ECON-4.2
jayz1974
supply_and_production.pdf
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Supply and Production
Microeconomics
ECO201
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THE SUPPLY CURVE
Shows the relationship between the
price of a good and the quantity
that producers want to sell.
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THE LAW OF SUPPLY
The higher the price, the
larger the quantity
supplied.
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What Causes Supply Curve To Shift (Change in relationship of price and Quantity)
Change (increase or decrease) in cost of
production -- inputs;
Increase (or decrease) in the number of
producers.
Change (increase or decrease) in tax rates.
State of production technology.
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00 SUPPLY
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00 SUPPLY
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RIGHTWARD
SHIFT
INCREASE IN SUPPLY
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00
SUPPLY
DECREASE IN SUPPLY
LEFTWARD
SHIFT
13 23
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00
SUPPLY
Greater
Supply
Lesser
Supply
(Greater quantity
for the same
price)
(Smaller quantity
for the same price)
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MARKET EQUILIBRIUM
The quantity of a product demanded is exactly
equal to the quantity supplied.
There is no pressure to change price.
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00
Market
Equilibrium
DEMAND
SUPPLY
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SHORTAGE
Occurs when the market price is below the
equilibrium price.
Consumers are willing to buy more of the
product, at this lower price, than producers
are willing to sell.
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00
Market
Equilibrium
26
SUPPLY DEMAND
shortage
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SURPLUS
Occurs if market price exceeds equilibrium
price.
Producers are willing to sell more, at this
higher price, than consumers are willing to
buy.
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Price
per
Pound
of
Apples
Thousands of Pounds of Apples per day
$$$
10 20 30
$0.20
$0.40
$0.60
$0.80
$1.00
Market
Equilibrium
15
SUPPLY DEMAND
surplu
s
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The role of costs in production
Everything costs something
When we decide on production possibilities, we
have to pay attention to costs
Economists have a distinctive way of looking at
costs.
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A firm’s actual cash payments
for its inputs.
$ $ $ $ $ $ $ $ $ $ $
EXPLICIT COSTS
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Implicit Costs Opportunity costs of non-purchased inputs
such as the entrepreneur’s time and money.
opportunity cost of something is what you sacrifice
to get it.
Opportunity cost of the entrepreneur’s time:
Time given up to operate a firm;
Opportunity cost of funds:
Money given up to set up and run a
business.
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Economic Cost
The sum of explicit and implicit costs.
The economic cost is higher because the
economist includes implicit costs but the
accountant does not.
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Accounting versus Economic Cost
Explicit Cost
(Purchased Inputs) $60,000 $60,000
Implicit Cost
(Opportunity cost of $30,000
entrepreneur)
(Opportunity cost of $10,000
funds)
------------- -------------
Total Cost $60,000 $100,000
Accounting Economic
Approach Approach
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SHORT RUN
A period of time over which at least one input to production is fixed. For most firms, the fixed input is capital: firm cannot modify production facility or build a new facility.
LONG RUN
A period of time over which a firm is perfectly flexible in its choice of inputs.
In the long run, a firm can build a new production facility (factory,store, office or restaurant) or modify an existing facility, hire a workforce, and buy raw materials.
TIME PERIODS
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Time Period Decisions
Short Run
How much output to produce;
Long Run
What type of production facility to build;
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Principle of Diminishing Returns
Suppose an output is produced with two or more
inputs, and we increase one input while holding
the other inputs fixed. Beyond some point -- called
the point of diminishing returns -- output will
increase at a decreasing rate.
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Short-Run Marginal Cost
The change in total cost resulting
from a one-unit increase in the
output of an existing production
facility.
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Short-Run Average Total Cost (SATC)
Equals the total cost divided by the quantity
of output, or the cost per unit output.
Total cost is the sum of the fixed cost per
chip, the labor cost per chip, and the
material cost per chip.
U-shaped.
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Average Costs
As production increases:
Fixed cost per chip decreases from
$72 to $24 to $18;
Labor cost per chip increases from $8 to $24 to
$40;
Material cost per chip doesn’t change
$10.
Cost is lowest ($58) at the medium level of production.
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Marginal & Average-Total Cost
Relationship Short-run average total cost is at its minimum value
where average total cost and marginal cost are
equal. Average total cost slope = 0.
If marginal cost is less than average total cost,
average total cost is decreasing -- has a negative
slope.
If marginal cost is greater than average total cost,
average total cost is increasing -- has a positive
slope.
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LONG-RUN AVERAGE COST
Total cost divided by the quantity of
output when the firm can choose a
production facility of any size
The long-run average cost curve is L-
shaped, initially the result of economies
of scale.
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Economies of Scale
Cost saving associated with scaling up -- adding more
capital, labor and materials to produce more output may
be caused by either of two effects:
• Indivisible inputs;
• Specialization
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Indivisible Inputs Inputs which cannot be scaled down to produce a small
quantity of output.
Examples:
Railroad track between two cities cannot be scaled from
two to one track.
An industrial mold must be complete to produce many
copies or a single copy.
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Specialization
In a small operation with just a few workers, each
performs a wide variety of tasks.
In a large operation with many workers, each worker
specializes in one or two tasks, and is more productive
because:
• Repetition increases productivity;
• Workers spend less time switching
from task to task.
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Minimum Efficient Scale
The output at which the long-run
average cost curve becomes horizontal.
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DISECONOMIES OF SCALE
Increase in output leads to increases in the
average cost of production: higher costs
accompany scaling up.
Diseconomies may occur for two reasons:
• Coordination problems;
• Increasing input costs.
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Coordination Problems
Large organizations require several layers of
management (a bureaucracy) to coordinate the
activities of the different parts of the
organization. This leads to a positively sloped
average-cost curve.
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Increasing Input Costs
As a firm increases its output, it will demand more
of each of its inputs, which may lead to higher
prices for some inputs.
Higher prices increases the average cost of
production, resulting in a positively sloped
average-cost curve.
