Econ 102: Supply

and Demand

Zhou Fang
What is
Supply?
• Supply refers to the total amount of a
product or service that producers are
willing and able to offer for sale at
different price levels
• What and how many to sell
• The decisions of sellers
Individual Supply
• Individual demand refers to the quantity of a particular good
or service that an individual seller is willing and able to sell at
various prices during a specific period of time.
Individual Supply
Curve
• An individual supply curve is a graphical
representation that shows the relationship
between the price of a particular good or service
and the quantity of that good or service that an
individual seller is willing and able to supply
during a specific period of time, while keeping
other factors constant.
• The quantity supplied is higher when the price is
higher.
• This is why the demand curve is upward sloping
 • Assume the college library is hiring
library assistants, the main duties are

Sell to check out books, find available

books and ensure that all books are
organized throughout the day.

Yourse • If you can work up to 20 hours a

week, how many hours would you

lf
like to spend on this job if the hourly
wage is $1, $5, $10, $20, and $50?
• Feel free to think about something
else you can sell!
Perfectly Competitive Markets
What is a perfectly competitive market?
 All firms in the industry sell an identical good.
 There are many buyers and many sellers, each of whom is small
relative to the size of the market.
Perfectly Competitive Markets
Why are we using a perfectly competitive market?
 The characteristics of perfectly competitive markets have important
implications for a firm’s price-setting strategy.
 Perfectly competitive firms are price-takers:
 A price-taker is an actor who charges the market price.
 A price-taker’s actions do not affect the market price.
Perfectly Competitive Markets

 Are all markets perfectly competitive?

 No!
 If a market has only a few buyers or
sellers, then they may have market
power (they may be able to influence the
price).
 However, having firms behave as price-takers
simplifies the analysis. Just like the spherical
chickens in a vacuum.
 For now, focus on perfectly competitive firms.

 Think: What is an example of a market that is

perfectly competitive (or close to it)?
How Many to Sell?
How do firms (sellers) decide what quantity to produce at each price?
 For now, the market is perfectly competitive.
 Determine what quantity to produce at each price by using the core
principles:
 the marginal principle.
 the cost-benefit principle.
 the opportunity cost principle.
 the interdependence principle.
Choosing the Best Quantity to
Supply
The cost-benefit principle
 Decisions depend on the balance of marginal benefits and marginal
costs.
 What is the marginal benefit of producing one more unit (what is the money
that you will get for one more unit)?
 What is the marginal cost of producing one more unit (what is the extra cost
for producing one more unit)?
 Produce one more unit if the marginal benefit exceeds the marginal
cost.
Choosing the Best Quantity to
Supply
The opportunity cost principle
 When determining the marginal cost, you should compare the cost of
production to its next best option – not producing.
 Marginal cost does include variable costs …
 Variable costs are those costs that vary with the quantity of output, such as
labor and raw materials.
 … but does not include fixed costs.
 Fixed costs don’t vary when the quantity of output changes, they are incurred
regardless of level of output.
 Fixed costs can only be eliminated if the firm quits the market.
Choosing the Best Quantity to
Supply
How do we put the core principles together to determine the quantity
supplied?
1.How many units should I supply?
2.Should I sell one more unit (marginal principle)?
3.Selling one more unit depends on price versus marginal cost (cost-
benefit principle).
4.Calculate the marginal cost (opportunity cost principle).
5.If the price is greater than the marginal cost, sell one more unit!
The Rational Rule for Sellers in
Competitive Markets
 Should sellers continue to sell if the price is less than the marginal
cost? Why?
 At what point is profit maximized?
 To maximize profits, keep applying the Rational Rule for Sellers,
continuing to produce until
Price = Marginal cost
Market Supply
• Market supply refers to the total quantity of a particular good
or service that all sellers in a given market are collectively
willing and able to sell at various prices during a specific
period of time. It is the aggregation of the individual supplies
of all sellers in the market.
The Market Supply Curve Is Upward-
Sloping.

Why do market supply curves slope upward (why do they follow the law of
supply)?
 A higher price leads individual businesses to supply a larger quantity.
 A higher price means more businesses are supplying their goods and services.
 A lower price means fewer businesses are doing so.
Movement Along
the Supply Curve

 Movement along the supply curve: A

price change causes movement from one
point on a fixed supply curve to another
point on the same curve.
 Change in the quantity supplied: The
change in quantity associated with
movement along a fixed supply curve.
What Shifts Supply?
• The interdependence principle tells us that sellers’ choices depend
on many other factors other than price and when those factors
change, so might their supply decisions.
• Shift in the supply curve: A movement of the supply curve itself.
• Increase in supply: A shift of the supply curve to the right.
• Decrease in supply: A shift of the supply curve to the left.
• For the good you discussed in the “market”, what would the possible
reasons for a shift?
 • 1. Input prices
Five • 2. Productivity and technology
• 3. Prices of related outputs
Reaso • complementary goods
• substitute goods

ns • 4. Expectations
• 5. The type and number of sellers
Supply Shifter 1:
Input Prices

 Interdependence principle: Choices

other businesses make affect your
decisions.
 When your suppliers change the
prices of your inputs, they change
your marginal costs.
 This will shift your supply curve.
 Example of input: wages paid to a worker
Supply Shifter 2: Your
Business’s Productivity
and Technology

 Productivity growth: Growth that occurs

when businesses figure out how to
produce more output with fewer inputs.
 Productivity growth is often driven
by technological change.
 Examples of technological change: the
invention of new types of machinery, the
adoption of new management
techniques
Supply Shifter 3: Prices
of Related Outputs

As a supplier, your decisions are

interdependent because there are many
different lines of businesses you can engage
in.
 Substitutes-in-production: Alternative
uses of your production capacity.
 Complements-in-production: Goods that
are made together.
Supply Shifter 4:
Expectations

Your decisions are linked through time.

 For example, in the short run, if you
expect the price of your products to rise
next year, you can increase your profits
by storing them and selling them next
year.
 This will decrease your supply this year.
Supply Shifter 5: The
Type and Number of
Sellers

Because the entry and exit decisions of

businesses are driven by expected future
profits, any factor that changes expected
future profits will change the number of
suppliers in the market.
 If new businesses enter the market,
supply increases.
 If businesses shut down, supply
decreases.
Shifts versus Movements Along
Supply Curves

When do we shift a supply curve, and when do we move along it?

 A simple rule of thumb:
 When the price changes: you’re thinking about a movement along the
supply curve.
 When other factors change: you need to think about shifts in the supply
curve.
The
Parallels
Between
Demand
and Supply