Economics Chapter 5

Notes Chapter 5 Section 1 – What is Supply?

The Law of Supply

• Key Concepts
  • Supply:  the willingness and ability to produce and sell a product.
    • Anyone who provides goods or services is a producer.
      • Examples: manufacturers, farmers, retailers, utility companies, airlines, etc.
  • The two key words in the definition of supply are willingness and ability.
    • For example:
      • A family owns a small farm where they grow fruits and vegetables.
      • They sell their produce at a local farmers’ market.
      • If the prices at the market are too low, the family may not be willing to take on the expense of growing and transporting their produce.
      • Also, if the weather is bad and the crops are ruined, they will not be able to supply anything for the market.
  • Just like with demand, PRICE is a major factor that influences supply.
  • Law of Supply:  states that when prices decrease, quantity supplied decreases, and when prices increase, quantity supplied increases.
    • Producers want to earn profit, so when the price of a good or service rises they are willing to supply more of it.
    • When the price falls, they want to supply less of it.
    • Price and quantity supplied have a DIRECT RELATIONSHIP.

    As prices falls…                 …quantity supplied falls               As prices rise…         …quantity supplied rises

• What kind of relationship does demand have?
  • INVERSE RELATIONSHIP
    • As price goes up quantity demanded goes down.
    • As price goes down quantity demanded goes up.

• Example Price and Supply
  • Let’s go back to our farming example
    • The farmers have a specialty product they are known for producing – Tomatoes
      • They know the standard price for tomatoes is $1/pound.
      • They decide they are willing and able to sell 24 pounds of Tomatoes.
      • How much would they make?
        • $24
    • What if the standard price of tomatoes went up to $2/pound? – SHOW ARROWS
      • The farmer may decide that prices is good and may be willing to offer 50 pounds of tomatoes instead.
    • What if the standard price of tomatoes fell to $0.50/pound? – SHOW ARROWS
      • The farmer may decide to supply only 10 pounds of tomatoes.
• Why do price and supply have a direct relationship?
  • Producers will supply more of something if they can make more money by selling it at a higher price.
• Why do producers and consumers have different attitudes towards price?
  • Producers want to make money by charging higher prices while consumers want to save money by paying lower prices.

Supply Schedules

• Supply Schedule:  lists how much of a good or service an individual producer is willing and able to off for sale at each price.
  • Example:  Farmer’s Tomato Supply Schedule:

• How many pounds of tomatoes are farmers willing to produce at $1.75?
  • 40
• This shows that quantity supplied depends on price.
• Market Supply Schedule: lists how much of a good or service all producers in a market are willing and able to offer for sale at each price.
  • Instead of looking at just one farm and their willingness and ability to supply tomatoes a market supply schedule would look at something like the entire farmers’ market.
  • It shows he quantity supplied by ALL of the producers who are willing and able to sell tomatoes.

• Notice that this market supply schedule is similar to our individual demand schedule, BUT the quantities supplied are much larger.
• What is the quantity supplied at $1.25?
  • 200 tomatoes
• How does the quantity supplied of tomatoes change when the price rises from $0.75/pound to $1.75/pound?
  • It increases from 100 to 300
• Try this – Practice creating a supply schedule
  • In your notebook solve the following problem:
    • Imagine you own a health food store that sells several kinds of granola bars.  Create a supply schedule showing how many bars you would be willing to sell each month at the prices of $1, $2, $3, $4, and $5.  Use the table to help you.

• Supply schedules should reflect the law of supply by showing higher quantities supplied at higher prices and lower quantities supplied at lower prices.

Supply Curves

• Supply curve:  shows the data from a supply schedule in graph form.
  • How is a supply curve related to a supply schedule?
    • A supply curve is the representation on a line graph of the information from the supply schedule.

• What does the supply curve look like?
  • It slopes upright / Increases.
• What do the points on the supply curve represent?
  • The quantity supplied at each price.

• Market supply curve:  shows the data from a market supply schedule in graph form.

Exit Ticket:  Using the supply schedule you created for granola bars, create an individual demand schedule.

Notes Chapter 5 Section 2:  What are the Costs of Production?

Labor Affects Production – Let’s look at why this is.

• Story
  • Let’s say you own a company that makes custom blue jeans.
  • You have 3 sewing machines and 3 workers.
    • They are able to produces 12 pairs of jeans each day.
  • What would hiring one more person do to production? – probably raise it.
  • You still have 3 sewing machines, but now you have 4 workers.
    • They are able to produce 19 pairs of jeans each day.
  • What is the difference in output (how much is produced) with a 4^th worker?
    • 7 pairs
    • (19 pairs – 12 pairs)
      • This difference is called the marginal product
        • Marginal Product:  The change in total output brought about by adding one more worker.
  • Let’s continue with our jean example.
    • Because adding a 4^th worker proved to be successful, you decide to add a 5^th worker to see what happens to output.
      • This turns out to be a great idea because the output has jumped from 19 to 29 – a marginal product of 10
  • How is the output increasing so much?  Remember you only have the 3 sewing machines, so not everyone can sew at the same time? (Hint:  What do your workers need to do before they can start sewing?)
    • Originally you had 3 workers and 3 sewing machines.
    • These 3 workers had to cut cloth, sew the jeans, package the jeans, and keep the shop clean.
    • The 4^th employee helped with the other tasks (cutting, packaging, cleaning).
    • The 5^th employee allowed labor to be divided even more efficiently which caused the increase in marginal product.
    • Having each worker focus on a particular facet of production is called specialization.
• Specialization:  having a worker focus on a particular aspect of production.
• Does hiring more works always cause marginal product to increase?
  • Not necessarily.
  • What are some problems a business may face if it has too few or too many workers?
    • Too few:
      • Resources are not used to full capacity
      • The company cannot produce as much as it wants
    • Too many:
      • Workers get in each other’s way
      • Not enough work to keep all workers busy.

What is this table telling us?

• Total product continues to increase, but at some point the marginal product begins to decrease.

At what number of workers is total product the highest?

• 10 (67 total pairs of jeans)

This is your business, how many workers would you ultimately hire based on this table?  Why?

• Six workers would be the ideal number of workers to hire based on this table because you are creating a large number of total products, and your marginal product is also at its highest.
  • This is probably because there are six tasks involved in creating the jeans: 3 people to sew, 1 person to cut, 1 person to package, 1 person to clean.
    • Each person has a specialized task.
• However, this table does NOT account for profit level which ultimately would show you how many workers to hire.
• Increasing Returns:  Occur when hiring new workers cause marginal product to increase.
• Diminishing Returns:  Occur when hiring new workers causes marginal product to decrease.

Production Costs

• Remember that producers want to make a profit.  Profit is the money the business gets for selling their products once the money it costs to make the products has been subtracted.
• Common business costs include:
  • Fixed costs
  • Variable costs
  • Total costs
  • Marginal costs
• Fixed Costs:  Costs that business owners have no matter how much they produced.
  • These occur whether a business produces nothing, a little, or a lot.
  • In our jeans example, fixed costs include the mortgage on the factory, insurance, management salaries, the cost of machinery, and utilities.
    • These costs are the same whether we are producing no jeans, 3 pairs, or 42 pairs of jeans per day.
• Variable Costs:  Costs that depend on the level of production output.
  • These are dependent on how much or little a company produces.
  • In our jeans example, variable costs include wages, fabric, thread, zippers, buttons, and shipping costs.
    • The more jeans the factory produces, the more out variable costs will increase.
      • We will may need to hire new workers raising the cost of wages.
      • We may producing more pairs of jeans so we need more supplies to make those jeans.
  • How do changes in variable costs relate to the slope of the demand curve?
    • Since variables costs increase as quantity supplied increases, a producer will only supply more product if he or she can charge a higher prices to cover the costs.
• Total Cost: The sum of fixed and variable costs (Fixed costs + Variable costs = total cost)
  • Example:  Complete the Jeans production chart.

• Marginal Costs:  The extra cost of producing one more unit.
• How do we calculate Marginal Costs?
  • Marginal Costs = Change in total cost ÷ Change in total product

Earning the Highest Profit

• Marginal Revenue:  The money made from the sale of each additional unit of output
• Total Revenue:  the company’s income from selling its products. 
  • Formula –
    • Total Revenue = Price x Quantity purchased at that price
• Profit-maximizing output:  The level of production at which a business realizes the greatest amount of profit.

Chapter 5 Section 3 What Factors Affect Supply?

• Changes in Quantity Supplied
  • Key Concepts
    • Change in quantity supplied:  A rise or fall in the amount producers offer for sale because of a change in price.
      • For example:  A change in the price of bicycles causes a change in the quantity supplied.
  • Changes along the Supply Curve
    • Each new point on the supply curve shows a change in quantity supplied.
      • A change in quantity supplied does not change the supply curve itself.
    • If you move right along a supply curve there is an increase in both price and quantity supplied.
    • If you move left along a supply curve there is a decrease in both price an quantity supplied.
• Changes in Supply
  • Key Concepts
    • Change in supply:  Occurs when a change in the marketplace prompts producers to sell different amounts at every price.
      • This will shift the demand curve.
      • When production costs increase, supply decreases, and the supply curve shifts to the left.
      • When production costs decrease, supply increases, and the supply curve shifts to the right.
    • There are 6 factors which shift the entire demand curve:
      • Input Costs
      • Labor Productivity
      • Technology
      • Government Action
      • Producer Expectations
      • Number of Producers
    • Input Costs:  The price of the resources used to make products.
      • Affects supply directly
      • Example:  Willy Wonka makes a chocolate bar that contains peanuts.  If the price of peanuts increase, then costs increase.
        • He cannot afford to produce as many nutrition bars, and her supply curve will shift to the left.
    • Labor Productivity:  The amount of goods and services that a person can produce in a given time.
      • Increasing productivity decreases the costs of production.
        •  This increases supply.
        • Better-trained and more-skilled workers can usually produce more goods in less time, and therefore lower costs.
        • Example:  A business that provides word-processing services can produce more documents if its employees type quickly and have experience with word processing software.
    • Technology:  Applying scientific methods and innovations to production.
      • Helps businesses to improve their productivity and increase supply.
      • Technology helps make goods more efficiently.
      • Example:  Increased automation, including the use of robots, has led to increased supplies of automobiles.
    • Government Action
      • Government action can affect the costs of production both positively and negatively.
      • Excise tax:  A tax on the making or selling of certain goods or services.
        • Often placed on items like alcohol and tobacco – things the government is trying to discourage people from using.
        • These taxes increase a producers’ costs and decrease the supply.
      • Subsidy:  A government payment that partially covers the cost of an economic activity.
        • Its purpose is to encourage or protect that activity.
        • Example:  Subsidies helped to double the supply of ethanol, a gasoline substitute made from corn.
      • Regulation:  a set of rules or laws designed to control business behavior.
        • These can also affect supply.
        • Example:  Banning a certain pesticide might decrease the supply of the crops that depend on the pesticide.
    • Producer Expectations:  The amount of product producers are willing and able to supply may be influenced by whether they believe prices will go up or down.
      • If producers expect the price of their product to rise or fall in the future, it may affect how much of that product they are willing and able to supply.
      • Example:  If a farmer expects the price of corn to be higher in the future, he or she may store some of the current crop, thereby decreasing supply.
    • Number of Producers:  A successful new product or service always brings out competitors who initially raise overall supply.
      • An increase in the number of producers means increased competition.
      • This will eventually drive less-efficient producers out of the market, decreasing supply.
      • Competition has a major impact on supply as producers enter and leave the market all of the time.

Chapter 5 Section 3 – What is Elasticity of Supply?

• Elasticity of supply
  • Key concepts
    • Elasticity of supply:  a measure of how responsive producers are to price changes in the marketplace.
  • Elastic Supply:  If a change in price leads to a relatively LARGE change in quantity supplied supply is elastic.
    • Example:  If a 10% increase in price causes greater then a 10% change in quantity supplied, supply is elastic.
  • Inelastic Supply:  If a change in pries leads to a relatively smaller change in quantity supplied supply is inelastic.
• What Affects Elasticity of Supply?
  • The ease of changing production to respond to price change is the main factor in determining elasticity of supply.
  • Example:  Industries that are able to respond quickly to changes by  increasing or decreasing production are those that don’t require a lot of capital, skilled labor, or hard to find resources.
    • The quantity supplied of a dog-walking service can increase rapidly with the addition of more people to walk dogs.
  • Example:  Industries that take a great deal of time to shift the resources of production to respond to price changes.
    • Automakers rely on large capital outlays or difficult to find resources.
      • It might take such suppliers a considerable amount of time to respond to price changes.
  • Given enough time, the elasticity of supply increases for most goods and services.