CHAPTER 5 THEORY OF SUPPLY

CHAPTER 5 Supply If a firm supplies a good or service, the firm Has the resources and technology to produce it. Can profit from producing it. Has made a definite plan to produce it and sell it. 38

Supply The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. 39

Supply What determines selling plans? The price of the good. The prices of resources used to produce the good. The prices of related goods produced. Expected future prices. The number of suppliers. Technology. 40

Supply The Basic Law of Supply (p.72) Other things remaining the same, the higher the price of a good, the greater is the quantity supplied, lower the price, the smaller the quantity offered for sale. 41

Supply Supply Curve and Supply Schedule Supply curves show the relationship between the quantity supplied of a good and its price (ceteris paribus). Supply schedules list the quantities supplied at each different price (ceteris paribus). Also read market supply schedule (page 73). 42

Supply Price Quantity (dollars per tape) (millions of tapes per week) b 2 3 c 3 4 d 4 5 e 5 6 Instructor Notes: The table shows the supply schedule of tapes. For example, at $2 a tape, 3 million tapes a week are supplied; at $5 a tape, 6 million tapes a week are supplied. 43

Supply e d c b a 6 Supply of Tapes 5 4 3 2 1 0 2 4 6 8 10 Price (dollar per tape) 3 c 2 Instructor Notes: 1) The supply curve shows the relationship between the quantity supplied and price, everything else remaining the same. 2) The supply curve usually slopes upward: As the price of a good increases, so does the quantity supplied. 3) A supply curve can be read in two ways. For a given price, it tells us the quantity that producers plan to sell. 4) And for a given quantity, it tells us the minimum price that producers are willing to accept for that quantity. b 1 a 0 2 4 6 8 10 Quantity (millions of tapes per week) 46

Supply in the Construction Industry (p.74) Many firms contribute to the supply of construction products, including large national contractors, material manufacturers, plant hirers and local site labourers. Read Table 5.2 Construction industry supply in Great Britain, 2006

Supply and Price Determinant (p76) Supply and Non-Price Determinants Cost of Production Government Supply Chain Management Expectations

Supply Understanding Changes in Supply When any factor that influences selling plans other than the price of the good changes, there is a change in supply. An increase in supply causes the supply to shift rightward. A decrease in supply causes the supply curve to shift leftward. 47

A Change in Supply Price of Productive Resources Price of Related Goods Goods Produced Substitutes in Production Complements in Production Expected Future Prices 48

A Change in Supply The Number of Suppliers Technology 48

Supply Quantity Price Quantity Price a 1 0 a' 1 3 b 2 3 b' 2 6 c 3 4 Original supply schedule New supply schedule New technology Old technology Quantity Price Quantity Price (dollars per tape) (dollars per tape) (millions of tapes per week) (millions of tapes per week) a 1 0 a' 1 3 b 2 3 b' 2 6 c 3 4 c' 3 8 d 4 5 d' 4 10 e 5 6 e' 5 12

Supply Supply of tapes (old technology) 6 a' b' c' d' e' 5 Price (dollar per tape) e 4 d 3 c 2 b Instructor Notes: An advance in technology increases the supply of tapes and shifts the supply curve rightward, as shown by the shift arrow and the resulting red curve. Supply of tapes (new technology) 1 a 0 2 4 6 8 10 12 14 Quantity (millions of tapes per week) 53

The Supply of Tapes The Law of Supply The quantity of tapes supplied Decreases if: The price of a tape falls. Increases if: The price of a tape rises. 54

The Supply of Tapes Changes In Supply The supply of tapes Decreases if: The price of a resource used to produce tapes rises. The number of tape producers decreases. The price of a substitute in production rises. 55

The Supply of Tapes Changes In Supply The supply of tapes (cont.) Decreases if: The price of a complement in production falls. The price of a tape is expected to rise in the future. 55

The Supply of Tapes Changes In Supply The supply of tapes Increases if: The price of a resource used to produce tapes falls. More efficient technologies for producing tapes are discovered. The number of tape producers increases. 56

The Supply of Tapes Changes In Supply The supply of tapes (cont.) Increases if: The price of a substitute in production falls. The price of a complement in production rises. The price of a tape is expected to fall in the future. 56

A Change in the Quantity Supplied Versus a Change in Supply A movement along a supply curve, which results from a change in price, shows a change in the quantity supplied. If some other influence on sellers’ plans changes, holding price constant, there is a change in supply. 57

A Change in the Quantity Supplied Versus a Change in Supply Increase in quantity supplied S2 S0 S0 S1 Price supply Decrease in Increase in supply Decrease in quantity supplied Quantity 62

Market Equilibrium Equilibrium in a market occurs when the price balances the plans of buyers and sellers. Equilibrium price is the price at which quantity demanded equals quantity supplied. Equilibrium quantity is the quantity bought and sold at the equilibrium price.

Market Equilibrium Price as a Regulator If the price is too low, quantity demanded exceeds quantity supplied. If the price is too high, quantity supplied exceeds quantity demanded.

Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per tape) (millions of tapes per week) 1 9 0 2 6 3 3 4 4 4 3 5 5 2 6 Instructor Notes: The table lists the quantities demanded and quantities supplied as well as the shortage or surplus of tapes at each price. 51

Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per tape) (millions of tapes per week) 1 9 0 -9 2 6 3 -3 3 4 4 0 4 3 5 +2 5 2 6 +4 Instructor Notes: 1) If the price is $2 a tape, 6 million tapes a week are demanded and 3 million are supplied. 2) There is a shortage of 3 million tapes a week, and the price rises. 3) If the price is $4 a tape, 3 million tapes a week are demanded and 5 million are supplied. 4) There is a surplus of 2 million tapes a week, and the price falls. 5) If the price is $3 a tape, 4 million tapes a week are demanded and 4 million are supplied. 6) There is neither a shortage nor a surplus. 7) Neither buyers nor sellers have any incentive to change price. 8) The price at which the quantity demanded equals the quantity supplied is the equilibrium price. 51

Market Equilibrium 6 Supply of tapes 5 4 3 2 1 Demand for tapes Surplus of 2 million tapes at $4 a tape 6 Supply of tapes 5 Price (dollar per tape) 4 Equilibrium 3 2 Instructor Notes: 1) If the price is $2 a tape, 6 million tapes a week are demanded and 3 million are supplied. 2) There is a shortage of 3 million tapes a week, and the price rises. 3) If the price is $4 a tape, 3 million tapes a week are demanded and 5 million are supplied. 4) There is a surplus of 2 million tapes a week, and the price falls. 5) If the price is $3 a tape, 4 million tapes a week are demanded and 4 million are supplied. 6) There is neither a shortage nor a surplus. 7) Neither buyers nor sellers have any incentive to change price. 8) The price at which the quantity demanded equals the quantity supplied is the equilibrium price. Shortage of 3 million tapes at $2 a tape 1 Demand for tapes 0 2 4 6 8 10 Quantity (millions of tapes per week) 46

Market Equilibrium Price Adjustments A shortage forces the price up. A surplus forces the price down. Such price changes are mutually beneficial to both buyers and sellers.

Predicting Changes in Price and Quantity A Change in Demand What would happen to the price and quantity of tapes if the price of a Walkman falls from $200 to $50?

The Effects of a Change in Demand Quantity demanded Price (millions of tapes per week) (dollars Quantity supplied per tape ) Walkman $200 Walkman $50 (millions of tapes per week) 1 9 0 2 6 3 3 4 4 4 3 5 5 2 6 51

The Effects of a Change in Demand Quantity demanded Price (millions of tapes per week) (dollars Quantity supplied per tape ) Walkman $200 Walkman $50 (millions of tapes per week) 1 9 13 0 2 6 10 3 3 4 8 4 4 3 7 5 5 2 6 6 51

The Effects of a Change in Demand Supply of tapes 6 Demand for tapes (Walkman $50) 5 Price (dollar per tape) 4 3 2 Instructor Notes: 1) As the price rises to $5, the quantity supplied increases, shown by the blue arrow on the supply curve--to the new equilibrium quantity of 6 million tapes a week. 2) Following an increase in demand, the quantity supplied increases but supply does not change--the supply curve does not shift. 1 Demand for tapes (Walkman $200) 0 2 4 6 8 10 12 14 Quantity (millions of tapes per week) 52

A Change in Demand Prediction When demand increases, both the price and quantity increase. When demand decreases, both the price and quantity decrease.

Predicting Changes in Price and Quantity A Change in Supply What would happen to the price and quantity of tapes if a new cost-saving production technology was developed?

The Effects of a Change in Supply Quantity supplied Price (millions of tapes per week) (dollars Quantity demanded old new per tape ) (millions of tapes per week) technology technology 1 9 0 2 6 3 3 4 4 4 3 5 5 2 6 51

The Effects of a Change in Supply Quantity supplied Price (millions of tapes per week) (dollars Quantity demanded old new per tape ) (millions of tapes per week) technology technology 1 9 0 3 2 6 3 6 3 4 4 8 4 3 5 10 5 2 6 12 51

The Effects of a Change in Supply Supply of tapes (old technology) 6 5 Price (dollar per tape) 4 Supply of tapes (new technology) 3 2 Instructor Notes: 1) As the price falls to $2, the quantity demanded increases--shown by the blue arrow on the demand curve--to the new equilibrium quantity of 6 million tapes a week. 2) Following an increase in supply, the quantity demanded increases but demand does not change--the demand curve does not shift. 1 Demand for tapes 0 2 4 6 8 10 12 14 Quantity (millions of tapes per week) 52

A Change in Supply Prediction When supply increases, the quantity increases and the price falls. When demand decreases, the quantity decreases and the price falls

Elasticity Elasticity is a measurement of the degree of responsiveness of supply to a change in price. Price Elasticity of Supply=(%ΔQs / %ΔP) 1. Price-inelastic supply 2. Price-elastic supply 3. Unit-elastic supply Perfectly inelastic supply (Fig. 5.3 page 81)

Predicting Changes in Price and Quantity COMBINING SUPPLY AND DEMAND (p.82) A Change in Both Demand and Supply What would happen if both demand and supply change together?

The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per tape ) Walkman old Walkman new $200 technology $50 technology 1 9 0 2 6 3 3 4 4 4 3 5 5 2 6 51

The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per tape ) Walkman old Walkman new $200 technology $50 technology 1 9 0 13 3 2 6 3 10 6 3 4 4 8 8 4 3 5 7 10 5 2 6 6 12 51

The Effects of an Increase in Both Demand and Supply Supply of tapes (old technology) Supply of tapes (new technology) 6 Demand for tapes (Walkman $50) 5 Price (dollar per tape) 4 3 Instructor Notes: 1) The new supply curve intersects the new demand curve at $3 a tape, the same price as before, but the quantity increases to 8 million tapes a week. 2) These increases in demand and supply increase the quantity but leave the price unchanged. 2 1 Demand for tapes (Walkman $200) 0 2 4 6 8 10 12 14 Quantity (millions of tapes per week) 52

A Change in Both Demand and Supply Prediction When both demand and supply increase, the quantity increases and the price decreases, or remains constant. When both demand and supply decreases, the quantity decreases and the price increases, decreases, or remains constant.

The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per tape ) CD player old CD player new $400 technology $200 technology 1 13 0 2 10 3 3 8 4 4 7 5 5 6 6 51

The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per tape ) CD player old CD player new $400 technology $200 technology 1 13 0 9 3 2 10 3 6 6 3 8 4 4 8 4 7 5 3 10 5 6 6 2 12 51

The Effects of an Decrease in Demand and an Increase in Supply Supply of tapes (old technology) 6 Supply of tapes (new technology) 5 Price (dollar per tape) 4 3 2 Instructor Notes: 1) The new supply curve intersects the new demand curve at $3 a tape, the same price as before, but the quantity increases to 8 million tapes a week. 2) These increases in demand and supply increase the quantity but leave the price unchanged. 1 Demand for tapes (CD player $400) Demand for tapes (CD player $200) 0 2 4 6 8 10 12 14 Quantity (millions of tapes per week) 52

The Effects of an Decrease in Demand and an Increase in Supply Prediction When demand decreases and supply increases, the price falls and the quantity increases, decreases, or remains constant. When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.

Mathematical Note Demand Curve P = a - bQD Intercept on y axis is a a Price (P) a Slope is - b Demand Quantity demanded (QD)

Mathematical Note Market equilibrium P* Q* Price (p) Supply Demand Q* Quantity supplied (Qs)

The End