economies markets t5 supply theory
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© University of South Wales
Economies Markets and Decision Making in International Contexts
Professor David Pickernell
Topic 5 : Supply Theory
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some key terms• Market
• a set of arrangements by which buyers and sellers are in contact to exchange goods or services
• Supply• the quantity of a good sellers wish to sell at each conceivable
price
1.2
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the supply curve shows the relation between price and quantity supplied holding other things constant
• “Other things” include:• input costs (factors of
production• Prices of related good• technology change• government regulations
• Changes in these other things affect the position of the supply curve
1.3
Quantity
Pric
e S
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a shift in supply
1.4
Q0
P0
Pric
e
Quantity
Suppose wages rise, increasing producers’ costsS0
S0
S1
S1
The supply curve shifts to S1S1
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Price Elasticity of Supply
• Meaning of price elasticity of supply…
• PES = % Change in Quantity Supplied
% Change in Price
1.5
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Price Elasticity of Supply
• Measuring price elasticity of supply %QS / %P• elastic and inelastic supply
• Determinants of price elasticity of supply• amount that costs rise as output increases• time period
1.6
6
market equilibrium
• Market equilibrium is at E0 where quantity demanded equals quantity supplied
• with price P0 and quantity Q0
D0
D0
S
S
Q0
P0 E0
Pric
e
Quantity
7
a shift in demand
D0
D0
S
S
Q0
P0 E0
Pric
e
Quantity
If the price of a substitute good increases ...
more will be demanded ateach price
D1
D1
The demand curve shiftsfrom D0D0 to D1D1.
E1
Q1
P1
The market moves to a new equilibrium at E1.
8
a shift in supply
D
D
Q0
P0 E0
Pric
e
Quantity
Suppose safety regulations are tightened, increasing producers’ costs
S0
S0
S1
S1
The supply curve shifts to S1S1
If price stayed at P0 there would be excess demand
Q1
P1
E2
So the market moves to a new equilibrium at E2.
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the production function
• The amount of output produced depends upon the inputs used in the production process
• A factor of production (“input”) is any good or service used to produce output
• The production function specifies the maximum output which can be produced given inputs
1.10
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short run vs. long run• The short run is the period in which a firm can
make only partial adjustment of inputse.g. the firm may be able to vary the amount of labour,
but cannot change capital.• The long run is the period in which a firm can
adjust all inputs to changed conditions.• The long-run total cost curve describes the
minimum cost of producing each output level when the firm is free to vary all input levels.
1.11
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the law of diminishing returns• Holding all factors constant except one, the law of
diminishing returns says that:• beyond some value of the variable input,• further increases in the variable input lead to steadily
decreasing marginal product of that input.e.g. trying to increase labour input without also increasing
capital will bring diminishing returns.
1.12
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the marginal product of labour• The marginal product of labour is the increase in output obtained by
adding 1 unit of the variable factor but holding constant the inputs of all other factors.
• Labour is often assumed to be the variable factor • with capital fixed.
1.13
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the short run• Fixed factor of production
• a factor whose input level cannot be varied• Fixed costs
• costs that do not vary with output levels
• Variable costs• costs that do vary with output levels
• STC = SFC + SVC
1.14
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Short-run Costs
• Average and marginal cost• marginal cost (MC) and the law of diminishing returns• relationship between MC and TC curves• average fixed cost (AFC)• average variable cost (AVC)• average (total) cost (AC)• relationship between AC and MC
1.15
04/27/2023 ER4S03 161.16Output (Q)
Cos
ts (£
)
AFC
AVC
MC
x
AC
y
z
Average and marginal costs
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short run vs. long run• The short run is the period in which a firm can
make only partial adjustment of inputse.g. the firm may be able to vary the amount of labour,
but cannot change capital.• The long run is the period in which a firm can
adjust all inputs to changed conditions.• The long-run total cost curve describes the
minimum cost of producing each output level when the firm is free to vary all input levels.
1.17
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the long-run average cost curve LAC
1.18
Output
Aver
age
cost SATC1
Each plant sizeis designed fora given outputlevel
SATC2
SATC3
SATC4
So there is a sequence of SATCcurves, eachcorresponding toa different optimal output level.
LAC
In the long-run, plant size itself is variable, and the long-run average cost curve LAC is found to be the ‘envelope’ of the SATCs
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long-run costs
1.19
The average cost of production is total cost divided by the level of output.
Long-run average cost (LAC) is often assumedto be U-shaped:
LAC
Aver
age
cost
Output
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economies of scale
1.20
Economies of scale – or increasing returns toscale – occur when long-run average costs decline as output rises:
LAC
Aver
age
cost
Output
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decreasing returns to scale
1.21
– occur when long-run average costs rise as output rises:
LAC
Aver
age
cost
Output
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constant returns to scale
1.22
– occur when long-run average costs areconstant as output rises:
LACAver
age
cost
Output
Topic 6 : Tasks
Task 1 The production function
Task 2 Low cost strategy
Task 3 The business model