Ch. 5 Supply MR. POPE- 2015

The Law of Supply (Looking through the eyes of the Producer)

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

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

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

Supply Curve Price (monthly bill) Quantity (of Cell Phone Subscribers) 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

Role of Costs in Shaping the Supply Curve  To understand the Law of Supply, we must recognize that companies need profits.  Profit occurs when revenues are greater than all costs (variable and fixed)  Variable Cost (VC)- are cost that CAN change month to month depending on production.  Fixed Costs (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  Variable Cost - are cost that CAN change month to month depending on production  Changes when production increases or decreases.  Examples:  Hourly wages of workers.  Electricity  Shipping  Gas

Role of Costs in Shaping the Supply Curve  Fixed Costs - are costs that CANNOT change month to month. They are steady regardless of the amount of production.  Do not change when production increases or decreases  Examples:  Rent  Manager’s salary  Insurance payment

Variable & Fixed Costs and the Supply Curve Let’s look at these costs as totals. $Price/Cost Quantity $14.00 $12.00 $4.00 $ 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.

Law of Diminishing Returns  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.  This law explains why the curve shifts upward.

Output Workers Law of Diminishing Returns Workers Total Product 0 Marginal returns diminish as more inputs are introduced into any production process. Marginal Returns (Mowed lawns) LAWN CARE SERVICE (only 2 lawn mowers)

As production increases, additional costs increase. Price (monthly bill) Quantity (of Cell Phone Subscribers) Supply 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

Elastic Supply  Elastic Supply - quantity supplied is sensitive to small price changes.  If the marginal (small) 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.

Inelastic Supply  Inelastic Supply - quantity supplied is not sensitive to small price change.  If the marginal (small) costs to make an additional good are high, then the producer will be less likely to produce the good if the price changes.  Products that are expensive and more specialized have less elasticity.

Elastic and Inelastic Supply Curves 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

Elastic and Inelastic Supply Curves 100,000 75, Chopper iPod QUANTITY Price (per unit) Price (per unit)

Elasticity is Short Run and Long Run  Short-run- firms don’t have enough time to adjust to production in a short period of time  Example: stuck with current factory size  Supply tend to be inelastic in the short-run  Long-run- firms have enough time to adjust in a longer period of time  Example: build a larger factory, thus benefiting from mass producing a good.  Supply tend to be more elastic in the long-run

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 ?

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

Changes in Supply Vs. Changes in Quantity Supplied

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 Quantity A shift to the left = decrease in supply A shift to the right = increase in supply 15 $ Price Quantity

The Determinates of Supply (shifters)  The only factors that can cause a supply curve to shift to the left (decrease) or right (increase) 15 $ Price Quantity

The Determinants of Supply (shifters)  What specific things determine the position of the supply curve? 1. Government Actions 2. Outlook of future 3. Size of Industry 4. Price of Related Products 5. Input Costs 6. Technology

The Determinants of Supply 1. Government Actions- taxes, subsidies, regulations 2. Outlook of Future  A storm is predicted to destroy most of the seaports where most imported oil is delivered.  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)

The Determinants of Supply 3. Size of the Industry 4. Price of Related Products  Donut Company: price of donuts decrease  Less likely to produce donuts and more likely to use the dough to produce more donut holes (supply curve for rolls shift right)  Therefore, an increase in price of good the resources could go toward = supply curve of the other good decreases (shifts left) $ = SUPPLY

The Determinants of Supply (shifters) 5. Input Costs ( prices of resources )  As the price of resources goes up then a supplier will decrease the supply of a good and look for something else to make.  As the price of a resource goes down then a supplier will increase the supply of a good because he/she is making a profit. LUMBER $ = SUPPLY HOUSE CONSTRUCTION

The Determinants of Supply (shifters) 6. Technology  Increase in technology = increase in amount supplied (shift right)  Decrease in technology = decrease in amount supplied (shift left ) T = SUPPLY