Supply

Unit 5

Law of Supply

• When Prices go up, Supply goes up

• When Prices go down, Supply goes down– Quantity supplied is a measure of the number

of suppliers in the market, and how many products can be sold at a high price.

– As the price goes higher, producers look at bigger profits, so they create more goods.

Understanding the Supply Curve

• The supply curve is a upward sloping curve, showing the proportional relationship between prices and quantity supplied.

Price

Quantity

Supply

Supply Schedules and Market Schedules

• Just as with demand, it is possible to set up a price versus supply schedule chart, to show how much is supplied at various prices. The graph of a supply curve is opposite of a demand curve. Where demand falls as prices increase, supply rises as prices increase.

Supply CurvePrice of

Ice-CreamCone

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

0.50

1. Anincrease in price ...

2. ... increases quantity of cones supplied.

Market Supply

• Market supply is the total of all individual supply curves in a given area.

• When the curves are added, it becomes flatter. Why?

+ + =

Grocery SupplyIn Pleasant Hill

Elasticity and Supply

• Elasticity with supply works just like elasticity with demand. Suppliers look at the amount of change in price, and look at the change in supply.

• Short and Long Run– In the short run, supply tends to be more inelastic,

while in the long run, it becomes very elastic (in other words, if demand is high, suppliers will continue to enter the market until demand is satisfied.)

Costs of Production

• One of the major factors of supply are the costs needed to produce an item. This will determine the baseline supply curve. How much each supplier can produce is largely a factor of costs.

Market Entry

• One of the basic tenets of supply, as noted above, is that as prices increase, new producers enter the market to supply more goods.

• This effect only happens when the barriers to entry to the market are low, and it does not cost much to enter the market.

• In many cases, entering a market has significant start up costs, and it is not likely new producers will enter the market unless there is a reasonable chance that the prices and demand will still be there when the new producer finally is able to make their product available. Would it be easier to start a new company making websites, or a new company making cars?

Labor and Output• To produce goods, labor is necessary. Assuming that the amount of materials to

make a product remain the same, as the number of workers increases, the ability of each worker to make more of a product also increases, up to a point.

• As workers are added to a workforce, there tends to be a synergistic effect, where each person works more efficiently as more workers are added. This effect applies until the number of workers increases to the point where they are getting in each others way.

• The addition of workers as output increases per worker is known as increasing marginal returns. This is where we look at the production of the last person hired, and how adding one new worker will affect the performance of the whole.

• Once a peak is reached, the addition of new workers does not increase the output of the whole, and it begins to decrease, this is known as diminishing marginal returns. If workers keep being added, there will come a point of having negative marginal returns, where the amount produced will actually start going backwards in response to adding a new worker.

Production Costs• Production costs come in fixed and variable costs. These are the costs

that go into how much a product will ultimately cost the consumer. • Fixed costs are costs that do not change (much) as each product is

made. Some examples of this can be the rent of the building(s), maintenance on machinery, salaries of individuals who need to keep working even if production is stopped.

• Variable costs can be the salaries of workers who do not get paid if production stops, the costs of materials, and utilities such as electricity and air conditioning.

• Total costs are the complete costs for making the products. This adds together all of the different costs.

• Marginal costs are the costs increasing or decreasing production at a given level, such as producing one more item, or adding one more worker.

Setting Output

• Once all the costs are considered, it is possible to set up a supply curve based on how much it costs to make goods. As the price increases, the marginal costs of producing more items become possible. Remember, all businesses are in this for profit. A supplier will not make more items if it costs them too much.

• If the demand drops for a good, or too many suppliers enter the market and the price drops enough, a supplier might be faced with the problem of not making a profit at any given production level, and shut down their operation. In such a situation, the fixed costs will still need to be paid, but the variable costs should drop to almost nothing.

Changes in Supply

• Changes in the price of a good can move the point of how much businesses will supply goods. Other changes that affect supply will instead move the whole curve.

1 5

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones0

S

1.00

A

C$3.00 A rise in the price of

ice cream cones results in a movement

along the supply curve.

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2

Input Costs• The most immediate changes in supply can occur due to

changes in the costs of inputs to the business. • The wages of workers, costs of supplies, change in rent,

and technology can all affect the marginal costs of making a good.

• When costs go up, the supply curve moves to the left (almost always). When costs go down, the curve moves to the right (sometimes.)

• When costs go down, you should not assume that the curve will move to the right, unless pressures are brought to bear on the company, such as competition. The reason for this is that when input prices go down, a business might just pocket the extra profit and keep supplies scarce to keep the product prices up.

Government Influence - Subsidies• Subsides are government monies used to prop up or lower prices for a good

by either having suppliers hold back on production, or to lower costs to make it more available.

• Examples – The United States grows too much wheat. If all the wheat growers were to put their goods on the market, the supply would be so large that prices would drop considerably. Because of the drop in prices, the average farmer would not be able to sell enough wheat to support their costs. By paying farmers NOT to grow wheat, the supply of wheat is made more scarce, thus raising the prices, and allowing farmers to make enough profits to keep producing wheat.

• Or the government can directly give money to a company to lower the costs of a good, thus increasing supply, and making that good available to more people and businesses that use that good. U.S. Steel industries have used subsidies like this to produce cheap steel that can be used by other companies to produce goods more cheaply, thus increasing the supply of secondary goods like automobiles.

• Subsidies can also be used to protect an industry from competition abroad, in order to insure that the business remains local in case of a crisis, or to build that industry up to the point where it can compete in the global market.

Regulations

• Regulations in business usually add to costs, making it more expensive to produce. This in turn reduces supply. Most regulations are considered a good trade off though, as it makes the goods safer. In times of crisis or recession, regulations can be relaxed to increase supply.

Excise Taxes

• The government can directly tax a good, to reduce consumption. This tax takes place after the good is produced, and is usually paid directly by the consumer. Products like liquor and tobacco have excise taxes on them.

Global Supply• As the global market becomes easier to trade in, many

goods supplied in the U.S. are made in other countries.

• This is because they can produce the items more cheaply than it could in the U.S. The main reason for this is because of the costs of labor.

• As many countries supply cheaper labor ($0.13/hour or even less), these goods can still be transported to the U.S. and sold for less, thus increasing supply.

• What effect do you think this has on the price of labor as a whole?

Expectations of Prices

• Suppliers are not only concerned about the prices of a good on the market now, but also look at what the prices will be in the coming months.

• If there is an expectation of a price increase, suppliers might stockpile a good, reducing the current supply, in order to take advantage of higher prices later.

• Conversely, if the price of a good in expected to go down, suppliers will sell as much as they can in the short run, to increase their profits over the long run.

• The hoarding of goods in expectations of future prices can cause considerable distress, as the short run supply drops. This causes prices to go up, and can cause financial hardship for families on a limited budget.

Location of Businesses

• The location of a business can be important. • If a supplier needs a lot of raw materials to produce a good

that is small, they will likely locate themselves close to the source of raw materials to reduce the cost of shipping.

• On the other hand, if a product is bulky after it is made, then it is better to produce that item close to the consumers.

• Another factor is whether the product has a short life span, such as a fresh food item. These foods will likely be made close to the consumers.

• Businesses that require lots of educated workers may situate themselves close to universities or in larger cities.