Chapter 5 Product Market Supply

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Chapter 5 Product Market
Supply

• This chapter examines the major causes of how
  much firms will supply of a specific good (under
  perfect competition), given the price of the
  good, the price of inputs (e.g. energy, and other
  causes that we will cover.
• It also explains how we distinguish between
  individual and market supply, and goes further
  into the individual producers production
  decision.

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Price and Quantity Supplied Direction of Change

• Recall the goods own price (P) is a cause of
  quantity supplied of that good (QS).
• P? ? QS?.
• Well examine why in more detail.

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Marginal Cost

• Marginal Cost (MC) the change in total cost
  that a firm experiences as a result of increasing
  the quantity or output of the good its producing
  (Q).
• Formula MC ?(Total Cost)/?Q.

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Properties of
Marginal Cost (MC)

• MC gt 0. Q? ? (Total Cost)?
• Comes from production function (relationship how
  inputs combine to produce output).

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The Law of Diminishing Returns and Marginal Cost

• The Law of Diminishing Returns (LDR) necessarily
  implies increasing Marginal Cost.
• In other words, beginning at the point of LDR,
  ?MC/?Q gt 0.
• LDR ? Total Cost increases at an increasing rate.
  It becomes more successively more expensive for
  the firm to produce the additional good.

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Marginal Cost and the Production Decision

• Downward sloping part of MC curve firm wouldnt
  consider stopping production there.
• Upward sloping part of MC curve individual firm
  evaluates the marginal benefit versus the
  marginal cost (MC) of producing the additional
  good.

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Marginal Benefit to Production (Perfect
Competition)

• Marginal Benefit of producing the additional good
  price that the good sells for in the market
  (P).
• Perfect Competition ? P is given to the
  individual producer.

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The Production Decision

• Individual producer evaluates the marginal
  benefit (P) versus the marginal cost (MC) of
  producing the additional unit.
• If P gt MC, produce it and consider producing the
  next additional unit.
• If P lt MC, do not produce and in fact consider
  decreasing output.
• If P MC, produce the additional unit and stop
  there (first order condition).

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The Supply Curve is the Marginal Cost Curve (LDR)

• Given price, the individual producer will
  increase production until P MC.
• Increase in price (P) implies that the producer
  will move up its MC curve, and increase the
  quantity supplied (QS).

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Individual Versus Market Supply

• The Market Supply for any good is obtained by
  summing up the individual supplies for all the
  producers of this good.
• Example consider the supply of pizzas.
• Suppose the producers consist of two firms, the
  Varsity and Cosmos.

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Supply of Pizzas

• Price () Varsity Cosmos Market
• 5.00 25 18 43
• 6.00 33 21 54
• 7.00 41 24 65
• 8.00 49 27 76
• 9.00 57 30 87
• 10.00 65 33 98

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Individual Firms Supply and Market Supply
Causes

• Price of Good (P), P? ? QS?.
• Price of Inputs (PINPUT), PINPUT? ? QS?.
• -- Labor (Wage Rate)
• -- Materials (e.g. Energy)
• -- Capital Stock
• Technology (Tech), Tech? ? QS?.
• Regulatory Environment (Reg),
  
• 
  Reg? ? QS ?.
• Number of Producers (entry and exit)
• (Market Supply only)

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Supply Graphical
Description

• Graph supply against the own price (P), upward
  sloping.
• Changes in causes other than P, described as
  shifts of supply curve.
• Changes that enhance supply shift the supply
  curve rightward.
• Changes that hinder supply shift the supply curve
  leftward.

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Example 1 Technology Under Perfect Competition

• Suppose that industries which produce calculators
  discover a more efficient way to make them
  (cheaper computer chips).
• Technology? ? QS?.
• Increase in Technology increases Supply,
  described by rightward shift of supply curve.
• As a result, P?, Q?.

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Example 2 Farming Problems Under Perfect
Competition

• Fact Many dairy farms are facing significant
  financial difficulties, because the market price
  of milk is too low relative to their costs.
• As a result, farms are closing.
• Number of Farms? ? QS?.
• This change decreases the market quantity
  supplied of milk, described by leftward shift of
  Supply curve.
• As a result, P?, Q?.

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Entry and Exit in Perfect
Competition

• Highly Favorable Markets
  ? new firms enter
  ? Market Supply increases
• (shifts rightward) ?
  P?.
• Highly Unfavorable Markets
  ? firms exit
  ? Market Supply decreases
• (shifts leftward) ? P?.