Chapter 3
1


Opportunity cost of production – Total
economic cost of producing a good or
service; The value of the production of other
goods sacrificed as the result of producing
the good
Economic costs are different from accounting
costs
2

Profit – When revenue is greater than the
opportunity cost of production
◦ The producer has increased the value of the
resources

Loss – When revenue is less than the
opportunity cost of production
◦ The producer has reduced the value of the
resources
3

In a pure market economy,
◦ profitable activities will continue and
◦ wasteful (loss) activities will stop, freeing up
resources for more productive uses
4

There is a direct (positive) relationship
between the price of a good and the quantity
of it producers are willing to supply
◦ When the price rises, quantity supplied rises
◦ When the price falls, quantity supplied falls
◦ Ceteris paribus!
5

Pizza Supply Schedule
Price
Quantity
Supplied
$20
230
16
170
12
110
8
70
4
50
Quantity supplied – the
number that people
willing to sell at each
price
6
Pizza Supply
Schedule
Pizza Supply Curve
Quantity
Supplied
25
$20
230
20
16
170
12
110
8
70
4
50
Price Pizza
Price
15
10
Supply
5
0
50
70 110 170 230
Quantity Pizza
7



How much are producers willing to produce
and sell at a give price?
What is the minimum price to induce
producers to sell?
Represents the opportunity cost of
production
8



Producer Surplus – the difference between
price suppliers actually receive and the
minimum price they would be willing to
accept.
Represents the net benefit (to all involved in
production) of producing the good.
Example: Old Navy makes a shirt for $5.
They sell it for $8. Their producer surplus is
$8 - $5 = $3
9
Price
Supply
P1
On a graph,
producer surplus is
the area above the
supply curve and
below the price
Q1
Quantity
10
Elastic supply
◦ Quantity supplied is quite
responsive to a change in
price
◦ The supply curve is
relatively flat (but still
upward sloping)
◦ When it is cheap/easy to
expand output, the
supply curve will be
elastic
Pop
Price

Supply
Quantity
11
Inelastic supply
◦ Quantity supplied is not
very responsive to a
change in price
◦ The supply curve is
relatively steep (but still
upward sloping)
◦ When expanding output
is difficult, supply will be
inelastic: doctor visits,
land, Picasso painting
Used Textbooks
(at the end of the semester)
Supply
Price

Quantity
12
Increase in Supply
S1
S2
Price
Price
Increase in Quantity
Supplied
Q1
Q2
Quantity
Quantity
13
Decrease in Supply
S2
S1
Price
Price
Decrease in Quantity
Supplied
Q2
Q1
Quantity
Quantity
14


Change in Quantity Supplied: caused by a
change in the price of the good.
Change in Supply: caused by changes in
factors other than a good’s price that
influence seller decisions
◦
◦
◦
◦
Changes in resource prices
Changes in technology
Elements of nature and political disruptions
Change in taxes
15

When resources prices
◦ Fall, supply increases
◦ Rise, supply decreases

When technology improves, supply
increases


Change in weather conditions
War, political unrest

When taxes increase, supply falls


Market – a concept encompassing the forces
of supply and demand
Equilibrium – when quantity supplied equals
quantity demanded
20



Excess demand – puts upward pressure on
the price
Excess supply – puts downward pressure on
the price
When Qs and Qd are not in balance, the price
will change
21


A situation in which all the gains from trade
have been realized.
With well-defined property rights and
competition, market equilibrium is efficient!
22
Price
S
C.S.
P1
P.S.
D
Q1
Quantity
23

Increase in Demand
◦ Higher Price
◦ Higher Quantity


Increase in Quantity
Supplied
Example: Natural gas,
which is used to heat
homes, during the
snowpocalypse of
2014
Price Natural Gas
S1
P2
P1
D2
D1
Q1
Q2
Quantity Natural Gas
24

Decrease in Demand
◦ Lower Price
◦ Lower Quantity


Price Bathing Suits
Decrease in Quantity
Supplied
Example: Bathing
suits, during the polar
vortex of 2014
S1
P1
P2
D2
D1
Q2
Q1
Quantity Bathing Suits
25

Increase in Supply
◦ Lower Price
◦ Higher Quantity


Increase in Quantity
Demanded
Example: an early
winter freeze and ice
wine
Price Ice Wine
S1
S2
P1
P2
D1
Q1
Q2
Quantity Ice Wine
26

Decrease in Supply
Price Beef
◦ Higher Price
◦ Lower Quantity


Decrease in Quantity
Demanded
Example: Livestock
need extra feed and
shelter to cope w cold
S2
S1
P2
P1
D1
Q2
Q1
Quantity Beef
27



Market prices communicate information to
decision makers
Prices coordinate actions of market
participants
Prices motivate economic players
28





Describe consumer behavior.
Separate the difference between a change in
demand and a change in quantity demanded.
Describe firm behavior.
Separate the difference between a change in
supply and a change in quantity supplied.
Investigate how a market establishes an
equilibrium price.
29