Reading Essentials and Study Guide

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1 Lesson 1 What Is Supply? ESSENTIAL QUESTION What are the basic differences between supply and demand? Reading HELPDESK Academic Vocabulary various different Content Vocabulary supply amount of a product offered for sale at all possible prices in a market Law of Supply principle that more will be offered for sale at high prices than at lower prices supply schedule a table showing the quantities produced or offered for sale at each and every possible price in the market supply curve a graph that shows the quantities supplied at each and every possible price in the market market supply curve supply curve that shows the quantities offered at various prices by all firms that sell the product in a given market quantity supplied amount offered for sale at a given price; point on the supply curve change in quantity supplied change in amount offered for sale in response to a price change; movement along the supply curve change in supply different amounts offered for sale at each and every possible price in the market; shift of the supply curve subsidy government payment to encourage or protect a certain economic activity supply elasticity responsiveness of quantity supplied to a change in price TAKING NOTES: Key Ideas and Details Use the Graphic Organizer below. In the Effect column, explain how supply and price react to demand. Cause Demand increases Demand decreases Effect 1

2 Supply is the amount of a product that would be produced or grown and offered for sale at all possible prices that could prevail in the market. Demand is how much buyers want an item or service. Sometimes, though, other factors influence production, especially in agricultural goods. Let us suppose you and your friends decide to spend a Saturday afternoon at a pick-your-own apple orchard. Many people are at the farm to pick apples. First you think that the price to pick a peck of apples is significantly higher than you remember from last year s visit to the orchard. Looking around, you then notice that many apples in the orchard have fallen on the ground and are not edible. The owner explains that a severe thunderstorm with high winds struck the orchards and damaged the apple crop. An Introduction to Supply Guiding Question: Why do supply and demand curves slope in opposite directions? All producers must decide how much of a product to offer for sale at various prices. Each producer makes this decision according to what is best for him or her. What is best depends upon the cost of producing the goods or services and the consumer s demand for them. A table or a graph can show the concept of supply, like it can for demand. The Supply Schedule The supply schedule is a list of the various quantities, or amounts, of a particular product supplied at all possible prices in the market. Panel A of Figure 5.1 shows a hypothetical, or imaginary, supply schedule for burritos. It shows the quantities of burritos that will be supplied at various prices, if other things are equal. If you compare it to the demand schedule in Panel A of Figure 4.1, you will see that the two are very similar. The main difference between Figure 5.1 and Figure 4.1 is that for supply, the quantity goes up when the price goes up rather than down as in the case of demand. This is because a high price is a reason for a producer to offer more. But the same high price is a reason for a buyer to buy less. The Individual Supply Curve We can also show the data in the supply schedule as the upward-sloping line in Panel B of Figure 5.1. To draw it, all we do is move each combination of price-quantity data in the schedule over to the graph. Then we connect the points to form the curve. The result is a supply curve, a graph showing the various quantities supplied at all possible prices that might succeed in the market at any particular time. Of course the prices and quantities in Figure 5.1 are a bit unlikely, but the numbers keep the graph simple. There is one main thing to remember. This is that all normal supply curves have a positive slope, which means that it goes up when you read the diagram from left to right. This shows that if the price goes up, the quantity supplied will go up, too. The supply schedule and curve in Figure 5.1 show the voluntary decisions of one imaginary burrito producer. But remember that supply is a very general concept. In fact, you are a supplier whenever you look for a job and offer your services for sale. Your economic product is your labor. You would probably be willing to supply more labor for a high wage than for a low one. 2

3 The Market Supply Curve The supply schedule and curve in Figure 5.1 show the information for a single producer. But often we are more interested in the market supply curve. This is the supply curve that shows the quantities offered at different prices by all producers that sell the product in a particular market. It is simple to get the data for the market supply curve. First add the number of burritos that each business would produce. Then place those numbers on a separate graph. In Figure 5.2, point a on the market supply curve represents three burritos that are for sale at a price of $2. The three burritos are two from the first company and one from the second company. In the same way, point b on the curve represents a total of five burritos for sale at a price of $4. Of course, two producers rarely represent all of the producers in a market. But if we could add all of them together, we might have a much more typical market supply curve like the one in Figure 5.2A. This figure has a wider range of prices and quantities because it represents all the producers in the market, not just two as in Figure 5.2. A Change in Quantity Supplied The quantity supplied is the amount that a single producer or all producers bring to market at any one price. A change in quantity supplied is the change in the amount offered for sale in response to a change in price. In Figure 5.2A, producers supply 24 million burritos when the price is $5, and 36 million when the price goes up to $7. These changes show a change in the quantity supplied. This change appears as a movement along the supply curve, just like demand. Notice that the change in quantity supplied can be an increase or a decrease. This depends on whether there is more or less of a product offered. For example, the movement from a to b in Figure 5.2A shows an increase. It shows an increase because the number of products offered for sale goes from 24 million to 36 million when the price goes up. If the movement along the supply curve had been from point b to point a, there would have been a decrease in quantity supplied. The decrease in quantity supplied would have been because the number of products offered for sale went down. In a market economy, producers react to changing prices in just this way. Take oil as an example. If the price of oil falls, producers may offer less for sale. They may even leave the market altogether if the price goes too low. If the price rises, producers may offer more for sale to take advantage of the better prices. It makes no difference whether we are talking about an individual supply curve or a market supply curve. In either case, a change in quantity supplied only happens if there is a change in price. Also, a change in quantity supplied will not shift the supply curve to the left or the right. The change in price only affects the amount offered for sale along an unmoving supply curve. Reading Progress Check Synthesizing How might a producer of bicycles adjust the quantity supplied when prices decrease? 3

4 Change in Supply Guiding Question: What might happen to make a producer decrease his or her supply of a product? Sometimes something happens to cause a change in supply. This is when suppliers offer different amounts of a product for sale at all possible prices in the market. Comparing a Change in Quantity Supplied to a Change in Supply The change in quantity supplied in Figure 5.2A is not the same as the change in supply shown in Figure 5.3. This is because the change in quantity supplied happens only when there is a change in price. When we have a change in supply, all quantities change even though the selling price stays the same. For example, the supply schedule in Figure 5.3 shows that producers are now willing to offer more burritos for sale at every price. Before, producers offered 24 million burritos at a price of $5, and now they offer 36 million. If producers offered 36 million at a price of $7 before, they now offer 50 million, and so on. When you put on a graph both old and new quantities supplied, it appears as if the supply curve has shifted to the right. This shows an increase in supply. For a decrease in supply to occur, producers would offer fewer products for sale at all possible prices. Then the supply curve would shift to the left. Factors that Can Cause a Change in Supply Changes in supply can be increases or decreases. These changes can occur for the reasons shown below. Cost of Resources A change in the cost of producing a product can cause a change in supply. Production costs can include land, labor, and capital. Supply might increase because of a lower cost of production, such as labor or packaging. This would allow suppliers to produce more at every price. This would then shift the supply curve to the right. An increase in production cost has the opposite effect. A higher production cost would force producers to offer fewer products for sale at every price. This would shift the supply curve to the left. Productivity Productivity is how many goods workers produce over a period of time. Productivity goes up whenever workers produce more with the same amount of resources. When management trains or motivates its workers, productivity usually goes up. This results in a supply curve that shifts to the right. But if workers become less motivated, untrained, or unhappy, then productivity could go down. They would produce fewer goods at every possible price. This would shift the supply curve to the left. Technology Using a new machine or industrial process can lower the cost of production and increase productivity. For example, improvements in jet aircraft fuel have lowered the cost of air passenger service. When production costs go down, a firm can produce more at every possible price. This shifts its supply curve to the right. New technologies do not always work at first, of course. In the beginning, the supply curve may briefly shift to the left. But companies expect new technologies to help over time, or they would not use them in the first place. 4

5 Taxes Firms consider most taxes to be a cost of production, just like raw materials and labor. This is one reason why businesses almost always lobby for lower taxes. If a company pays fewer taxes, it can produce more at each possible price. This would shift its supply curve to the right. However, if taxes go up, its production costs go up and it will produce less at each and every price. This would shift its supply curve to the left. Subsidies A subsidy is a payment to an individual, business, or other group to encourage or protect a certain type of economic activity. Today many farmers in the milk, cotton, corn, wheat, sugar, and soybean industries receive subsidies to support their incomes. This shifts their supply curves to the right. When a government removes subsidies, production costs go up. Then companies either leave the market entirely or produce less at each possible price. This shifts their supply curves to the left. Government Regulations If government lessens its regulations on business, production costs go down and firms are able to produce more at all possible prices. This shifts individual supply curves to the right. But more often, government increases its regulations. This raises a typical business s cost of production. For example, when the government requires new auto safety features such as air bags, emission controls, or higher collision safety standards, cars cost more to produce. Producers then adjust to the higher production costs by producing fewer cars at every possible price. This shifts the market supply curve to the left. Exploring the Essential Question How do government regulations affect supply and demand? In a paragraph, explain how a government regulation to increase bicycle safety might affect supply and demand. The new government regulation requires bicycle manufacturers to put a chain guard on bicycles they make. Would that affect the supply of bicycles? Give reasons for your answer. Number of Sellers Most markets are fairly active, with firms entering and leaving all the time. You may see this where you live, especially when one store closes and another opens in its place. Whenever an industry grows because more firms are coming in, the market supply curve shifts to the right. Or, if the industry is shrinking because firms are leaving, there are fewer products at the same prices as before. This shifts the market supply curve to the left. Expectations Expectations that is, what a firm thinks will happen in the future can also affect the decisions a firm makes. These expectations may affect anything from the cost of production to the demand for the firm s products. But unless we know more about these expectations, it is not possible to make any simple statements about the way they affect a firm s supply curve. As you can see, there are many factors that can cause a change in supply and so cause the market supply curve to shift to the left or to the right. But, only a change in price which we learned in the previous section can cause a change in quantity supplied, shown by a movement along a stationary, or nonmoving, supply curve. 5

6 Reading Progress Check Explaining Why do factors that cause a change in individual supply also affect the market supply curve? Elasticity of Supply Guiding Question: How does the production of a product affect the elasticity of supply? Just as demand has elasticity, so does supply. Supply elasticity is how much the quantity supplied responds to a change in price. As you might imagine, there is very little difference between supply and demand elasticities. Demand elasticity relates to the buying of quantities of a product. Supply elasticity relates to the producing and offering for sale quantities of a product. Three Cases of Supply Elasticity Figure 5.4 shows three examples of supply elasticity. In each case, we look at how the quantity supplied responds to a change in price. The quantity supplied depends on the change in price. Elastic Supply The supply curve in Panel A is elastic because the change in price causes a proportionally larger change in quantity supplied. Doubling the price from $1 to $2 causes the quantity supplied to triple from two to six units. Again, the prices and numbers are very simple, but it makes the diagrams easier to understand. Inelastic Supply Panel B shows an inelastic supply curve. In this case, a change in price causes a proportionally smaller change in quantity supplied. When the price doubles from $1 to $2, a 100 percent increase, the quantity supplied goes up only 50 percent, or from two units to three units. Unit Elastic Supply Panel C shows a unit elastic supply curve. Here a doubling, or a 100 percent change in price, causes an equally proportional change in the quantity supplied. As the price goes from $1 to $2, the quantity supplied also doubles. What Determines Supply Elasticity? The elasticity of a producer s supply curve depends on the type of production. If a firm can adjust to new prices quickly, then supply is likely to be elastic. If the type of production causes adjustments to take much longer, then supply is more likely to be inelastic. For example, the supply curve for nuclear power is inelastic in the short term. No matter what price is being offered, it is hard for electric utilities to increase nuclear power output. This is because of the huge amount of capital and technology needed. There is also the issue of extensive government regulation to consider. 6

7 Lesson 1 What Is Supply? However, the supply curve is likely to be elastic for many toys, candy, and other products that can be made quickly without huge amounts of capital and skilled labor. If consumers are willing to pay more for any of these products, most producers will be able to quickly prepare to greatly increase production. Unlike demand elasticity, only production issues determine supply elasticity. If a firm can react quickly to a changing price, then supply is likely to be elastic. If the firm takes longer to react to a change in price, then supply is likely to be inelastic. Reading Progress Check Comparing How are the elasticities of supply and demand similar? How do they differ? 7