05__Law_of_Supply

05__Law_of_Supply - Lecture 5 Lecture 5 Supply and Cost ■...

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Unformatted text preview: Lecture 5 Lecture 5 Supply and Cost ■ Our objectives: Our ► Explain individual choices given unlimited wants in the face of limited resources resources ► Develop a theory that helps us understand what we observe in the world. world. Opportunity Cost Opportunity Cost ■ The cost of any choice is the best opportunity not taken (sacrificed). Hence we say “opportunity cost.” This can only be known by the individual decision maker. ■ We assume people act as if they understand the costs of their actions ■ When we measure costs incurred by suppliers, opportunity cost is the true measure, but we focus on accounting or measured or objective costs. They can fool us. Cost Is Subjective Cost Is Subjective Cost can never be known. Costs and benefits are held in the mind of the individual who considers alternatives. They change all the time as we change our minds. Other people cannot know what each person thinks about cost and benefit: every person is different. This is human nature, so will not change. We do the best we can given this fact. Repeating an Important Point Repeating an Important Point Feelings, such as happiness, are subjective to each person. There is no objective measure, so we can never fully know costs and benefits as perceived by others. We do the best we can given this fact. The (weak) Law of Supply The (weak) Law of Supply ■ Holding other relevant factors constant, the higher (lower) the price of a good, the greater (smaller) will be the quantity supplied. supplied. ► Like all scientific propositions, it is a ceteris paribus (“other things equal”) statement paribus ► Note the terminology: Note - changes in the price of the good lead to changes changes in “quantity supplied” changes - they do not lead to changes in “supply” Foundations Foundations ■ The principle of Rising Marginal Cost The ► As the rate of production rises in a certain time period, given fixed inputs and technology, at some point the marginal marginal cost of producing the next unit rises cost ► In a market, supply generally reflects the marginal cost (MC) of suppliers. the You Are All Garbage Men You Are All Garbage Men Holding all else constant, the following is true if we survey a group of possible workers: Number of Volunteers Price Offered 1 $10/hour 2 $12/hour 3 $14/hour 4 $17/hour 5 $22/hour Rising Marginal Cost or Rising Marginal Cost or Opportunity Cost of Suppliers Price 22 17 14 12 10 1 2 3 4 5 Volunteers per time period MARGINAL COST = SUPPLY The Supply Function The Supply Function ■ S = f (P, I, T, etc.) (P, Price of the good itself—determines the location Price along the supply curve along ■ Other factors—determine the placement of the supply curve: placement ► Prices of inputs (also called “factor prices”) Prices ► Technology (e.g, state of knowledge; regulations) Technology ► Other variables particular to each good, including weather conditions, etc. conditions, Change in Price Change in Price A change in the price of a good means a movement along a given supply curve. Price Pa Pb Quantity/time Supply Qb Qa Increase in Supply Increase in Supply Price (A Decrease in Supply Is Opposite) Caused by: Lower Factor Prices, Improvements in Technology; other changes that lower marginal costs of production. Sa Pa Sb Not caused by Change in price Qa Qb Quantity Question on Supply Question on Supply In 1998, DVD players cost almost $1,000. Only a few were sold. Now DVD players cost as little as $40. Why can suppliers provide them at such a lower cost? How might this affect demand? What else impacted demand? Question on Supply Question on Supply There are 47,258 commercial wheat farmers in the U.S. From the perspective of one farmer, what does the market supply curve look like? What would we call this kind of market? Perfect Competition: Perfect Competition: One way to look at it One farmer sees an infinite supply since he is a trivial part of the market. Perfect competition. $ Market Price Supply D Quantity Competitive Markets Competitive Markets Participants in highly competitive markets see only the current market price—one point. The market itself is a bigger picture. $ Market Supply Market Demand Q Opportunity Cost question: Opportunity Cost question: Tickets to the Superbowl (football) in the U.S. usually sell for $500, but can be resold for about $3,000. Suppose you were able to buy a ticket for $500 and can go to the game. Is the cost of the ticket $500? What is the opportunity cost of going to the game? Economies of Scale Economies of Scale The demand for computer services has been growing rapidly for over 20 years, and no end seems to be in sight (no “saturation” of the market). Despite the increases in demand, the price of computers and computer services generally falls. What does that say about economies of scale and supply in that industry? Answer Answer In the computer industry, Price Supply curve with Economies of scale Demand keeps increasing (moving outward) and the Supply curve appears to be downward sloping due D D’ D” to economies of scale. Evidence indicates not Quantity just lower cost from larger volume, but learning with growth helps reduce costs too. Flat Screen TVs and Movies: Flat Screen TVs and Movies: Change in One Market Impact Another Matsushita invested $1 billion in a new flat screen TV plant. Production over 2.5 million per year. Huge economies of scale allows price to drop while profits increase due to lower per unit cost compared to rivals. Some rivals will die. At the same time: Big increase in bandwidth via satellite and cable means cost of delivering movies to a home user falling 20% per year. Movie theaters having harder time competing. ...
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