SUPPLYChapter 5

Section 1

Understanding Supply

What is Supply? Supply is the amount of goods

available. Law of Supply– As the price of a good

increases, producers will offer more of it and as the price decreases, they will offer less.

This includes two movements: Individual firms changing their level of production Firms entering or exiting the market

Profit’s Influence on Production Levels

If a firm is earning a profit from the sale of a good or service, then an increase in the price will, in turn, increase the firm’s profits.

In general, the search for profit drives the choices made by the producer.

Profit’s Influence on Market Entry Rising prices encourage new firms to

join the market and will add to the quantity supplied of the good.

Take, for example, the music market: When a particular type of music

becomes popular, such as 70’s disco or 90’s grunge, more bands will play that type of music in order to profit from such music’s popularity.

This action reflects the law of supply.

The Supply Schedule Supply of a good can be measured using a

supply schedule. A supply schedule shows the relationship between

price and quantity supplied for a particular good.

An individual supply schedule shows how much of a good a single supplier will be able to offer at various prices.

A market supply schedule shows how much of a good all firms in a particular market can offer at various prices.

The Supply Graph A supply schedule can be represented

graphically by plotting points on a supply curve. A supply curve always rises from left to right

because higher prices leads to higher output

Elasticity of Supply Elasticity of supply, based on the same

concept of elasticity of demand, measures how firms will respond to changes in the price of a good. Elastic

When elasticity is greater than one, supply is very sensitive to price changes

Inelastic When elasticity is less than one, supply is not

very responsive to price changes.

Elasticity in the Short Run In the short run, it is difficult for a firm to

change its output level, so supply is inelastic.

Many agricultural businesses, such as harvesting cranberries, have a hard time adjusting to price changes in the short term.

Elasticity in the Long Run In the long run, supply can become

more elastic.

Just like demand, supply becomes more elastic if the supplier has a longer time to respond to a price change.

Section 2

Costs of Production

Maximizing Profits When thinking about how to

maximize profits, producers think about the cost involved in producing one more unit of a good.

Costs producers take into consideration are:

Operating costVariable costTotal costMarginal cost

Labor and Output All business owners

must decide how many workers they will hire. The addition of new

workers will increase production until it reaches its peak, at which point, production actually decreases.

Marginal Returns The addition of

more workers to a firm allow for a greater amount of specialization. Specialization

increases the output and the firm enjoys increasing marginal returns.

Marginal Returns, cont. Eventually, though, the

benefits of specialization end and the addition of more workers increases total output but at a diminishing rate. A firm with diminishing

marginal returns will produce less and less output from each additional unit of labor.

Fixed Costs Production costs are

divided into two categories - fixed costs and variable costs. Fixed costs mainly

involve the production facility and include: Rent Machinery repair Property taxes Worker’s salaries

Variable Costs Variable costs

include: Price of raw

materials Some labor Electricity and

heating bills

Fixed costs and variable costs are added together to find the total cost.

Marginal Cost of Production Knowing the total cost of several levels of

output helps determine the marginal cost of production at each level, or the additional costs of producing one more unit.

One way to find the best level of output is to figure out where marginal cost is equal to marginal revenue, or the additional income from selling one more unit of a good.

Setting Output A firm’s primary goal is to maximize profits. The firm wants to make the most profit with

the least amount of total production cost to the firm.

Determining a Firm’s Profit The graph below shows how a firm’s

profit per hour can be determined by subtracting total cost from total revenue.

The Shutdown Decision What happens to a factory that

starts to lose money? Sometimes, even though a factory is

producing at its most profitable level, the market price is so low that the factory’s total revenue is still less than its total cost.

The factory owners have two choices: Continue to produce goods and lose money Shut down the factory

Option 1: Continue to Produce The firm should keep the factory

open if the total revenue from the goods is greater than the cost of keeping the factory open.

This would work if the benefit of operating the factory is greater than the variable cost.

Option 2: Shut Down

If a firm shuts the factory down it still has to pay all of its fixed costs so it would have money going out but nothing coming in.

The firm would lose an amount equal to its fixed costs.

Section 3

Changes in Supply

Shifts in the Supply Curve Several factors cause the supply

curve to shift. These include:Shifts in pricesRising costsTechnologyChanges in the global economyFuture expectations of pricesNumber of suppliers

Input Costs Any changes in

the cost of an input used to make a good will affect supply.

A rise in the cost of raw materials, for example, will result in a decrease in supply because the good has become more expensive to produce.

Rising Costs and Technology If costs continue to rise, a firm will have

to cut production and lower its marginal cost.

It is possible for input costs to drop. In many industries, advances in technology

can lower production costs. Examples of technology advances include:

Automation Computers E-mail

Government’s Influences In addition to input costs, the federal

government also has the power to affect the supplies of many types of good. Subsidies

The government often gives subsidies to the producers of a good.

Subsidies generally lower cost, which allows a firm to produce more goods.

Reasons for subsidizing products include: To provide for people during food shortages To protect young industries from foreign

competition.

Government Influences, cont. Taxes

Excise taxes increase production costs by adding an extra cost for each unit sold.

They are sometimes used to discourage the

sale of a good the government deems harmful, such as cigarettes and alcohol.

Government Influences, cont. Regulation

Indirectly, government regulation often has the effect of raising costs. When the government regulated the auto

industry to cut down on pollution, these regulations led to an increase in the cost of manufacturing cars.

Non-Price Influences Changes in the global economy

Since many goods and services are imported, changes in other countries can affect the supply of those goods. An increase in wages in one country or the

increased supply of a good in another will cause the overall supply curve to shift.

Restrictions on imports also affect supply.

Shifts in the Supply Curve Factors that reduce supply shift the

supply curve to the left, while factors that increase supply move the supply curve to the right.

Future Expectations of Prices If a seller expects the price of a good to

rise in the future, the seller will store the goods now in order to sell more in the future.

If the prices of good is expected to drop in the near future, sellers will earn more by placing goods on the market immediately, before the price falls.

Number of Suppliers If more suppliers enter a market, the

market supply will rise and the supply curve will shift to the right.

If suppliers stop producing a good and leave the market, market supply will decline, causing the supply curve to shift to the left.

Where do Firms Produce? A key factor in where a firm will

locate is transportation. When inputs such as raw materials are

expensive to transport, a firm will locate close to the inputs.

When outputs (the final product) are more costly to transport, firms will locate close to the consumer.