# Supply. Understanding Economics, Chapter 5

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1 Supply Understanding Economics, Chapter 5

2 What is Supply? Chapter 5, Lesson 1

3 What is Supply?! Supply the amount of a product a producer or seller would be willing to offer for sale at all possible prices at a given point in time! The higher the price is, the more sellers will want to sell.! Law of Supply rule stating that more will be offered for sale at higher prices and less at lower prices! Supply schedule listing showing the amount of a product a seller is willing to sell at all possible prices! See the supply schedule for a seller for burritos.

4 Supply Curve! Supply curve graph showing the quantities supplied at every possible price! Notice that supply curves are always upward sloping.! A higher price is an incentive for sellers to sell more. A lower price motivates them to sell less.! The supply curve is formed by plotting the combinations of price and quantity supplied from a supply schedule.! See a supply schedule for a seller of burritos at right.! Interesting You are a seller when you look for a job. Your product is your labor.

5 Market Supply! Market supply curve supply curve that shows the quantities offered at various prices by all firms that sell the same product in a given market.! Add the individual supply curves together by adding the quantities for each at each price.! There are usually many sellers in a given market, not just two.

6 Change in Quantity Supplied! Quantity supplied specific amount offered for sale at a given price; a point on the supply curve! Change in quantity supplied movement along the supply curve showing that a different quantity is offered in response to a change in price.! If the price of burritos goes up from \$5 to \$7, then the quantity supplied goes up from 24 million to 36 million! This is a slide along the supply curve from point a to point b.! If the price drops, a seller may not offer as much for sale or may even leave the market altogether.! If the price goes up, a seller will offer more for sale to take advantage of the higher prices.

7 Change in Supply! Change in supply different quantities of a product are offered for sale at every price, causing the supply curve to shift to the left or to the right.! This is caused by factors in the market other than price.! A shift to the right is an increase in supply.! A shift to the left is a decrease in supply.

8 Change in Supply (Shift) Taxes on Businesses Subsidies Technology Government Regulations Productivity Number of Sellers Cost of Resources Factors causing a change in supply (shift of curve) Seller Expectations for the Future

9 Change in Supply (Shift) Cost of Resources The cost of land, labor and capital impacts supply A decrease in the cost of resources means that suppliers can produce more at every price. This means an increase in supply and a shift right. An increase in the cost of resources means a decrease in supply and a shift left. Productivity Productivity increases whenever more products are produced with the same amount of resources. An increase in productivity means the supplier can produce more with the same resources. This is an increase in supply or a shift right. A decrease in productivity means a decrease in supply and a shift left. Technology An improvement in technology can lower the cost of production, which increases productivity. An improvement to technology that reduces costs leads to an increase in supply and a shift right. In reality, new technologies do not get taken away, but sometimes there is a learning curve with a new technology, where it is less productive as workers get used to it. This means a decrease in supply and a shift left.

11 Change in Supply (Shift) Number of Sellers Most markets are fairly active with firms entering and leaving all the time. When an industry grows because more firms are entering the market, supply for the industry increases (shifts right) If the industry is shrinking because firms are leaving the market, supply for the industry decreases (shifts left) Change in Sellers Expectations for the Future Expectations for the future affects the decisions businesses make. This can affect costs. To be able to make predictions about the affect of sellers expectations for the future, we need more specifics about those expectations. For example, many businesses were uneasy about having Obama as a president because they feared higher taxes and more regulations. As a result, they did not grow their businesses as they decided to wait out his presidency. This led to a decrease in supply or a shift left.

12 Supply Elasticity! Supply elasticity a measure of the degree to which the quantity supplied changes in response to a change in price.! Elastic when the change in price causes a proportionally larger change in the quantity supplied (flat supply curve)! Inelastic when the change in price causes a proportionally smaller change in the quantity supplied (steep supply curve)! Unit elastic when a change in price causes a proportional change in the quantity supplied.! Supply elasticity is determined by how long it takes for the business to change its production.! If a business can change production quickly in response to a change in price, supply is more elastic.! If a business cannot change its production quickly in response to a change in price, supply is more inelastic. (Ex: nuclear power plant)

13 The Theory of Production Chapter 5, Lesson 2

14 The Production Function! Production function graph showing how a change in a single variable input affects total output! All other variables are held constant except one.! The production function on the next slide shows how output will change as the number of workers increases from 0 to 12.! Short run production period so short that only variable inputs can be changed! Variable inputs inputs into production that can be easily changed to change the amount of output produced like labor and raw materials! The production function on the next slide represents the short run.! Long run production period long enough to change the amount variable and fixed inputs used in production! Fixed inputs inputs that do not often change to produce a change in output produced like machinery, technology and buildings

15 The Production Function

16 The Production Function! Total product total output produced by a business! Marginal product the extra output produced due to the addition of one more unit of input! The marginal product of the third worker is the total product for 3 workers minus the total product for 2 workers (38 20 = 18)! Notice that the marginal product for each worker is different. This is normal.! Stages of production phases of production (on the production function) that consist of increasing, decreasing and negative returns.! This is where marginal production is increasing with each worker added, decreasing with each worker added and negative with each worker added.! Decreasing marginal product note that you are still getting more output with each additional worker just the marginal product is decreasing.

17 Stages of Production Stage I Increasing Marginal Returns Where the marginal product for each additional unit of output (worker) is increasing This happens because as workers are added, they cooperate or specialize to make better use of their equipment. In our example, the first 5 workers are in stage I. Businesses do not knowingly produce in Stage I. They will keep adding workers until they are in Stage II. Stage II Decreasing Marginal Returns Total production keeps growing but by smaller and smaller amounts. Each worker is making a diminishing, but positive contribution to total output. Diminishing returns stage of production where output increases at a decreasing rate as more units of a variable input are added In our example, Stage II goes from the 6 th worker thru the 10 th worker. The goal of businesses is to operate in Stage II. Stage III Negative Marginal Returns The marginal product of each worker is negative. As more workers are added, the firm produces less output. Each worker decreases total output because in this stage there are too many workers and they are getting in each others way or otherwise interfering with production. Businesses do not produce in Stage III. They will let workers go until they are in Stage II.

18 Cost, Revenue and Profit Maximization Chapter 5, Lesson 3

19 Production, Cost, Revenues and Profits

20 Finding Marginal Cost! Fixed costs costs of production that do not change when output changes! The business incurs these costs even if there is little to no production.! Overhead another name for fixed costs! Includes salaries for executives, interest cost on debt, rent or mortgage payments, property taxes, depreciation! Depreciation the charge for gradual wear and tear on machinery! Variable costs production cost that varies as output changes! Includes labor, raw materials, electric power to run machines! In our example, the variable cost is for labor at \$90 per worker per day.! Total cost all of the costs associated with production (variable costs plus fixed costs)! Marginal cost the extra cost of producing one additional unit of output! The marginal cost for the 5 th worker is total cost for 5 workers minus total cost for 4 workers divided by the marginal product of the 5 th worker: ( )/28 = \$3.21

21 Finding Marginal Revenue! Average revenue the average price that every unit of output sells for! Total revenue total amount earned by a firm from the sale of its products.! Also, average price of a good times the quantity sold! In our example, each unit sells for \$15. Total revenue is calculated as \$15 times total product.! Marginal revenue the extra revenue from the sale of one additional unit of output.! Calculated as the change in total revenue marginal product.! For the 5 th worker, this is ( ) 28! Notice that since all of our units of product in our example sell for \$15, our marginal product is also \$15. In reality, firms charge different prices for the product, so these will not be the same.

22 Profit Maximization and Break Even! Total profit total revenue minus total costs! Businesses seek to produce the quantity that maximizes profit.! In our example, the firms would hire 8 or 9 workers because that corresponds to the quantity that maximizes profits at \$1300.! Profit-maximizing quantity of output level of production where marginal cost = marginal revenue! In our example, this occurs at 9 workers.

23 Profit Maximization and Break Even! Sometimes a firm may not be able to sell enough product to maximize profits, so it needs to know how much it needs to sell to cover its costs (not lose money).! Break-even point the level of production that generates just enough revenue to cover its operating costs.! This is the point where total cost = total revenue! In our example, with one worker, total revenue is \$105 and total cost is \$140 and costs would not be covered.! With two workers, total revenue is \$300 and total cost is \$230. Since this is just enough to cover costs, the break-even point for this firm is for them to hire 2 workers.! E-commerce electronic business or business conducted over the internet! This has become very popular with businesses because it is much less expensive. Businesses do not have the costs of operating a store.! As such, the break-even point of sales is much lower.

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