The Law of Supply

The Law of SupplyThe Law of Supply

When prices go up, quantity When prices go up, quantity supplied goes upsupplied goes up

When prices go down, quantity When prices go down, quantity supplied goes downsupplied goes down

Why Does it Work That Why Does it Work That Way?Way? Every company has a certain Every company has a certain

amount of resourcesamount of resources Companies will use the resources Companies will use the resources

they have to produce the most they have to produce the most profitable goods and servicesprofitable goods and services

If the price goes up and people still If the price goes up and people still buy it, businesses make more buy it, businesses make more money!money!

Supply ScheduleSupply Schedule

Works just like a demand Works just like a demand schedule, with a column for price schedule, with a column for price and a column for quantity and a column for quantity suppliedsupplied

Supply CurveSupply Curve

Graphs the Graphs the supply supply scheduleschedule

The line is The line is opposite the opposite the demand curve!demand curve!

Supply and ElasticitySupply and Elasticity

Supply is elastic when a small Supply is elastic when a small price change leads to a big price change leads to a big change in quantity suppliedchange in quantity supplied

Supply is inelastic when a big Supply is inelastic when a big price change still has little effect price change still has little effect on quantity suppliedon quantity supplied

Elasticity in the Short Elasticity in the Short RunRun

Some business Some business cannot respond cannot respond to price changes to price changes quicklyquickly Producers of Producers of

goods (farmers, goods (farmers, factories, etc.)factories, etc.)

Elasticity in the Short Elasticity in the Short RunRun Other business Other business

respond very respond very quickly to price quickly to price changeschanges Service industry Service industry

can hire more can hire more workers to workers to produce more produce more immediatelyimmediately

Elasticity in the Long RunElasticity in the Long Run

When businesses have a long When businesses have a long time to respond to price time to respond to price changes, supply is even more changes, supply is even more elasticelastic

Time is the most important factor Time is the most important factor in determining elasticity of supplyin determining elasticity of supply

Costs of ProductionCosts of Production

Labor and OutputLabor and Output

How do companies decide how How do companies decide how many people to hire?many people to hire?

Marginal Product of Labor – the Marginal Product of Labor – the change in production output from change in production output from hiring one more workerhiring one more worker

Marginal Product of Marginal Product of LaborLabor

Increasing Marginal Returns – Increasing Marginal Returns – when adding workers increases when adding workers increases productionproduction

Marginal Product of Marginal Product of LaborLabor Diminishing Marginal Returns – Diminishing Marginal Returns –

when adding workers still when adding workers still increases production, but at a increases production, but at a slower rateslower rate

Marginal Product of Marginal Product of LaborLabor

Negative Marginal Returns – Negative Marginal Returns – when adding more workers when adding more workers decreases productiondecreases production

Production CostsProduction Costs

Production costs are any Production costs are any expenses that go into making a expenses that go into making a productproduct

Electricity, Worker’s Wages, Electricity, Worker’s Wages, Worker’s Benefits, Rent, Gas, Worker’s Benefits, Rent, Gas, Raw Materials, etc. Raw Materials, etc.

Production CostsProduction Costs Fixed Cost – does Fixed Cost – does

not change, no not change, no matter how little matter how little or much is or much is producedproduced

For example: For example: machinery machinery repairs, rent, repairs, rent, salaried salaried employeesemployees

Production CostsProduction Costs Variable Costs – Variable Costs –

costs that rise or costs that rise or fall based on fall based on how much is how much is producedproduced

For example: For example: Raw Materials, Raw Materials, Hourly Workers, Hourly Workers, Gas, ElectricityGas, Electricity

Calculating Total CostCalculating Total Cost

Total Cost = Fixed Cost + Variable Total Cost = Fixed Cost + Variable CostCost

TC = FC + VCTC = FC + VC

Calculating Average Total Calculating Average Total CostCost

Average Total Cost = Average Total Cost = Total CostTotal Cost Total Output Total Output

ATC = TC / QsATC = TC / Qs

Production CostsProduction Costs

Marginal Cost – the additional Marginal Cost – the additional total cost of producing one more total cost of producing one more unitunitSo if producing one Sweet So if producing one Sweet

Onion Chicken Teriyaki costs Onion Chicken Teriyaki costs $1.50, and producing two costs $1.50, and producing two costs $2.50, marginal cost is $1.00.$2.50, marginal cost is $1.00.

Production CostsProduction Costs

At first, the more you produce, At first, the more you produce, the cheaper it is per item to the cheaper it is per item to produce themproduce them

Later on, increasing production Later on, increasing production will actually will actually hurthurt the company’s the company’s profitsprofits

That’s Right!That’s Right!

Because eventually, diminishing Because eventually, diminishing and negative marginal returns and negative marginal returns set in when you have too many set in when you have too many workers!workers!

Setting OutputSetting Output

Businesses, thus, base their Businesses, thus, base their hiring decisions on maximizing hiring decisions on maximizing profit – they study marginal costprofit – they study marginal cost

How can I line my pockets with more

indescribable wealth?

Marginal Revenue and Marginal Revenue and Marginal CostMarginal Cost Marginal Revenue is the Marginal Revenue is the

additional income from selling additional income from selling one more productone more product Typically, MR = PriceTypically, MR = Price

The best formula for a business The best formula for a business to use is for their marginal to use is for their marginal revenue to = their marginal costrevenue to = their marginal cost

Responding to Price Responding to Price ChangesChanges

When the price goes up for a When the price goes up for a good, how do businesses good, how do businesses respond?respond?

Responding to Price Responding to Price ChangesChanges

Remember: Your marginal revenue is now way above

marginal cost

When to ShutdownWhen to Shutdown

If marginal revenue = marginal If marginal revenue = marginal cost and you are still losing cost and you are still losing money…money…

You are in big trouble!You are in big trouble! Profit is already maximized and Profit is already maximized and

you are still behind!you are still behind!

5 Factors that Shift 5 Factors that Shift SupplySupply

1. Input Costs – costs that go into 1. Input Costs – costs that go into producing your goodproducing your good The business would naturally produce The business would naturally produce

less if the product is less profitableless if the product is less profitable Higher input costs shift supply left, Higher input costs shift supply left,

lower input costs shift it rightlower input costs shift it right

5 Factors that Shift 5 Factors that Shift SupplySupply 2. Technology - can decrease 2. Technology - can decrease

input costsinput costs Email has virtually eliminated Email has virtually eliminated

many long distance phone bills many long distance phone bills and mail delivery charges for and mail delivery charges for some businessessome businesses

Better technology shifts supply to Better technology shifts supply to the rightthe right

5 Factors that Shift 5 Factors that Shift SupplySupply

3. Market Entry/Exit3. Market Entry/Exit New businesses entering the New businesses entering the

market shifts supply to the rightmarket shifts supply to the right Businesses closing down and Businesses closing down and

leaving the market shift supply to leaving the market shift supply to the leftthe left

5 Factors that Shift 5 Factors that Shift SupplySupply

4. Government4. Government Can encourage Can encourage

or discourage or discourage production of production of certain goodscertain goods

5 Factors that Shift 5 Factors that Shift SupplySupply

If the government If the government wants to shift supply wants to shift supply left, it uses:left, it uses:

Excise Taxes – a Excise Taxes – a tax on the tax on the production or production or sale of a goodsale of a good

5 Factors that Shift 5 Factors that Shift SupplySupply If the government If the government wants to shift supply wants to shift supply left, it uses:left, it uses: Regulations – Regulations –

government government intervention that intervention that affects the price, affects the price, quantity, or quality of quantity, or quality of a gooda good

5 Factors that Shift 5 Factors that Shift SupplySupply If the government wants to push If the government wants to push

the supply curve to the right, it the supply curve to the right, it uses: uses: Subsidies- pays the producer a Subsidies- pays the producer a

set amount per goodset amount per goodDeregulation – gets rid of Deregulation – gets rid of

existing gov. regulationsexisting gov. regulations

5 Factors that Shift 5 Factors that Shift SupplySupply 5. Producer Expectations5. Producer Expectations

If producers expect prices to If producers expect prices to go up in the future, they store go up in the future, they store their goods now until they can their goods now until they can sell them for the higher pricesell them for the higher price

Shifts current supply leftShifts current supply left

5 Factors that Shift 5 Factors that Shift SupplySupply 5. Producer Expectations5. Producer Expectations

If producers expect prices to If producers expect prices to go down in the future, they go down in the future, they flood the market now to get rid flood the market now to get rid of them before the price dropsof them before the price drops

Shifts current supply rightShifts current supply right

QUESTIONS?