V. Supply

A. What Is Supply?

1. An Introduction to Supply-

At the other side of every transaction is a seller. Economists refer to the behavior of sellers as that market force of supply. It is the combined forces of supply and demand that make up a market economy. In microeconomics, the smallest unit of supply is the firm, which is analogous to the demand unit of the household. Firms operate independently of each other, making decisions about what to sell, and how much to sell, depending on the price. How do firms make their selling decisions? Once they have decided what to sell, a decision they make based on what they believe buyers will want to buy, their decision is then influenced by the market price of the goods.

2. Supply and the Supply Schedule

a. Supply Curve- Economists graphically represent the relationship between product price and quantity supplied with a supply curve. Typically, supply curves are upwards sloping, because as price increases, sellers are more likely to be willing to sell something. For instance, if someone offered you \$10 for one of your favorite shirts, you might not want to part with it, since it wouldn't be worth it. However, if someone offered you \$500 for that same shirt, you would probably consider it. Each individual seller can have their own supply curve, showing how many products they are willing to sell at any given price, as shown below. This graph shows what James's supply curve for hours of tutoring in economics might be:

b. Law of Supply- The tendency of suppliers to offer more for sale at high prices that at low prices forms the basis for the law of supply. Th law states that the quantity supplied, or offered for sale, varies directly with the its price.

3. Change in Quantity Supplied- In a competitive economy, producers generally react to changing prices by relying on the interactions of the supply and demand curve. The final price of the product however is still up to the producer and they can always adjust the amount of production.

4. Change in Supply (Supply Curve Shifts)

a. Cost of Inputs- If the price of inputs go up, the number of quantity produced will go down. If the price of inputs go down, the number of quantity produced will go up.

b. Productivity- The more motivated the producer, the more they will supply. However, the less inclined a firm is to produced (unmotivated, unhappy or untrained), the less they will supply.

c. Technology- New technology tends to make the supply curve shift outward as the item (and its production) become more efficient. The industrial process of production will allow for costs to go down and supply to go up.

However, new technologies do not always work and their repair may ultimately make the supply go down (and costs go up).

d. Number of Sellers- Because the supply curve represents the different quantities that all producers offer at various prices, supply increases (when more suppliers enter the market).

e. Taxes and Subsidies- These two functions have the same effect as "costs" would. The more taxes a producer has to pay, the less likely the supply. The more subsidies they receive, the more likely they are to produce.

f. Expectations- The anticipation of future events can affect the supply curve in two ways.

1. Producers may think the item price will go up, hence they hold on to some of their supply, causing market supply to decrease.

2. Producers may expect lower prices in the future and they will want to produce and sell as much as possible before that happens.

g. Government Regulations- An increase in regulations generally means more costs prohibitive features on the product (ex: bumpers, air bags, emission controls, etc). When this happens, the producer incurs more cost and the price goes up. That means the supply goes down.

5. Elasticity of Supply

a. Supply Elasticities

1. Elastic- The change in price causes a relatively large change in the quantity supplied.

2. Inelastic- The change in price causes a relatively smaller change in quantity supplied.

3. Unit Elastic- A given change in price, causes a proportional change in quantity supplied.

b. Determinants of Supply Elasticity-

1. Elastic- Goods that are produced easily and cheaply. This is said, because producers can respond to market demands quickly.

2. Inelastic- Goods that require a lot of technology and capital. This is said because a sudden increase in demand will not likely cause an immediate need in supply.

c. Comparing Demand and Supply Elasticity- They are relatively the same. They are both responsive to the changes in price.

B. The Theory of Production- Is the relationship between the factors of production and the output of goods and services. It looks at how output changes when inputs are changed.

1. Law of Variable Proportions- State that in the short run, output will change as one input is varied while the others are held constant. As a parallel, if you take one aspirin for a headache, if you take two you may feel even better. If you take a third, fourth or more...then you become sicker. As the amount of input- the aspirin - increasingly varies, so does the output (effect) and the quality of that output.

It will try to answer the question of "how is the output of the final product affected as more units of one variable input or resource are added to a fixed about of other resources?"

2. The Production Function- Is a concept that relates changes in output to different amounts of a single input while other inputs are held constant. This could be natural resources, labor or any other factor of production.

a. Total Product- Or the total output of the firm when adding their resources. For example if you were to add more employees, your production will increase dramatically initially. Then over time you will find stagnation and only marginal improvement. There will come a time that when new employees are added they actually withdraw from the process of production (over-staffing).

b. Marginal Product- The added output generated by one additional unit of variable input.

3. Three Stages of Production

a. Stage 1: Increasing Returns- Lured by increasing profits with added inputs, firms tend to grow dramatically in this stage.

b. Stage II: Diminishing Returns- As more units of a certain variable input are added to a constant amount of other resources, total output keeps rising, but only at a diminishing rate.

c. Stage III: Negative Returns- At this stage of production, any new additional inputs incur losses.

C. Supply and the Role of Cost

1. Productivity and Cost- Businesses that use raw materials in manufacturing must decide which grade of materials suits their needs. Because efficiency is related to both cost and productivity, it is important that care be taken in selecting the proper materials.

2. Measures of Cost

a. Fixed Cost- The kind of cost that a business incurs even if the plant is idle and output is zero. This may include such things as rent, leased goods, property taxes, etc.

Fixed costs will also include such things as depreciation as well. This is the gradual wear and tear on capital goods over time and through use.

b. Variable Cost- Is a cost that will change when the business rate of operation or output changes.

Generally, these are wage related or raw material costs.

c. Total Cost- This is the sum of all the fixed and variable costs combined.

d. Marginal Cost- The extra cost incurred when a business produces one additional unit of a product. Because fixed costs do not change, marginal costs stem from variable costs and additional factors of production.

3. Practical Applications of Cost Principles (Read Text for Analysis)

a. Gas Stations

b. Movie Theaters

4. Measures of Revenue

a. Total Revenue- Total quantity sold multiplied by the price per unit.

b. Marginal Revenue- Is the extra revenue associated with the production and sale of one additional unit of output.

5. Marginal Analysis- Why do economists use this???

a. Break-even Analysis-The point in production where the total output or total product the business needs to sell in order to cover its total costs.

b. Profit Maximization- Is when marginal costs and marginal revenue are equal.