Lesson 4. Adam Smith and the Free Market 1/27/2013. Markets and Competition. Supply. Unit 2. Krugman, Module 6 pp

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1 Unit 2 Adam Smith and the Free Market Lesson 4 Krugman, Module pp Markets and Competition A market is a group of buyers and sellers of a particular product. A competitive market is one with many buyers and sellers, each has a negligible effect on price. A perfectly competitive market: all goods exactly the same Large numbers of buyers & sellers so that no one can affect market price In this chapter, we assume markets are perfectly competitive. 1 Supply The quantity supplied of any good is the amount that sellers are willing and able to sell. Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises. The reasons for this: Increasing Costs or - Diminishing Marginal Utility Total Revenue is equal to X Quantity 2 1

2 The Supply Schedule Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied. Example: Starbucks supply of lattes. Notice that Starbucks supply schedule obeys the Law of Supply. of lattes Quantity of lattes supplied Starbucks Supply Schedule & Curve $.00 $5.00 $4.00 $3.00 $2.00 $ Q of lattes Quantity of lattes supplied Market Supply versus Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two sellers in this market. (Q s quantity supplied) Starbucks Jitters Market Q s

3 The Market Supply Curve $.00 $5.00 $4.00 $3.00 $2.00 $1.00 Q Q S (Market) Supply Curve Shifters The supply curve shows how price affects quantity supplied. Non-price determinants of supply change businesses willingness and ability to produce products for sale in the market. Changes in Non-price determinants shift the S curve 7 Supply Curve Shifters: government Government can encourage production by subsidizing production, lowering costs for businesses -shifts S curve to the right. Government can discourage production by taxing production, increasing costs for businesses -shifts S curve to the left. 8 3

4 Supply Curve Shifters: other profit opportunities An increase in profits in this market will cause the number of sellers to increase as new firms enter or existing firms expand -shifts S curve to the right. An decrease in profits in this market will cause the number of sellers to decrease as firms leave the market -shifts S curve to the left. 9 Supply Curve Shifters: number of sellers An increase in the number of sellers increases the quantity supplied at each price, shifts S curve to the right. 10 Supply Curve Shifters: investment Technology determines how much inputs are required to produce a unit of output. A cost-saving technological improvement has the same effect as a fall in input prices, shifts S curve to the right. 11 4

5 Supply Curve Shifters: resource costs Examples of resource costs: wages, rent, and interest. A fall in factor prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right. 12 Supply Curve Shifters: costs $.00 $5.00 $4.00 $3.00 $2.00 $1.00 Q Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example). 13 Supply Curve Shifters: expectations Example: Events in the Middle East lead to expectations of higher oil prices. In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price. S curve shifts left. In general, sellers may adjust supply * when their expectations of future prices change. 14 5

6 Summary: Variables That Affect Supply Variable Government Other rofit Opportunities No. of sellers Investment A change in this variable causes a movement along the S curve Cost of Resources Expectations 15 Supply curve Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. rofessional tax return preparers raise the price of the services they provide. 1 A. fall in price of tax return software of tax return software 1 2 S 1 S curve does not shift. Move down along the curve to a lower and lower Q. Q 2 Q 1 Quantity of tax return software 17

7 B. fall in cost of producing the software of tax return software 1 S 1 S 2 S curve shifts to the right: at each price, Q increases. Q 1 Q 2 Quantity of tax return software 18 C. professional preparers raise their price of tax return software S 1 This shifts the demand curve for tax preparation software, not the supply curve. Quantity of tax return software 19 CHATER SUMMARY A competitive market has many buyers and sellers, each of whom has little or no influence on the market price. Economists use the supply and demand model to analyze competitive markets. The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good s price. Other determinants of supply include government taxes and subsidies, other profit opportunities, resource costs, investment in technology, expectations, and the # of sellers. Changes in these factors shift the S curve. 20 7