Chapter 5: SupplySection 1

Objectives

1. Explain the law of supply.

2. Interpret a supply schedule and a supply graph.

3. Examine the relationship between elasticity of supply and time.

Key Terms

• supply: the amount of goods available• law of supply: producers offer more of a good

as its price increases and less as its price falls• quantity supplied: the amount that a supplier

is willing and able to supply at a specific price• supply schedule: a chart that lists how much

of a good a supplier will offer at various prices • variable: a factor that can change

Key Terms, cont.

• market supply schedule: a chart that lists how much of a good all suppliers will offer at various prices

• supply curve: a graph of the quantity supplied of a good at various prices

• market supply curve: a graph of the quantity supplied of a good by all suppliers at various prices

• elasticity of supply: a measure of the way quantity supplied reacts to a change in price

Introduction

• How does the law of supply affect the quantity supplied?

– As prices rise, producers will offer more of a good and new suppliers will enter the market in the hopes of making a profit.

– The law of supply states that as prices rise, so will the quantity supplied.

The Law of Supply

• Supply is the amount of goods available.

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

– The law of supply includes two movements:• Individual firms changing their level of production• Firms entering or exiting the market

What is the Law of Supply?

Higher Production

• 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.

Market Entry

• Checkpoint: Why do firms increase production when the price of a good goes up?– 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.

Supply Schedule

• The supply schedule lists how many slice of pizza one pizzeria will offer at different prices. The market supply schedule represents all suppliers in a market.– What does the individual

supply schedule tell you about the pizzeria owner’s decisions?

– How does the market supply schedule compare to the individual supply schedule?

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.– Checkpoint: What are the two variables represented in

a supply schedule or supply curve?

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.

Review

• Now that you have learned how the law of supply affects the quantity supplied, go back and answer the Chapter Essential Question.– How do suppliers decide what goods and

services to offer?

Chapter 5: SupplySection 2

Objectives

1. Explain how firms decide how much labor to hire in order to produce a certain level of output.

2. Analyze the production costs of a firm.

3. Explain how a firm chooses to set output.

4. Identify the factors that a firm must consider before shutting down a profitable business.

Key Terms

• marginal product of labor: the change in output from hiring one additional unit of labor

• increasing marginal returns: a level of production in which the marginal product of labor increases as the number of workers increases

• diminishing marginal returns: a level of production in which the marginal product of labor decreases as the number of workers increases

• fixed cost: a cost that does not change, no matter how much of a good is produced

Key Terms, cont.

• variable cost: a cost that rises and falls depending on the quantity produced

• total cost: the sum of fixed costs plus variable costs

• marginal cost: the cost of producing one more unit of a good

• marginal revenue: the additional income from selling one more unit of a good

• average cost: the total cost divided by the quantity produced

• operating cost: the cost of operating a facility

Introduction

• How can a producer maximize 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 cost• Variable cost• Total cost• Marginal 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.

What is the marginal product of labor when the factory employs five workers?

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.

Why is the marginal revenue always equal to $24?

Determining a Firm’s Profit• The graph to the right shows how a firm’s profit

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

– What would happen

to output if market price fell to $20?

– Why would the firm increase output if the price of a beanbag rose to $37?

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

• Checkpoint: When should a firm keep a money-losing factory open?

– 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 the Factory• 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.

Review

• Now that you have learned how a producer can maximize profits, go back and answer the Chapter Essential Question.– How do suppliers decide what goods and

services to offer?

Chapter 5: SupplySection 3

Objectives

1. Explain how factors such as input costs create changes in supply.

2. Identify three ways that the government can influence the supply of goods.

3. Analyze other factors that affect supply.

4. Explain how firms choose a location to produce goods.

Key Terms

• subsidy: a government payment that supports a business or market

• excise tax: a tax on the production or sale of a good

• regulations: government intervention in a market that affects the production of a good

Introduction

• Why does the supply curve shift?

– Several factors cause the supply curve to shift. These include:

• Shifts in prices• Rising costs• Technology• Changes in the global economy• Future expectations of prices• Number 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.

The high input costs that dairy farmers pay for feed, labor, and fuel result in higher prices for milk and other dairy products.

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 Influence

• 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.

– Which graph best represents the effects of higher costs?

– Which graph best represents advances in technology?

Future Expectations of Prices

• Checkpoint: What happens to supply if the price of a good is expected to rise in the future?– 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?

• Checkpoint: When is a firm likely to locate close to its consumers?

– 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.

Review

• Now that you have learned why the supply curve shifts, go back and answer the Chapter Essential Question– How do suppliers decide what goods and

services to offer?