The Law of Supply – Demand and Supply (2/4) | Principles of Microeconomics

The Law of Supply – Demand and Supply (2/4) | Principles of Microeconomics


Let’s move on and talk about the law of
supply. What does it actually mean for a firm to supply
a good or service? Three criteria must be met. Firstly, the firm must have the resources
and technology to produce it. The resources and technology available to
a firm act as a constraint on how much it can produce. The firm must be able to make a profit, or
at least break even, from supplying the good. If it makes losses from producing a good then
there’s no incentive to do so. The firm must also plan to produce and sell
this good. If all of these criteria are met, then we
can say that a firm supplies a good or service. The quantity supplied of a good or service
is the amount that the producers plan to sell during a given period at a given price. Keep in mind that the quantity supplied is
not necessarily the same as the quantity sold. We’ll learn why this is the case when we
study equilibrium theory in the next lecture, but for now just know that the quantity sold
to end consumers and the quantity supplied by firms are not always the same thing. The law of supply describes the positive relationship
between the price and the quantity supplied of a good or service. Essentially, this means that as price increases,
the quantity supplied of a good increases, and that as price decreases, the quantity
supplied of a good decreases. Both price and quantity supplied move in the
same direction. You might be wondering why increases in prices
cause increases in the quantity supplied. Can’t firms just increase the quantity at
any price to increase their profit margins? Well, not really. The incremental cost required to produce an
additional unit, or the marginal cost of an additional unit, increases. Think about it this way. If a factory wants to increase its output
in the short run, the only factor of production that it can change to do so is labour. As more and more people work in this factory,
each worker has a smaller and smaller work area, making it harder for them to produce
an additional unit of the good. Thus, they need to work longer hours to make
the same good. This means that you will be paying them more
to make the same good. Thus, the cost of producing an additional
unit of a good goes up. Companies want to at least cover the costs
of production, therefore the market price must equal the cost of production for the
company to even think about producing the good, and this is why the quantity supplied
of a good or service increases as the price of that good increases. The supply curve is just a graphical representation
of the entire relationship between the price of a good and its quantity supplied. We can determine the quantity supplied at
any given price by simply taking a point on the curve, and checking the price and quantity
that correspond with that point. We can interpret the supply curve as a minimum-supply-price
curve. This essentially describes a curve that shows
the lowest price at which firms are willing to sell an additional unit of a good. We just talked about how the marginal cost
of production increases as we produce a greater quantity, and so the company wants to cover
at least its costs of production, if not make a profit on top of that, for each good that
it produces. Thus, the supply curve shows us the price
required to induce a firm to produce each given quantity of that good. Just as we saw in the lecture about demand
theory, we can observe shifts in the supply curve as well. We say that supply changes when any factor
that influences selling plans, of course, other than price, changes. This causes the quantity supplied at any given
price to either increase or decrease, depending on what the situation is. Note that when we say that supply has increased,
we shift the curve down and to the right, and when we say that supply has decreased,
we shift the curve up and to the left. The first factor that affects supply is the
prices of factors of production. In order to think about this intuitively,
let’s consider the supply curve as the minimum-supply-price curve again. If the price of labour, for example, increases,
then the firm spends more on each unit produced, and thus would require a higher selling price
to induce it to supply more of a given good, thus the supply curve would shift up and to
the left. If the price of a factor of production increases,
then the supply curve would shift to the left. In the same way, if the price of a factor
of production decreased, then supply would increase and the curve would shift down and
to the right. Just as a side note, from now on I’ll just
say that the supply curve shifts to the left and/or right even though I really mean up
and to the left or down and to the right. It’s just easier to say. The second factor that can influence supply
as a whole is the prices of complements and substitutes in production. Complements in production are two goods that
can be produced together. As an example, let’s consider beef and cowhides. Both beef and cowhides come from cows. Let’s say that we’re looking at the market
for beef, and we are told that the price of cowhides just went up. If this is the case, then the quantity supplied
of cowhides would increase. In essence, more cows are being killed for
their cowhides. Excuse the imagery, but now we have all these
dead cows lying around, so firms use them to produce beef. Essentially, the supply of beef has increased
because the price of cowhides has increased. It works both ways – if the price of cowhides
were to fall, then the supply of beef would fall, thus shifting the curve to the left. Substitutes in production are goods that can
be produced by using the same resources. Think about energy drinks and energy bars. A firm has to split up its resources between
energy drinks and energy bars. It’s not like cowhide and beef where both
goods come from the same cow. If the price of energy drinks increases, then
the firm wants to increase its quantity supplied of energy drinks. Thus, it will reduce the supply of energy
bars and use those resources to produce energy drinks. In this case, the supply of energy bars shifts
to the left. It works both ways; if the price of energy
drinks decreases, then the supply of energy bars would increase. Expected future prices should be pretty intuitive. If I, as a firm, expect to earn more in the
future from selling a good, then I would hold off on selling right now and sell my goods
in the future instead at higher prices. Thus, today, the supply of the good would
decrease. Conversely, if the expected future price of
a good fell, then the supply of that good today would increase. Firms would rather sell the good today when
its price is higher to make greater profits. The number of suppliers should also be quite
intuitive. If we have more firms producing the good,
then regardless of what the price is, we will have a greater quantity produced. Thus, as the number of suppliers increases,
so does the supply. If the number of suppliers decreases, then
the supply of the good decreases. Technology is a factor which doesn’t really
ever decrease supply, rather it almost always increases it. If some new technology is developed which
makes a firm more efficient at producing a good, then it can supply more of that good
with a given quantity of resources, effectively reducing its costs of production. Thus, supply would increase. We need to keep in mind the difference between
the quantity supplied of a good and its entire supply. When we say that the quantity supplied has
changed, we are referring to a movement along the supply curve. This can only be induced by a change in the
price of that good. When we refer to a change in supply, we are
talking about a shift of the entire curve. A shift of the entire supply curve represents
a change in the quantity supplied at all possible prices, and is caused by the factors that
we discussed in the previous slide.

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