Chapter 5: Supply
Section 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: Supply
Section 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: Supply
Section 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?