The Theory of Supply

1
The Theory of Supply
2
Supply

• The quantity supplied of a good or service is the
  amount that producers plan to sell during a given
  time period at a particular price.

3
Supply

• What determines selling plans?

• The price of the good
• The prices of resources used to produce the good
• Technology
• The number of suppliers
• The prices of related goods produced
• Expected future prices

4

• What happens to supply curve if the price of the
  good changes?

• Other things remaining the same, the higher the
  price of a good, the greater is the quantity
  supplied. This is the Law of Supply.
  
• Why? When the price of a good rises, other
  things remaining the same, producers are willing
  to incur the higher marginal cost and increase
  production.

5
A Supply Schedule
Price Quantity (dollars per pizza) (millions
of pizzas per week)

• 6 0
• 8 3
• 9 4 10 5
• 12 6

6

• What happens to supply if the price of a good
  changes?
  
• Supply schedules list the quantities supplied at
  each different price (ceteris paribus).

• Supply curves show the relationship between the
  quantity supplied of a good and its price
  (ceteris paribus).
  

7
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

8
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

9
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

10
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

c
b
a
11
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

12
SUPPLY
Price Quantity dollars
millions of per
pizza pizzas per week

• 6 0
• 8 3
• 9 4
• 10 5
• 12 6

13
Supply
e
d
c
b
a
0 2 4 6 8 10
Quantity (millions of pizzas per week)
14
Supply
Supply of Pizzas
e
d
c
b
a
0 2 4 6 8 10
Quantity (millions of pizzas per week)
15

• A change in price results in a movement along the
  supply curve. This is known as a change in the
  quantity supplied.

16
What happens to the supply curve if factors
other than price change?

• 1) Price of productive resources
• an example What happens to the supply
  of pizzas if wages of pizza producing
  employees increase?

17
Hint Pick a point to focus on. What happens to
the supply of pizzas at 9.00 per pizza if the
wage of workers rises?
Supply for Pizzas (W 8.00)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
18
Will producers supply more or less pizzas at a
price of 9.00 when wages increase?
Supply for Pizzas (W 8.00)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
19
Supply for Pizzas (W 8.00)
At 9.00 a pizza firms costs have increased, so
firms will supply less to the market.
0 2 4 6 8 10
2
Quantity (millions of pizzas per week)
20
What happens to the supply curve if factors
other than price change?

• 2) Technology
• an example Suppose a technological
  advance occurs in the production of pizzas
  so firms can produce more pizzas with the
  same amount of inputs. What will happen to
  the supply curve?

21
At a price of 9.00/pizza, will a firm supply
more or less when a technological improvement
occurs?
Supply for Pizzas (Tech1)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
22
Supply for Pizzas (Tech2)
Supply for Pizzas (Tech1)
A tech. improvement lowers the cost of production
so firms will supply more at 9.00. The supply
curve shifts to the right.
0 2 4 6 8 10
6
Quantity (millions of pizzas per week)
23
What happens to the supply curve if factors
other than price change?

• 3) The number of sellers
• an example Suppose more firms enter
  the pizza industry. What will happen to
  the industry supply curve of pizzas?

24
With only one producer in the market, the
quantity of pizzas supplied at 9.00 is equal to
4 million units.
Supply for Pizzas ( of sellers 1)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
25
Supply for Pizzas ( of sellers 1)
Supply for Pizzas ( of sellers 2)
With more producers, more will be supplied on the
market at the price of 9.00. The supply curve
will shift to the right.
0 2 4 6 8 10
6
Quantity (millions of pizzas per week)
26
What happens to the supply curve if factors
other than price change?

• 4) Price of related goods
• substitutes in production- goods that can be
  produced by using the same resources.
  
• an example Suppose you produce
  pizza. The price of sandwiches increases.
  What will happen to the number of pizzas
  a firm supplies at a price of 9.00?

27
Before the opportunity costs of selling pizzas in
the market increases, the quantity supplied at
9.00 is equal to 4 million units.
Supply for Pizzas (PBread1)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
28
Supply of Pizzas (PBread2)
Supply of Pizzas (PBread1)
Firms will supply less pizza at 9.00 so they can
supply more sandwiches to the sandwich market.
The supply curve will shift to the left.
0 2 4 6 8 10
2
Quantity (millions of pizzas per week)
29
What happens to the supply curve if factors
other than price change?

• 5) Expected future prices
• Supply depends on beliefs regarding the future
  price of goods and services.
  
• an example Suppose firms expect the
  price of pizzas to increase next month. A
  the price of 9.00, will firms supply
  more or less?

30
At 9 a pizza, consider how the change in beliefs
of the future price of pizzas effects suppliers
willingness to produce.
Supply of Pizzas (Pe9)
0 2 4 6 8 10
Quantity (millions of pizzas per week)
31
Supply of Pizzas (Pe9)
At the price of 9.00, when firms expect future
prices to be higher, firms will withhold goods
from the market today and wait for the higher
price tomorrow. The Supply curve will shift to
the left.
0 2 4 6 8 10
2
Quantity (millions of pizzas per week)
32
A Change in Supply

• If a determinant of supply other than price
  changes, the supply curve will shift position.
  
• This is known as a change in supply.

33
A Change in the quantity supplied versus a change
in supply

• A movement along a supply curve, which results
  from a change in price, shows a change in the
  quantity supplied.
  
• If some other influence on sellers plans
  changes, holding price constant, there is a
  change in supply.

34
The supply of pizzas

• Changes in supply
• The supply of pizzas
• Decreases if
• The price of a resource used to produce pizzas
  rises
  
• The number of pizza producers decreases
• The price of a substitute in production rises
• The price of a pizza is expected to rise in the
  future

35
The supply of pizzas

• Changes in supply
• The supply of pizzas
• Increases if
• The price of a resource used to produce pizzas
  falls
  
• More efficient technologies for producing pizzas
  are discovered
  
• The number of pizza producers increases
• The price of a substitute in production falls
• The price of a pizza is expected to fall in the
  future

36
A change in the quantity supplied versus a change
in supply
S0
Price
Quantity
37
A change in the quantity supplied versus a change
in supply
S0
Price
Quantity
38
IV Market Equilibrium
39
Market equilibrium

• Equilibrium in a market occurs when the price
  balances the plans of buyers and sellers.
  
• Equilibrium price is the price at which quantity
  demanded equals quantity supplied.
  
• Equilibrium quantity is the quantity bought and
  sold at the equilibrium price.

40
A Market Equilibrium
Quantity Quantity Demanded Supplied

• 9 0
• 6 3
• 4 4
• 3 5
• 2 6

Supplyfor pizzas
Equilibrium
Demandfor pizzas
41
A Market Equilibrium
Price(dollar per pizza)
6
Supply of pizzasS (Cost, Tech, Firms, Po, Pe)
5
4
3
2
Demand of pizzasD (Po, Y, POP, T, Pe)
1
0 2 4 6 8 10
Quantity (millions of pizzas per week)
42
Market disequilibrium and market adjustment

• Excess demand- whenever price is below the
  equilibrium price, excess demand will occur.

43
Market Disequilibrium
Price(dollar per pizza)
Supply of pizzas
6
At P 2.00
5
Qd 6 Million
4
Qs 3 Million
Shortage of 3 Million pizzas
3
2
1
Demand for pizzas
0 1 2 3 4 5 6 7 8 9
10
3
6
Quantity (millions of pizzas per week)
44
What will happen in a market characterized by
excess demand?

• Firms will see a shortage or a shrinking
  inventory of pizzas.
  
• They will increase production and price.
• When prices increase, fewer consumers will demand
  pizzas and the shortage will disappear.

45
Market Disequilibrium and Market Adjustment

• Excess supply- whenever price is above the
  equilibrium price, excess supply will occur.

46
Market Disequilibrium
Price(dollar per pizza)
Supply of pizzas
6
At P 4.00
5
Qd 3 Million
4
Qs 5 Million
Surplus of 2 Million pizzas
3
2
1
Demand for pizzas
5
0 1 2 3 4 5 6 7 8 9
10
3
Quantity (millions of pizzas per week)
47
What will happen in a market characterized by
excess supply?

• Firms will see a surplus and lower prices.
• This will result in a decrease in supply.
• The lower price will bring some consumers into
  the market and the surplus will disappear.

48
V Applications of Demand and Supply Analysis
49
Methodology

• Identify the Ceteris Paribus variable that
  changed.
  
• Shift the Demand and/or Supply curve.
• Find the new Equilibrium.

50
Example

• Suppose consumer income increases.
• What will happen to the price of pizzas?

51
Step 1 Find the initial equilibrium
Price (dollar per pizza)
S
D (Y1)
Quantity (millions of pizzas per week)
52
Step2 Shift the demand curve due to the change
in the ceteris paribus variable.
Price (dollar per pizza)
S
P1
D (Y1)
Q1
Quantity (millions of pizzas per week)
53
Step3 Find the new equilibrium given the newest
demand and supply info.
Price (dollar per pizza)
S
At P1what is the Quantity Supplied?
P1
D (Y2)
D (Y1)
Quantity (millions of pizzas per week)
54
Step3 (continued)
Price (dollar per pizza)
S
At P1what is the Quantity demanded when income
is Y2?
P1
D (Y2)
D (Y1)
Quantity (millions of pizzas per week)
55
Step3 (continued)
Price (dollar per pizza)
As the quantity demanded exceeds the quantity
supplied there is a shortage of the product.
S
Shortage
P1
D (Y2)
D (Y1)
Quantity (millions of pizzas per week)
56
Step3 (continued)
Price (dollar per pizza)
S
Next, locate the new equilibrium, where quantity
demanded (Qd) (Qs) quantity supplied.
P1
P1
D (Y2)
D (Y1)
Q1
Quantity (millions of pizzas per week)
57
Step3 (continued)
Price (dollar per pizza)
S
last price adjusts upward to the new
equilibrium at P2, Q2.
P2
P1
D (Y2)
D (Y1)
Q1
Q2
Quantity (millions of pizzas per week)
58
Step 4 Prediction

• The price of pizzas will increase
  (from P1 to P2)
  
• The quantity demanded and supplied to market will
  increase. (from Q1 to Q2)

59
Example

• Suppose a union negotiates with the pizza
  producer on a wage contract. They agree to a
  wage increase for employees.
  
• What will happen to the price of pizzas?

60
Step 1 Find the initial equilibrium
Price (dollar per pizza)
S1 (Costs1)
P1
D1
Q1
Quantity (millions of pizzas per week)
61
Step2 Shift the supply curve due to the change
in the ceteris paribus variable.
Price (dollar per pizza)
S1 (Costs1)
P1
D1
Q1
Quantity (millions of pizzas per week)
62
Step3 Find the new equilibrium given the newest
demand and supply info.
Price (dollar per pizza)
S2 (Costs2)
S1 (Costs1)
At P1what is the Quantity Supplied?
P1
D1
Quantity (millions of pizzas per week)
63
Step3 (continued)
Price (dollar per pizza)
S2 (Costs2)
S1 (Costs1)
At P1what is the Quantity demanded?
P1
D1
Quantity (millions of pizzas per week)
64
Step3 (continued)
Price (dollar per pizza)
S2 (Costs2)
S1 (Costs1)
As the quantity demanded exceeds the quantity
supplied there is a shortage of the product.
P1
Shortage
D1
Quantity (millions of pizzas per week)
65
Step3 (continued)
Price (dollar per pizza)
S2 (Costs2)
S1 (Costs1)
Next, locate the new equilibrium, where quantity
demanded (Qd) (Qs) quantity supplied.
P1
D1
Q1
Quantity (millions of pizzas per week)
66
Step3 (continued)
Price (dollar per pizza)
S2 (Costs2)
S1 (Costs1)
P2
last price adjusts upward to the new
equilibrium at P2, Q2.
P1
D1
Q2
Q1
Quantity (millions of pizzas per week)
67
Step 4 Prediction

• The price of pizzas will increase
  (from P1 to P2)
  
• The quantity demanded and supplied to market will
  decrease. (from Q1 to Q2)

68
Example

• The price of health care has increased by 1.6
  times between 1980 and 1995.
  
• How can we explain this?

69
Example Health Care in the U.S.

• In 1980 the market provided the quantity Q1,
  given Supply1 and Demand1.

• Using this years price level for comparison,
  the price of health care was to 100.

• By 1995, the demand for health care had
  increased to Demand2 while the supply only
  increased to Supply2. The result is an increase
  in the quantity delivered to market (to Q2
  from Q1) and an increase in the price level (from
  100 to 160).

Supply1
PriceIndex
PriceIndex
180
180
160
160
140
140
120
120
100
100
Demand1
Quantity
Q2
Q1
1980
1995
1985
1990
70
V The Government and the Market
71
Price Ceiling

• The price level for a good or service is not
  allowed to rise above a certain level.
  
• Price ceilings result in permanent shortages as
  the market adjustment process is not allowed to
  work.

72
Example Rent Controls

• Rent controls are legally established rent limits
  on apartments and other housing.
  
• Rent controls on apartments establish a maximum
  price for which the space may be let.

73
An Application

• Take the market for apartments in Chapel Hill,
  North Carolina.

74
An Application
Price (dollar per month)
S1998
1200
1000
Find the initial market equilibrium before
controls are implemented
800
600
400
D1998
200
6
0 2 4 6 8 10
Quantity (thousands of apartments per month)
75
Rent Controls

• The equilibrium price in the market is800 a
  month.
  
• Citizens decide that this price level is too
  high, and consequently is hard on families.
  
• Citizens demand that a law is passed to make the
  maximum price for apartments 400 a month.
  
• The law passes.

76
An Application
Price (dollar per month)
S1998
1200
At 400 what is the quantity of
apartments demanded?

1000
600
D1998
200
0 2 4 6 8
10
.
Quantity (thousands of apartments per month)
77
An Application
Price (dollar per month)
S1998
1200
At 400 what is the quantity of
apartments supplied?

1000
600
D1998
200
0 2 4 6
10
Quantity (thousands of apartments per month)
78
An Application
Price (dollar per month)
S1998
1200
At 400 the quantity demanded exceeds
the quantity supplied there is a shortage of t
he apts.
1000
600
D1998
200
0 2 6
10
.
Quantity (thousands of apartments per month)
79
Rent Controls

• As the price of apartment rent goes down, by
  mandate, consumers look at apartment living as a
  housing alternative differently.
  
• In 1999, based on rent levels at the new low
  price ceiling P1, the demand for apartments
  increases to D1999.

80
An Application
Price (dollar per month)
S1998
1200
Based on rent levels at the new low price .
, the demand for apartments increases to
D1999.
1000
600
D1998
200
0 2 4 6 8
10
Quantity (thousands of apartments per month)
81
Rent Controls

• As the price of apartment rent goes down,
  property owners look at apartment leasing as a
  property use alternative differently.
  
• In 1999, based on rent levels at the new low
  price ceiling P1, the supply of apartments
  decreases to S1999.

82
An Application
Price (dollar per month)
S1998
1200
Based on rent levels at the new low price .
, the supply of apartments decreases to S1999.
1000
600
D1999
D1998
200
0 2 4 6 8
10
Quantity (thousands of apartments per month)
83
An Application
Price (dollar per month)
S1999
S1998
At . , 400, the quantity demanded far
exceeds the quantity supplied. .there is
a shortage of the product.
1200
1000
600
Even more homeless
D1999
D1998
200
0 2 4 6 8 10
11
Quantity (thousands of apartments per month)
84
Rent Controls

• The objective of the rent control was to keep
  rents low because the 800 original P1 was
  perceived as being too high.
  
• By instituting a price ceiling of 400 both the
  demand for and supply of the good changed.
  
• With the price ceiling a persistent shortage was
  created with . (2000) apartments brought to
  market, and consequently sold, despite the
  exceptional demand for . (11000) units not
  available in the market.

85
Rent Controls

• In order to solve the problem, the rent control
  law is abandoned.
  
• Prices are allowed to adjust to their market
  equilibrium, given the demand for and supply of
  the good in the market.
  
• Will there be consequences for interfering with
  the market mechanism?

86
An Application
Price (dollar per month)
S1999
S1998
1200
3rd locate the new equilibrium, where quantity
demanded (Qd) (Qs) quantity supplied.
1000
600
D1999
D1998
200
0 2 4 6 8 10
11
Quantity (thousands of apartments per month)
87
An Application
Price (dollar per month)
S1999
S1998
1200
last price adjusts upward to the new
equilibrium at
, .
1000
600
D1999
D1998
200
0 2 4 6 8
10 11
Quantity (thousands of apartments per month)
88
An Application

• We started here. 800. 6000
• and instituted a rent maximum, a price control.
• A shortage resulted and the law was repealed.

S1998
1200
1000
800

600
400
D1998
200
0 2 4 6 8 10
11
89
An Application

• We ended here. 1200. 6000
• with the new level of demand and supply, the
  equilibrium price went up. This was not the
  intent, it was the consequence.

S1999
S1998
1200
1000
800
D1999
600
400
D1998
200
0 2 4 6 8 10
11
90
Price Floor

• The price level for a good or service is not
  allowed to fall below a certain level.
  
• Price floors result in permanent surpluses as the
  market adjustment process is not allowed to
  operate.

91
Price Floor
Price (dollar per pizza)
S
At P1, a government established minimum price,
what is the quantity demanded?
P1
Qd
D1
Qd
Quantity (millions of pizzas per week)
92
Price Floor
Price (dollar per pizza)
S
At P1 what is the quantity supplied?
P1
Qs
D1
Qs
Qd
Quantity (millions of pizzas per week)
93
Price Floor
Price (dollar per pizza)
As at P1 the quantity demanded exceeds the
quantity suppliedQs Qdthere is a surplus of
the product.
S
P1
D1
Qs
Qd
Quantity (millions of pizzas per week)
94
Price Floor
Price (dollar per pizza)
S
Price Floor
Artificial price levels enforced in the market at
levels above P result in permanent surpluses.
P1
D1
Qs
Qd
Quantity (millions of pizzas per week)
95
An Application

• Take the market for minimum wage labor in Chapel
  Hill, North Carolina.
  

96
An Application
Price (dollars per hour)
S
6
5
1st Find the initial equilibrium
4
3
2
1
D
0 2 4 6 8
10
Quantity (thousands of hours per week)
97
Minimum Wage

• The equilibrium price, wage, in the market was
  4.00 an hour.
  
• Citizens decide that this price level is too low,
  and consequently is hard on families.
  
• Citizens demand that a law is passed to make the
  minimum wage, price of minimum wage labor, 5.00
  an hour.
  
• The law passes.

98
An Application
Price (dollars per hour)
S
6
At P1 (5), the minimum wage, what is the
quantity of min. wage labor demanded?
5
4
3
2
Qd 4000
1
D
0 2 4 6 8
10
Quantity (thousands of hours per week)
99
An Application
Price (dollars per hour)
S
6
At P1 (5), a price floor, what is the quantity
of min. wage labor supplied?
5
4
3
2
Qs 8000
1
D
0 2 6 8 10
Quantity (thousands of hours per week)
100
An Application
Price (dollars per hour)
As at P1 (5) the quantity supplied exceeds the
quantity demandedQS QDthere is a surplus of
the service, min wage labor.
S
6
5
4
3
2
1
D
0 2 6 10
Quantity (thousands of hours per week)
101
An Application
Price (dollars per hour)
As at P1 (5) the quantity of jobs demanded by
employers is lower than at the original market
price P. As Qd due to the min wage law.
S
6
5
4
3
2
1
D
0 2 6 8
10
Quantity (thousands of hours per week)