Chapter Five Supply Section One What is Supply? Section Two The Theory of Production Section Three Cost, Revenue, and Profit

Maximization

Section One What is Supply?

Objectives:– Understand the difference between the supply

schedule and the supply curve.– Explain how market supply curves are derived.– Specify the reasons for a change in supply.

Supply- the amount of a product that would be offered for sale at all possible prices that could prevail in the market.

What is Supply? (cont’d)

Law of Supply- the principle that suppliers will normally offer more for sale at high prices and less at lower prices.

An Introduction to Supply:– The Supply Schedule- a listing of the various quantities

of a particular product supplied at all possible prices in the market.

– The Supply Curve- a graph showing the various quantities supplied at each and every price that may prevail in the market.

• Supply curves ALWAYS slope upward from left to right!

Supply Schedule and CurveFigure 5.1Figure 5.1

What is Supply? (cont’d)

– Two Types of Supply Curves:• Individual Supply Curve• Market Supply Curve- the supply curve that shows the

quantities offered at various prices by all firms that offer the product for sale in a given market.

Change in Quantity Supplied– Quantity Supplied- the amount that producers bring to

market at any given price.– Change in Quantity Supplied- the change in amount

offered for sale in response to a change in price.• A Change in Quantity Supplied is shown by the movement of

the dots on the supply curve.

Market Supply CurveFigure 5.2Figure 5.2

What is Supply? (cont’d) Change in Supply- the situation where suppliers

offer different amounts of products for sale at all possible prices in the market.– Result is the entire curve shifts either to the left or

right.– Causes for a Change in Supply:

• Cost of Inputs• Productivity• Technology• Taxes and Subsidies

– Subsidy- a government payment to an individual, business, or other group to encourage or protect a certain type of economic activity.

• Expectations• Government Regulations• Number of Sellers

Change in Supply Figure 5.3Figure 5.3

What is Supply? (cont’d)

Elasticity of Supply– Supply Elasticity- a measure of the way in

which quantity supplied responds to a change in price.

• Types of Supply Elasticity:– Elastic Supply- a change in price causes a relatively

LARGER change in quantity supplied. (ex.)

– Inelastic Supply- a change in price causes a relatively SMALLER change in quantity supplied. (ex.)

– Unit Elastic Supply- a change in price causes a PROPORTIONAL change in quantity supplied.

What is Supply? (cont’d)

– Determinants of Supply Elasticity:• Products that are costly to produce or limited in

supply, such as oil reserves , are INELASTIC in supply. ( Require huge amounts of capital or human investments.)

• Products that are not costly or those not limited in supply, such as candy bars, are ELASTIC in supply. (Do not require huge amounts of capital or human investments.)

Section Two The Theory of Production Objectives:

– Explain the theory of production.– Describe the three stages of production.

The Theory of Production- the relationship between the factors of production and the output of goods and services.– Short Run- a period of production that allows producers

to change only the amount of the variable input called LABOR.

– Long Run- a period of production long enough for producers to adjust the quantities of all their resources , including capital.

The Theory of Production (cont’d) Law of Variable Proportions- states that, in the

short run, output will change as one input is varied while the others are held constant.

The Production Function- a concept that describes the relationship between changes in output to different amounts of a single input while other outputs are held constant.

• Raw Materials- unprocessed natural products used in production.

– Total Product- is total output produced by the firm.– Marginal Product- the extra output or change in total

product caused by the addition of one more unit of variable input.

The Theory of Production (cont’d) The Three Stages of Production- are based

on the way marginal product changes as the variable input of labor is changed.– Increasing Returns (Stage One)– Diminishing Returns (Stage Two)

• Most firms operate in stage two!!

– Negative Returns (Stage Three)

The Law of Variable ProportionsFigure 5.5aFigure 5.5a

The Law of Variable Proportions (cont’d)

Figure 5.5bFigure 5.5b

Section Three Cost, Revenue, and Profit Maximization

Objectives:– Define four key measures of cost.– Identify two key measures of revenue.– Apply incremental analysis to business

decisions.

Cost, Revenue, and Profit Maximization (cont’d) Measures of Cost:

– Fixed Cost (overhead)- the cost a business incurs even if the plant is idle and output is zero. (examples: salaries, interest payments, rent, property taxes, and retirement costs)

– Variable Cost- the cost that changes when the business rate of operation or output changes. (examples: hourly wages, utilities,and shipping costs)

– Total Cost- the sum of the variable and fixed costs.

– Marginal Cost- the extra cost incurred when a business produces one additional unit of a product.

• Factories that produce durable goods have a high fixed cost and smaller variable costs.

Cost, Revenue, and Profit Maximization (cont’d) Measures of Revenue:

– Total Revenue- the number of units sold multiplied by the average price per unit.

– Marginal Revenue- the extra revenue associated with the production and sale of one additional unit of output.

Marginal Analysis- a type of cost-benefit decision making that compares the extra benefits to the extra costs of an action. – Break-even point- the total output or total product the

business needs to sell in order to cover its total costs.– Profit-maximizing quantity of output- is when marginal

cost and marginal revenue are equal.

The End of Chapter Five

Chapter Review Tomorrow!