour OR 288 a day Cost to operate machine: $20 per hour ($480 per day) OR 25¢ per snack Cost to operate grandma: $25 per hour ($600 per day) OR 48¢ per snack Sales price: $1.00 Sales price: $1.00 Elasticity and the Size of the Firm

25. Changes in Supply vs. Quantity Supplied  Change in “Supply” - shift OF the supply curve due to a determinate change.  Change in “Quantity Supplied” - movement ON the supply curve in response to a price change. 15 $ Price Quantity10 1.00 5.00 8.00 A shift to the left = decrease in supply A shift to the right = increase in supply 15 $ Price Quantity10 1.00 5.00

26. THE SHIFTERS (DETERMINATES) OF SUPPLY OF SUPPLY THE ONLY FACTORS THAT CAN CAUSE A SUPPLY CURVE TO SHIFT TO THE LEFT (decrease) OR RIGHT (increase). 15 $ Price Quantity10 1.00 5.00 8.00

27. What specific things determine the position of the supply curve? “G.O. S.P.I.T.” Determinants of Supply

28. 5. INPUT COSTS (inverse relationship) 3. SIZE OF INDUSTRY (Growth of the whole industry…positive relationship) 6. TECHNOLOGY (positive relationship) 4. PRICE OF RELATED PRODUCTS 2. OUTLOOK OF FUTURE (Supplier’s Expectations) Taxes, Subsidies, Regulations THE DETERMINANTS OF SUPPLY “GO SPIT” 1. GOVERNMENT ACTIONS (Look at the market price of a good to determine which one to produce.)

29. 2. Outlook of Future (positive relationship) THE DETERMINANTS OF SUPPLY  Gas companies, expect that consumer demand after the storm will increase so they cut back on the current supply (shift left).  After the storm hits and demand increases, suppliers will increase their supply until it runs out (usually because they take advantage of the higher prices). A storm is predicted to destroy most of the seaports where most imported oil is delivered. $ Price Quantity(gallons) 3.00 5m10m 5.00

30. 4. PRICE OF RELATED PRODUCTS THAT SHARE THE SAME RESOURCES Look at the market price of a good to determine which one to produce. Look at the market price of a good to determine which one to produce. THE DETERMINANTS OF SUPPLY  DONUT COMPANY: price of donuts decreases  Less likely to produce donuts and more likely to use the dough to produce more donut holes (supply curve for rolls shifts right)  THEREFORE, an increase in price of good the resources could go toward = supply curve of the other good decreases (shifts left) $= SUPPLY

31. As the price of resources goes then a supplier will the supply of a good and look for something else to make. 5. Input Costs (Prices of Resources..Inverse Relationship) THE DETERMINANTS OF SUPPLY $ As the price of resources goes then a supplier will the supply of a good because he/she is making a profit. $ LUMBER $ = SUPPLY HOUSE CONSTRUCTION

32. 6. TECHNOLOGY (positive relationship) THE DETERMINANTS OF SUPPLY Increase in technology = increase in amount supplied (shifts right) Decrease in technology = decrease in amount supplied (shift left) T = SUPPLY

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