When discussing supply, we must talk about costs.

Remember first:  

       As a supplier, you don't want to use sunk costs in your decisions -- they are irrelevant.

            Sunk cost:

The law of supply:
 

This section relates to IMPORTANT CONCEPT READING TEN:  THE LAW OF SUPPLY

The supply curve:
A schedule showing the amount of a good that producers are willing and able to supply (produce and sell) at various prices during a specific period of time (ceteris paribus).

If we gathered some data from the real world, we could graph the supply curve:

Individual supply:  Supply by one seller.

Market supply:  Sum of the supplies of all sellers in a market.  So as suppliers exit an industry, supply decreases.  As suppliers enter an industry, supply increases.

Explanations for (or theories behind) the law of supply:

The first thing that you must understand is that producer's costs are opportunity costs.  The amount of money a producer must pay for any resource will depend upon what the owner of that resource can obtain from someone else, and this will depend upon the value of what that resource can create for someone else (i.e., the consumer).

Therefore, consumers determine the opportunity costs of resources in markets.  This, in turn, determines their price (and therefore the cost of production for the producers). 

As producers produce more of a good, they use more resources.  But as more resources are used, they become more scarce, so-to-speak.  They are being pulled away from other uses -- and this increases their marginal cost.  Therefore, as suppliers produce more, their marginal opportunity costs increase.  In other words, it is cheaper to produce the first unit of a good than it is to produce the marginal unit when 5,000 units are produced.  This is because resources are more scarce, and are therefore being pulled away from higher and higher valued alternative uses.  In order to pull the resources in - a higher price must be paid.

Therefore, the quantity supplied of a good depends upon:

1.  Able to supply - As the price of x goes up, ceteris paribus, suppliers have more revenue by which to purchase resources (inputs), ceteris paribus, therefore they can produce more of x. 

As marginal opportunity costs of production increase, suppliers will plan to increase production of x only if they expect to be compensated by higher prices (of x).  Suppliers must cover their costs in order to stay in business.  As their marginal opportunity costs increase (from bidding more and more resources into their production process), they must get a higher price for their good in order to cover those higher costs.

        Remember:  relate this to the law of supply.

2.  Willing to supply - When the price of x goes up, ceteris paribus, the relative profitability from producing x increases, and other alternatives for investment (i.e. marginal opportunity costs) become less attractive, pulling more resources into the production of x.  If the price of x goes down, ceteris paribus, the relative profitability from producing x decreases, and some suppliers will move their resources into other production processes.

        Remember:  relate this to the law of supply.

DO ICE SEVEN

The supply function:

Qx supplied = f( Px, price of a substitute in production, price of a complement in production, technological innovations, price of resources or inputs, taxes and subsidies, changes in opportunity costs, price and profit expectations, time)

Just like with the demand curve, when the Px changes, we move along the curve (change in quantity supplied).
When any other independent variable changes, we shift the curve (change in supply) - we need a whole new curve.

Px:

Price of a Substitute in Production: 

Price of a Complement in Production: 

Technological innovations:  an increase in technology increases productivity.

Resource (or input) prices: 

Taxes and Subsidies:

            In general:  When a supplier is taxed, supply will fall (basically, producing becomes more expensive).  When a supplier receives a subsidy from the government, supply will increase (basically producing becomes cheaper).

Changes in Opportunity Costs (of the suppliers):

            As suppliers opportunity costs of supplying good X increases (let's say the profit opportunity in producing another good increases), they consider moving resources out of X and into the more profitable good and vice versa.  This is what we discussed earlier (are the suppliers willing to supply the good?)

            Note:  Changes in opportunity costs of the resources used by the suppliers is reflected in their prices.

Price and Profit expectations:

Time:

            Note:  Productivity can also change due to natural events (weather, for example - included in the time variable).

The Price Elasticity of Supply:

E_s = % Q_x^S
      % P_x

Supply curves can also have ranges of perfectly elastic supply or perfectly inelastic supply.

Influences on the Price Elasticity of Supply:

• Some goods can only be produced in a fixed quantity (ex. land) for a period of time.  It takes time to produce goods and services.  Therefore, more time, more elastic supply will be (ceteris paribus).  Contrast, for example, a crop of corn to the supply of milk.  The supply of milk is price elastic because of a short time span from cows producing milk and products reaching the market place.

• How easily (and at what cost) can resources be substituted across production processes?  Some resources have alternative uses (how easily can a hotel room be turned into office space, for example?).  The easier it is to use resources in alternative uses, the more elastic supply will be.  Another example might be a printing press -- this can switch easily between printing magazines and greeting cards.

• Spare production capacity: If there is plenty of spare capacity then a business can increase output without a rise in capacity costs and supply will be elastic in response to a change in demand. Generally speaking, the supply of goods and services is most elastic during a recession, when there is plenty of spare labor and capital resources.

• Stocks of finished products and components: If stocks of raw materials and finished products are at a high level then a firm is able to respond to a change in demand - supply will be elastic. Conversely when stocks are low, dwindling supplies force prices higher because of scarcity in the market.

DO ICE EIGHT