Law of Supply

Students will explain how the Law of Supply, prices, and profit work to

determine production and distribution in an economy

Law of Supply• Law of Supply- refers to the relationship between price and

the quantity of a good or service that firms are willing to produce. The higher the price of the product leads to more supplies and more companies making the product.

Price As price increases…

SupplyQuantity supplied

increases

PriceAs price falls…

SupplyQuantity supplied

falls

How does the Law of Supply work? • Quantity supplied- describes how much of a good is offered

for sale at a specific price.

• Elasticity of supply- is a measure of the way a quantity supplied reacts to a change in price, it is very sensitive.

1. Inelastic- not sensitive to changes in prices. (Bread)2. What effects Elasticity?- TIME, in the short term a firm

can not change its supply level, but in the long term a firm is more flexible.

• Supply Curve- is a graph of the quantity supplied of a good by all suppliers at different prices. ALWAYS GOING UP

Market Supply Schedule• Market supply schedule- is a chart that lists how much of a

good all suppliers will offer at different prices

$.50 1,000

Price per slice of pizza Slices supplied per day

Market Supply Schedule

$1.00 1,500

$1.50 2,000$2.00 2,500

$2.50 3,000

$3.00 3,500

Market Supply Curve

Pric

e (in

dol

lars

)

Output (slices per day)

3.00

2.50

2.00

1.50

1.00

.50

0

0 500 1000 1500 2000 2500 3000 3500

Supply

Cost of Production• Firms- always look at how the number of workers they hire

will affect production. 1. Marginal Cost of Production- represents the change in

output for hiring one additional workerMarginal Product of Labor

Labor (number of workers)

Output (beanbags per hour)

Marginal product of labor

0 0 —1 4 42 10 63 17 74 23 6

5 28 56 31 37 32 18 31 –1

Increasing, Diminishing, and Negative Marginal Returns

Labor(number of workers)

Mar

gina

l Pro

duct

of l

abor

(bea

nbag

s pe

r hou

r)

8

7

6

5

4

3

2

1

0

–1

–2

–3

Diminishing marginal returns- occurs when marginal production levels decrease with new investment.

4 5 6 7

Diminishing marginal returns

Negative marginal returns- occurs when the marginal product of labor becomes negative.

8 9

Negative marginal returns

Marginal Returns

1 2 3

Increasing marginal returns

Increasing marginal returns- occurs when marginal production levels increase with new investment.

Production Costs• Fixed cost- is a cost that does not change,

regardless of how much of a good is produced. 1.Examples: Rent & Salaries

• Variable costs- are costs that rise or fall depending on how much is produced.

1. Examples: costs of raw materials & some labor costs.

• Total cost- is the fixed costs plus variable costs.

How do Production Costs Affect Supply?

• Changes- any change in the cost of an input such as raw materials, labor, cost.

1. Increase- a rise in cost will cause a fall in supply as the product becomes more expensive to make

2. Decrease- the fall of input costs causes supplies to increase.

Government Influences on Supply

• Subsidy- is a government payment that supports a business or market. Subsidies cause the supply of a good to increase.

Government Influences on Supply

• Regulation- occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.

Government Influences on Supply

• Excise Tax- tax on the production or sale of a good. This increases production costs by adding extra costs for every item sold. Causes the supply of the item to decrease on all levels.

• Examples- some are used to discourage the buying of a good considered harmful to the public good.

1. Cigarettes2. Alcohol3. Tariff on Imported Goods (Foreign Food) makes them

more expensive to buy

Influences on Supply

• Future Expectations of Prices- Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect.

Influences on Supply

• Number of Suppliers- if more firms enter a market and sell a good the supply increases, if more leave the supply decreases.