CHAPTER 5: SUPPLY
SSEMI2 THE STUDENT WILL EXPLAIN HOW THE LAW OF
DEMAND, THE LAW OF SUPPLY, PRICES, AND PROFITS
WORK TO DETERMINE PRODUCTION AND DISTRIBUTION
IN A MARKET ECONOMY.
A. DEFINE THE LAW OF SUPPLY.
B. DESCRIBE THE ROLE OF BUYERS AND SELLERS IN
DETERMINING MARKET CLEARING PRICE.
C. ILLUSTRATE ON A GRAPH HOW SUPPLY AND
DEMAND DETERMINE EQUILIBRIUM PRICE AND
QUANTITY.
D. EXPLAIN HOW PRICES SERVE AS INCENTIVES IN A
MARKET ECONOMY.
SECTION 1: WHAT IS SUPPLY?
AN INTRODUCTION TO SUPPLY—FOR ALMOST ANY GOOD
OR SERVICE, THE HIGHER THE PRICE, THE LARGER THE
QUANTITY THAT WILL BE OFFERED FOR SALE.
SUPPLY: THE AMOUNT OF A PRODUCT FOR SALE AND
DEALS WITH HOW PRICES AFFECT QUANTITIY SUPPLIED
(PRICES AND QUANTITIES MOVE IN THE SAME
DIRECTION).
SUPPLY IS THE AMOUNT OF A PRODUCT THAT WOULD BE
OFFERED FOR SALE AT ALL POSSIBLE PRICES IN THE
MARKET.
DEMAND: THE DESIRE, ABILITY, AND WILLINGNESS TO
BUY, AND DEALS WITH HOW PRICES AFFECT CONSUMER
SPENDING (THEY VARY INVERSELY).
1. WHAT DOES THE LAW OF SUPPLY STATES?
THE LAW OF SUPPLY STATES THAT SUPPLIERS WILL
NORMALLY OFFER MORE FOR SALE AT HIGH PRICES AND
LESS AT LOWER PRICES.
FOR EXAMPLE, IN WHICH CASE WILL A TOYMAKER
OFFER MORE FASHION DOLLS: IF THE COMPANY CAN
CHARGE $20 FOR EACH DOLL, OR IF IT CAN CHARGE $10
FOR EACH DOLL.
THE TOYMAKER WILL OFFER MORE FASHION DOLLS FOR
$20 BECAUSE SUPPLIERS OFFER GREATER QUANTITIES AT
HIGHER PRICES.
2. EXPLAIN HOW EACH OF THE FOLLOWING TOOLS CAN
HELP BUSINESS MAKE PRODUCTION DECISIONS.
THE SUPPLY SCHEDULE IS A LISTING OF THE VARIOUS
QUANTITIES OF A PARTICULAR PRODUCT SUPPLIED AT
ALL POSSIBLE PRICES IN THE MARKET.
AN INDIVIDUAL SUPPLY CURVE ILLUSTRATES HOW THE
QUANTITY THAT A PRODUCER WILL MAKE VARIES
DEPENDING ON THE PRICE THAT WLL PREVAIL IN THE
MARKET.
A MARKET SUPPLY CURVE ILLUSTRATES THE QUANTITIES
AND PRICES THAT ALL PRODUCERS WILL
OFFER IN
THE MARKET FOR ANY GIVEN PRODUCT OR SERVICE.
SUPPLY SCHEDULE FOR CDS
PRICE PER CD
QUANTITY SUPPLIED
(IN MILLIONS)
$10
100
$12
300
$14
500
$16
700
$18
900
$20
1,100
IF YOU WERE TO GRAPH THIS SUPPLY SCHEDULE, THE
SUPPLY CURVE WOULD
A. BE HORIZONTAL.
B. SLOPE UPWARD FROM LEFT TO RIGHT.
C. BE VERTICAL.
ANS:
D. SLOPE DOWNWARD FROM LEFT TO RIGHT.
B
ACCORDING TO THIS SUPPLY CURVE, 400 MOVIE VIDEOS WILL BE
SUPPLIED AT WHAT PRICE?
A.
$10
C.
$14
ANS: B
B.
$12
D.
$16
ACCORDING TO THIS SUPPLY CURVE, IF THE PRICE OF MOVIE VIDEOS
DECREASES FROM $18 TO $16, THE QUANTITY SUPPLIED WILL
A.
RISE FROM 800 TO 1000.
C.
RISE FROM 600 TO 800.
B.
FALL FROM 1000 TO 800.
D.
FALL FROM 800 TO 600.
ANS: B
WHAT DOES THE MOVEMENT SHOWN ON THIS GRAPH REPRESENT?
A.
A CHANGE IN SUPPLY
B.
A CHANGE IN QUANTITY SUPPLIED
C.
THE LAW OF DIMINISHING RETURNS
D.
A SHIFT IN THE MARKET SUPPLY CURVE
ANS: B
ECONOMISTS ANALYZE SUPPLY BY LISTING QUANTITES
AND PRICES IN SUPPLY SCHEDULE (TABLE/CURVE).
WHEN THE SUPPLY DATA IS GRAPHED, IT FORMS A SUPPLY
CURVE WITH AN UPWARD SLOPE.
HOW DO YOU EXPLAIN THAT PRICES AND QUANTITIES
MOVE IN THE SAME DIRECTION IN A SUPPLY SCHEDULE?
PRODUCERS WILL PRODUCE HIGH QUANTITIES AT
THE HIGHEST PRICES AND LOW QUANTITIES AT
THE LOWEST PRICES.
CHANGE IN QUANTITY SUPPLIED
3. WHAT DOES A CHANGE IN QUANTITY SUPPLIED
RESPOND TO?
A CHANGE IN QUANTITY SUPPLIED IS THE CHANGE IN THE
AMOUNT OFFERED FOR SALE IN RESPONSE TO A CHANGE
IN PRICE.
PRODUCERS HAVE THE FREEDOM, IF PRICES FALL TOO
LOW, TO SLOW OR STOP PRODUCTION OR LEAVE THE
MARKET COMPLETELY.
IF THE PRICES RISES, THE PRODUCER CAN STEP UP
PRODUCTION LEVELS.
CHANGE IN SUPPLY
A CHANGE IN SUPPLY IS WHEN SUPPLIERS OFFER
DIFFERENT AMOUNTS OF PRODUCTS FOR SALE AT ALL
POSSIBLE PRICES IN THE MARKET.
WHEN BOTH OLD AND NEW QUANTITIES SUPPLIED ARE
PLOTTED IN THE FORM OF A GRAPH, IT APPEARS AS IF
THE SUPPLY CURVE HAS SHIFTED TO THE RIGHT
(SHOWING AN INCREASE IN SUPPLY).
4. WHY DOES THE SUPPLY CURVE SHIFT TO THE LEFT?
FOR A DECREASE IN SUPPLY(REASON FOR SHIFTING TO
THE LEFT) TO OCCUR, LESS WOULD BE OFFERED FOR
SALE AT EACH AND EVERY PRICE, AND THE SUPPLY
CURVE WOULD SHIFT TO THE LEFT.
5. NAME THE SEVEN FACTORS THAT DETERMINE
WHETHER SUPPLIES INCREASE OR DECREASE.
1. THE COST OF INPUTS (LABOR OR PACKAGING);
2. PRODUCTIVITY LEVELS (EFFICIENT LABOR OF
WORKERS;
3. TECHNOLOGY (INTRODUCTION TO NEW MACHINE,
CHEMICAL, OR INDUSTRIAL PROCESS);
4. TAXES OR THE LEVEL OF SUBSIDIES (TAXATION
COST OR GOVERNMENT PAYMENT TO
INDIVIDUALS)
5. EXPECTATIONS (PREDICT THE FUTURE)
6. GOVERNMENT REGULATIONS (MONITOR
WORKPLACE OR SENDS MANDATES ON NEW AUTO
SAFETY);
7. NUMBER OF SELLERS (WHO WILL BUY—AFFECTS
BOTH THE INDIVIDUAL AND MARKET SUPPLY
CURVE).
SUBSIDY—A GOVERNMENT PAYMENT TO AN INDIVIDUAL,
BUSINESS, OR OTHER GROUP TO ENCOURAGE OR
PROTECT A CERTAIN TYPE OF ECONOMIC ACTIVITY.
PRICE FLOOR—MINIMUM ALLOWABLE BY GOVERNMENT
FOR PRODUCTS OR EVEN WAGES (WHICH CREATES A
SURPLUS).
NOTE: INCREASED GOVERNMENT REGULATIONS CAN
CAUSE THE SUPPLY CURVE TO SHIFT TO THE LEFT.
WHICH OF THE FOLLOWING STATEMENTS BEST EXPLAINS
WHY THE SUPPLY CURVE FOR LAND IS VERTICAL?
A. LAND HAS PERFECT PRICE ELASTICITY OF SUPPLY.
B. THE SUPPLY OF LAND IS FIXED.
C. LAND-LORDS ARE EXTREMELY STUBBORN ABOUT
RECEIPTS OF RENT PAYMENTS.
ANS: B
D. LAND-LORDS ARE PRICE MAKERS.
1. IF THE GOVERNMENT DECIDED TO SUBSIDIZE THE
PRODUCTION OF BOBBLE-HEAD DOLLS
A) THE COST OF SUBSTITUTES WILL RISE.
B) THE SUPPLY CURVE WILL SHIFT TO THE LEFT.
C) THE PRICE OF BOBBLE-HEAD DOLLS WILL RISE.
D) THE SUPPLY CURVE WILL SHIFT TO THE RIGHT.
ANS: D
2. IN A MARKET ECONOMY, A HIGH PRICE IS A SIGNAL FOR
A) PRODUCERS TO SUPPLY LESS AND CONSUMERS TO
BUY LESS.
B) PRODUCERS TO SUPPLY LESS AND CONSUMERS TO
BUY MORE.
C) PRODUCERS TO SUPPLY MORE AND CONSUMERS TO
BUY LESS.
D) PRODUCERS TO SUPPLY MORE AND CONSUMERS TO
BUY MORE.
ANS: C
ELASTICITY OF SUPPLY
6. WHAT IS SUPPLY ELASTICITY?
SUPPLY ELASTICITY IS A MEASURE OF THE WAY IN
WHICH QUANLITY SUPPLIED RESONDS TO A CHANGE
IN PRICE.
SUPPLY IS ELASTIC WHEN A SMALL INCREASE IN PRICE
LEADS TO A LARGER INCREASE IN OUTPUT AND SUPPLY.
FOR AN EXAMPLE, THE SUPPLY IS ELASTIC IF YOU
WOULD BE DOUBLING THE PRICE OF DRINKS
FROM $1 TO $2 CAUSES THE QUANTITY
(NUMBER) BROUGHT TO MARKET TO INCREASE
POSSIBLE TRIPLE; MEANING AS THE PRICE
INCREASE SO DOES THE NUMBER PRODUCE—MORE
THAN PROPORTIONAL)
SUPPLY IS INELASTIC WHEN A SMALL INCREASE IN PRICE
CAUSES LITTLE CHANGE IN SUPPLY.
7. WHAT CHARACTERIZES AN INELASTIC SUPPLY CURVE?
A RELATIVELY SMALLER CHANGE IN QUANTITY
SUPPLIED.
FOR AN EXAMPLE, WHEN THE PRICE IS DOUBLED FROM $1
TO $2, THE QUANTITY BROUGHT TO MARKET GOES UP
ONLY 50%, FROM TWO UNITS TO THREE UNITS (1/2 OF THE
WHICH IS CONSIDERED LESS THAN PROPORTIONAL).
8. WHAT CHANGES DOES A UNIT ELASTIC SUPPLY CURVE
SHOW?
SUPPLY IS UNIT ELASTIC WHEN A CHANGE IN PRICE
CAUSES A PROPORTIONAL CHANGE IN SUPPLY.
FOR EXAMPLE, IN A UNIT ELASTIC CURVE, IF THE PRICE
DOUBLES FROM $1 TO $2 THE QUANTITY BROUGHT TO
THE MARKET WOULD ALSO DOUBLE.
DETERMINANTS OF SUPPLY ARE RELATED TO HOW
QUICKLY A PRODUCER CAN ACT WHEN THE CHANGE IN
PRICE OCCURS.
IF ADJUSTING PRODUCTION CAN BE DONE QUICKLY, THE
SUPPLY IS ELASTIC.
IF PRODUCTION IS COMPLEX AND REQUIRES MUCH
ADVANCE PLANNING, THE SUPPLY IS INELASTIC.
ANOTHER FACTOR IS SUBSTITUTION
IF SUBSTITUTING FOR A GIVEN PRODUCT IS EASY, THE
SUPPLY IS ELASTIC.
IF IT IS DIFFICULT TO SUBSTITUTE, THE SUPPLY IS
INELASTIC.
WHAT IS THE DIFFERENCE BETWEEN DEMAND
ELASTICITY AND SUPPLY ELASTICITY?
BOTH MEASURE THE WAY QUANTITY (WHETHER
BOUGHT OR PRODUCED) ADJUSTS TO A CHANGE IN
PRICE. REMEMBER THE NUMBER OF SUBSTITUTES
AND ABILITY TO DELAY THE PURCHASE ARE
IMPORTANT FOR DEMAND ELASTICITY BUT NOT
SUPPLY ELASTICITY.
DO YOU THINK THE SUPPLY OF HANDMADE CLOTHING IN
THE MARKET IS LARGER OR SMALLER THAN THE SUPPLY OF
MACHINE-MADE CLOTHING? EXPLAIN.
THE SUPPLY OF HANDMADE CLOTHING IS SMALLER
BECAUSE MACHINERY OR TECHNOLOGY TENDS TO
INCREASE THE SUPPLY OF THE PRODUCT.
WHICH FIRM IS MORE LIKELY TO HAVE AN ELASTIC
SUPPLY—A CANDY PRODUCER OR A SHALE OIL PRODUCER?
EXPLAIN.
A CANDY PRODUCER IS MORE LIKELY TO HAVE AN
ELASTIC SUPPLY BECAUSE CANDY CAN BE PRODUCED
MORE READILY THAN OIL CAN BE PRODUCED FROM
SHALE.
ASSUMING THAT THE GRAPH FOLLOWS THE NORMAL
LAWS OF ECONOMICS, THE LINE REPRESENTS
A)DEMAND.
C) EQUILIBRIUM PRICE.
B) SUPPLY.
D) PRODUCTION POSSIBILITIES.
ANS: B
1. WHICH RELATIONSHIP IS THE BEST EXAMPLE OF THE
LAW OF SUPPLY?
A) THE QUANTITY OF A GOOD SUPPLIED RISES AS THE
PRICE RISES.
B) THE QUANTITY OF A GOOD SUPPLIED RISES AS THE
PRICE FALLS.
C) THE QUANTITY OF A GOOD SUPPLIED FALLS AS THE
PRICE RISES.
D) THE QUANTITY OF A GOOD SUPPLIED IS NOT
IMPACTED BY PRICE.
ANS: A
2. WHICH FACTOR MIGHT CAUSE AN INCREASE IN THE
SUPPLY OF A PRODUCT?
ANS: C
A) A DECREASE IN PRODUCTIVITY
B) FEWER SELLERS IN THE MARKETPLACE
C) THE INTRODUCTION OF NEW TECHNOLOGY
D) AN INCREASE IN THE COST OF RAW MATERIALS
NOTE: IF A COMPANY CAN’T SELL ITS PRODUCT AT THE
PRICE IT HAS CHOSEN, IT WILL BE FORCED TO LOWER
THE PRICE IN ORDER TO SELL ITS SUPPLY. AS THE PRICE
GOES DOWN, DEMAND FOR THE PRODUCT WILL GO UP.
AT A CERTAIN PRICE THE DEMAND FOR THE PRODUCT
WILL EQUAL THE SUPPLY. THE PRODUCER WILL BE ABLE
TO SELL THE ENTIRE SUPPLY, AND CONSUMERS WILL BE
ABLE TO BUY THE EXACT AMOUNT THEY WANT.
THIS POINT IS CALLED THE MARKET CLEARING PRICE OR
EQUILIBRIUM PRICE. THE EQUILIBRIUM PRICE WILL BE
SHOWN ON AS DEMAND CURVE AND SUPPLY CURVE
TOGETHER ON A GRAPH.
3. IF THE SUPPLY OF COMPUTER ENGINEERS INCREASES AT THE
SAME TIME THAT THE DEMAND FOR THESE WORKERS DECREASES,
WHAT WOULD BE THE MOST LIKELY EFFECT ON WAGES FOR
THESE WORKERS?
A) WAGES WOULD STAY THE SAME AS JOB OPPORTUNITIES
INCREASE.
B) WAGES WOULD INCREASE AS THE NUMBER OF WORKERS
INCREASES.
C) WAGES WOULD DECLINE AS THE COMPETITION FOR JOBS
INCREASES.
D) WAGES WOULD INCREASE AS COMPETITION FOR THESE
WORKERS INCREASES.
ANS: C
4. IN ECONOMICS, "EQUILIBRIUM PRICE" IS A SITUATION IN WHICH
A) A PARTIAL TEMPORARY REDUCTION IN PRICES OCCURS.
B) THERE IS NEITHER SHORTAGE NOR SURPLUS OF GOODS.
C) THE QUANTITY DEMANDED IS GREATER THAN THE
QUANTITY SUPPLIED.
D) THE QUANTITY SUPPLIED IS GREATER THAN THE
QUANTITY DEMANDED.
ANS: B
5. IF A PRODUCT IS SOLD AT THE PRICE INDICATED AND SUPPLIED IN
THE QUANTITY INDICATED BY THE INTERSECTION OF THE
SUPPLY AND DEMAND CURVES IN THE GRAPH, THERE SHOULD BE
A) AN INCREASE IN PRICE.
ANS: B
B) NO SHORTAGE AND NO SURPLUS.
C) A SHORTAGE UNTIL THE PRICE IS RAISED.
D) A CHANGE IN THE EXPECTED FUTURE PRICE.
6. IN THE GRAPH, THE EQUILIBRIUM PRICE IS APPROXIMATELY
ANS: B
A) $1.00
C) $5.00
B) $3.00
D) $6.00
SECTION 2: THE THEORY OF PRODUCTION
**A CHANGE IN THE VARIABLE INPUT CALLED LABOR
RESULTS IN A CHANGE IN PRODUCTION**
LAW OF VARIABLE PROPORTIONS
1. WHAT DOES THE LAW OF VARIABLE PROPORTIONS
STATE?
IN THE SHORT RUN, OUTPUT WILL CHANGE AS ONE
VARIABLE INPUT IS ALTERED, WHILE OTHER
INPUTS ARE KEPT CONSTANT.
THE LAW OF VARIABLE PROPORTIONS LOOKS AT HOW
THE FINAL PRODUCT IS AFFECTED AS MORE UNITS OF
ONE VARIABLE INPUT OR RESOURCE ARE ADDED TO A
FIXED AMOUNT OF OTHER RESOURCES.
ECONOMISTS PREFER THAT ONLY A SINGLE VARIABLE BE
CHANGED AT ANY ONE TIME SO THE IMPACT OF THIS
VARIABLE ON TOTAL OUTPUT CAN BE MEASURED.
2. WHAT HAPPENS WHEN MORE THAN ONE FACTOR OF
PRODUCTION IS VARIED?
IT BECOMES HARDER TO GAUGE THE IMPACT OF A
SINGLE VARIABLE ON TOTAL OUTPUT.
II. THE PRODUCTION FUNCTION
THE CONCEPT ILLUSTRATES THE LAW OF VARIABLE
PROPORTIONS WITHIN A PRODUCTION SCHEDULE OR GRAPH.
3. WHAT IS A PRODUCTION FUNCTION?
IT DESCRIBES THE RELATIONSHIP BETWEEN CHANGES
IN OUTPUT TO DIFFERENT AMOUNTS OF A SINGLE
INPUT WHILE OTHERS ARE HELD CONSTANT.
4. WHAT ARE RAW MATERIALS?
UNPROCESSED NATURAL PRODUCTS USED IN
PRODUCTION.
TOTAL PRODUCT IS THE TOTAL OUTPUT THE COMPANY
PRODUCES: A PRODUCTION SCHEDULED SHOWS THAT, AS
MORE WORKERS ARE ADDED, THE TOTAL PRODUCTION
RISES UNTIL A POINT THAT ADDING MORE WORKERS
CAUSES A DECLINE IN TOTAL PRODUCT.
5. WHAT HAPPENS TO RESOURCES IF THERE ARE TOO
FEW WORKERS?
THE RESOURCES MAY STAND IDLE (NOT WORKING)
BECAUSE THE PLANT IS BARELY OPERATING.
6. WHAT HAPPENS TO OUTPUT IF THERE ARE TOO MANY
WORKERS?
THE WORKERS GET IN THE WAY OF OTHERSD AND
TOTAL OUTPUT FALLS.
7. WHAT IS MARGINAL PRODUCT?
THE EXTRA OUTPUT OR CHANGE IN TOTAL
PRODUCT CAUSED BY ADDING ONE MORE UNIT OF
VARIABLE INPUT.
THREE STAGES OF PRODUCTION
8. AT WHAT POINT ARE CHANGES IN MARGINAL
PRODUCT OF SPECIAL INTEREST?
WHEN IT COMES TO DETERMINING THE OPTIMAL
NUMBER OF VARIABLE UNITS TO BE USED IN
PRODUCTION, (CHANGES IN MARGINAL PRODUCT
ARE OF SPECIAL INTEREST).
9. WHAT ARE THE STAGES OF PRODUCTION BASED ON?
THEY ARE BASED ON THE WAY MARGINAL
PRODUCTS CHANGES AS THE VARIABLE INPUT OF
LABOR IS CHANGED.
Stages of Production
STAGE I: INCREASING RETURNS
10. WHAT IS THE CRITERION FOR DETERMINING HOW
LONG TOTAL OUTPUT WILL RISE?
AS LONG AS EACH NEW WORKER HIRED
CONTRIBUTES MORE TO TOTAL OUTPUT THAN THE
WORKER BEFORE (MARGINAL OUTPUT INCREASES
WITH EACH NEW WORKER).
NOTE: COMPANIES ARE TEMPTED TO HIRE MORE
WORKERS, WHICH MOVES THEM TO STAGE II.
11. WHEN SHOULD COMPANIES STOP HIRING?
WHEN THE MARGINAL PRODUCT OF THE NEXT
WORKER HIRED BEGINS TO DIMINISH.
STAGE II: DIMINISHING RETURNS
TOTAL PRODUCTION KEEPS GROWING BUT THE RATE OF
INCREASE IS SMALLER; EACH WORKER IS STILL
MAKING A POSITIVE CONTRIBUTION TO TOTAL OUTPUT,
BUT IT IS DIMINISHING.
12. WHAT HAPPENS TO THE RATE OF INCREASE IN TOTAL
PRODUCTION DURING THIS STAGE?
IT IS STARTING TO SLOW.
13. WHAT IS THE PRINCIPLE OF DIMINISHING RETURNS?
THE STAGE AT WHICH OUTPUT INCREASES AT A
DIMINISHING RATE AS MORE UNITS OF VARIABLE
INPUT ARE ADDED.
STAGE III: NEGATIVE RETURNS
14. WHAT HAPPENS TO MARGINAL PRODUCT DURING
THIS STAGE?
MARGINAL PRODUCT BECOMES NEGATIVE.
15. WHAT HAPPENS TO TOTAL PLANT OUTPUT DURING
THIS STAGE?
THE TOTAL PLANT OUTPUT DECREASES.
16. WHAT EFFECT DOES THIS STAGE HAVE ON HIRING?
MOST COMPANIES DO NOT HIRE WORKERS WHOSE
ADDITION WOULD CAUSE TOTAL PRODUCTION TO
DECREASE.
SECTION 2: COST, REVENUE, AND PROFIT MAXIMIZATION
MEASURES OF COST
FIXED COSTS ARE THOSE THAT A BUSINESS HAS EVEN IF IT HAS NO
OUTPUT. THESE INCLUDE MANAGEMENT SALARIES, RENT, TAXES,
AND DEPRECIATION ON CAPITAL
GOODS.
TOTAL FIXED COST, OR OVERHEAD, REMAINS THE SAME.
VARIABLE COSTS ARE THOSE THAT CHANGE WHEN THE RATE OF
OPERATION OR PRODUCTION CHANGES, INCLUDING HOURLY LABOR,
RAW MATERIALS, FREIGHT CHARGES, AND ELECTRICITY.
TOTAL COST IS THE SUM OF ALL FIXED COSTS AND ALL VARIABLE
COSTS.
MARGINAL COST IS THE EXTRA (VARIABLE) COST INCURRED WHEN A
BUSINESS PRODUCES ONE ADDITIONAL UNIT OF PRODUCT.
NOTE: ALL COST ARE VARIABLE IN THE LONG RUN.
APPLYING COST PRINCIPLES
A SELF-SERVICE GAS STATION IS AN EXAMPLE OF HIGH
FIXED COSTS WITH LOW VARIABLE COST. THE RATIO OF
VARIABLE TO FIXED COST IS LOW. WHERE AS, A FULLSERVICE GAS STATION MAY HAVE HIGER VARIABLE COSTS
THAN ONE THAT SELLS ONLY GAS, BECAUSE IT EMPLOYS
A VARIETY OF EMPLOYEES.
E-COMMERCE (ELECTRONIC BUSINESS OR EXCHANGE
CONDUCTED OVER THE INTERNET) IS AN EXAMPLE OF AN
INDUSTRY WITH LOW FIXED COSTS.
MEASURES OF REVENUE
TOTAL REVENUE IS THE NUMBER OF UNITS SOLD
MULTIPLIED BY THE AVERAGE PRICE PER UNIT.
**UNIT SOLD X AVERAGE PER UNIT**
MARGINAL REVENUE IS THE EXTRA REVENUE
CONNECTED WITH PRODUCING AND SELLING AN
ADDITIONAL UNIT OF OUTPUT.
MARGINAL ANALYSIS
MARGINAL ANALYSIS IS COMPARING THE EXTRA BENEFITS TO THE
EXTRA COSTS OF A PARTICULAR DECISION.
***COST-BENEFIT DECISION MAKING***
THE BREAK-EVEN POINT IS THE TOTAL OUTPUT OR TOTAL PRODUCT
THE BUSINESS NEEDS TO SELL IN ORDER TO COVER ITS TOTAL COSTS.
BUSINESSES WANT TO FIND THE NUMBER OF WORKERS AND THE
LEVEL OF OUTPUT THAT GENERATES MAXIMUM PROFITS.
THE PROFIT-MAXIMIZING QUANTITY OF OUTPUT IS REACHED WHEN
MARGINAL COST AND MARGINAL REVENUE ARE EQUAL.
WHICH SOCIETY’S ECONOMIC GOALS ARE ASSOCIATED WITH PROFIT
MAXIMIZATION?
ECONOMIC FREEDOM AND ECONOMIC EFFICIENCY
SECTION 3: CHANGES IN SUPPLY
• Explain factors that create changes in supply.
– Input costs—the cost of an input used to produce a good such as
raw materials, machinery, or labor will affect supply. A rise in cost
will cause a fall in supply at all price level because of the expense.
• Technology lowers costs and increases supply at all price
levels.
– Government’s influence on Supply—the government can
discourage or encourage an entrepreneur or an industry within
the country or abroad.
• Subsidies (a government payment) encourages and supports
the entrepreneur.
• Taxes (an entrepreneur payment) discourages and reduces
the supply of some goods by placing and excise tax.
• Regulation (government intervention) affects the price,
quantity, or quality of a good.
SECTION 3: CHANGES IN SUPPLY
• Explain factors that create changes in supply.
– Supply in a Global Economy—the supply of one good produced in
one country and imported by another to be sold to consumers.
• Import restrictions such a tariffs and quotas could cause the
supply curve to shift to the left.
– Other influences on Supply—the government can discourage or
encourage an entrepreneur or an industry within the country or
abroad.
• Future expectations of prices affects output decisions by the
entrepreneur, such as inflation, climate conditions (drought,
storm, etc).
• Number of suppliers affects the price, quantity, or quality of a
good.
2. What is a subsidy, and how do subsidies affect the supply
curve?
A subsidy is a government payment that supports a business or
market. The government often pays a producer a set subsidy for each
unit of a good produced. In the United States, the federal government
subsidizes producers in many industries. Subsidies increases the supply
of goods and services and would shift the supply curve to the right.
3. What is an excise tax, and how do excise taxes affect the
supply curve?
An excise tax is a tax on the production or sale of a good. It is
actually a type of tax that is levied on manufacture, purchase, sale, or
consumption of a specific product. Excise taxes are often used on
controversial items, they usually effect low income people. Excise tax
causes the supply of goods and services to shift to the left.
4. What effect do regulations have on the supply
curve? Why?
Regulations are government intervention in a
market that affects the production of a good.
Government could raise or lower the supply through
indirect means.
Why producers look at productivity when making
supply decisions:
to determine how efficiently their resources are
being used in production, to maximize efficiency, and
to increase profits
How varying levels of input affects the levels of
output:
Adding levels of input increases productivity up
to a point and then eventually results in decreased
productivity and in negative marginal product.
How changes in production costs affect producers’
supply decisions:
by determining the prices at which producers
supply quantities of goods or services
by determining production goals
1. Assume cars and gasoline are complements. When the price of
gasoline goes up, which of the following will happen to the market for
cars?
a. The equilibrium price of cars will increase.
Ans. B
b. The equilibrium quantity of cars will decrease.
c. The supply curve for cars will shift to the left.
d. The supply curve for cars will shift to the right.
2. Suppliers produce two goods, cheese and butter. Assume that there is
no cost to switch resources from cheese production to butter
production and vice versa. Suppose the demand for butter increases.
What do we expect to happen to the equilibrium in the market for
cheese?
a. The price will go up and the quantity will drop. Ans. A
b. The price will go up and the quantity will rise.
c. The price will go down and the quantity will drop.
d. The price will go down and the quantity will rise.
3. If the government announces today that a tax increase of
50 cents per pack of cigarettes is to take place in two weeks,
what would you expect to happen today to the current
market for cigarettes?
a. The demand for cigarettes would increase.
b. The demand for cigarettes would decrease.
c. The price of cigarettes would increase.
Ans. D
d. Both a) and c) are correct.
4. If bread is an inferior good, then what will happen in the
market for bread as the consumer income increases?
a. The quantity will increase.
b. The quantity will decrease. Ans. D
c. The price will fall.
d. Both b) and c) are correct.
5. If OPEC decided to cut oil production for the coming year,
what would be the MOST LIKELY effect?
A. prices would not change
B. the price for substitute products would decline
C. oil prices would probably rise
Ans. C
D. oil prices would probably decline
6. Which determinant MIGHT increase supply in the market?
A. an increase in the price of complementary goods
B. an increase in the number of sellers of a product
C. an increase in the number of consumers in the
market
D. an increase in the price of inputs to make the
product
Ans. B
7. A price set below the current market price is a
characteristic of a
A. price floor.
C. regular price.
B. price ceiling.
D. equilibrium price.
Ans. B
8. If the government decided to subsidize the production of
bobble-head dolls
A. the supply curve will shift to the left.
Ans. B
B. the supply curve will shift to the right.
C. the demand for bobble-heads will decrease.
D. the demand for bobble-heads will equal the supply.
9. A modest price increase for a monthly cell phone package
has had little or no effect on demand. This MOST LIKELY
indicates that demand for the product is
A. complementary.
C. elastic.
B. inelastic.
D. variable Ans. B
10. An increase in the market demand for gasoline in the present, all
else equal, could be caused by
Ans. A
A. a rise in peoples’ income.
B. a reduction in the price of the gasoline.
C. an expected price decrease in the near future.
D. a reduction in the cost of drilling and refining petroleum
11. A price set below the current market price is a characteristic of a
A. price floor.
C. regular price.
Ans. B
B. price ceiling.
D. equilibrium price.
12. Which situation is the MOST LIKELY result of a price ceiling being
set below the equilibrium price?
A. decreased demand
Ans. C
B. a surplus in the market
C. a shortage in the market
D. a higher equilibrium price
13.
Which example BEST demonstrates the effect of artificial price
controls on supply and demand?
A. Both rent controls and minimum wage laws result in
shortages.
B. Both rent controls and minimum wage laws result in
surpluses.
C. Rent controls result in surpluses and minimum wage laws
result in shortages.
D. Rent controls result in shortages and minimum wage laws
result in surpluses.
Ans. D
14. Looking at the graph, if there is an increase in income for
the households in this market, what is the MOST LIKELY
result?
A. The equilibrium price will fall.
B. The demand curve will shift to the left.
C. The demand curve will shift to the right. Ans. C
D. The supply curve will become a vertical line.