Supply
Supply Curve a function that shows the quantity supplied at
different prices.
Quantity Supplied the amount of a good that sellers are will-
ing and able to sell at a particular price.
Producer Surplus the producers gain from exchange, or the
difference between the market price and the minimum price
at which a producer would be willing to sell a particular
quantity.
Producer Surplus the area above the supply curve and below
the price.
Why produce more when prices rise?
You spent a few weeks analyzing this in microeconomics. Basi-
cally when resources have competitive uses, it tends to be more
costly to produce extra output in the short-run. Hence, higher
prices are required to cover costs that increase at the margin.
9
Two ways to read a supply curve
It can be read horizontally or vertically.
Horizontally given the price of a good, how much will be pro-
duced? Start with the price. ⇒ then ⇓ to get Q.
Vertically given the amount people want to sell, what is the
lowest price they willing to charge? Start at Q. Read ⇑then ⇐ to get price.
Figure 4 illustrates this.
10
Figure 4: A graph from (Cowen and Tabarrok, 2011, ch. 3): Two ways to
read a supply curve.
11
Figure 5: A graph from (Cowen and Tabarrok, 2011, ch. 3). Given the price
of oil is $40, the producer surplus will be the area below $20 and above the
supply curve, which is shaded in green.
Producer Surplus
What benefits do producer get from trade? It depends on the
difference between how much they are willing to accept to pro-
duce and what they actually get paid for producing that amount.
It’s the difference between price and the supply curve. See Fig-
ure 5.
12
Changes in Supply
When something alters how much you are willing to produce of
a good at each possible market price, we say that supply has
changed. Graphically, this appears as a shift in the location of
the supply curve. There is a new set of prices for each quantity
(or new quantities for each set of prices).
Increase in Supply Producers are willing to produce more of
the good at existing prices. Supply shifts to the right.
Decrease in Supply Producers aren’t willing to produce as
much of the good at existing prices. Supply shifts to the
left.
13
What changes or shifts supply?
1. Technological innovations – technology improves, supply in-
creases, shifting to the right.
2. Changes in input (resource) prices – resource prices rise,
costs rise and supply decreases, shifting supply curves to
the left.
3. Taxes and subsidies – taxes increase costs and decrease sup-
ply (shift left), subsidies reduce costs and increase supply
(shift right).
4. Entry or exit of producers into industry – more firms usu-
ally means more competition which tends to increase sup-
ply.
5. Changes in opportunity costs – in general, higher opportu-
nity costs reduce supply.
14
Equilibrium
The demand curve is a simple model of how consumers behave in
a market. The supply curve is a model of the provision of those
goods or services. Together, they form a market and, provided
that institutions that govern ownership, buying, and selling are
goods ones, prices will adjust to bring about a balance between
the wishes of both sides of the market. This balance is referred
to as equilibrium.
Equilibrium Price the price at which quantity supplied is equal
to quantity demanded.
Surplus when quantity supplied exceeds quantity demanded.
Cause: price is above equilibrium.
Shortage when quantity demanded exceed quantity supplied.
Cause: price is below equilibrium
15
The adjustment process
If buyers compete with one another for scarce goods, then rivalry
tends to drive prices up. So, when there are shortages, prices
rise as potential buyers outbid each other. Suppliers are willing
to provide more in response to the rising prices. Eventually, the
shortages are eliminated as equilibrium is approached.
If sellers compete with each other for customers, then there
is an incentive for prices to fall towards the cost of production–
eliminating all excess profits. Surpluses are eliminated by com-
petition among sellers which result in falling prices. Falling
prices discourage production and the surplus is eliminated as
equilibrium is appoached.
So, as long as we have sufficient competition markets are
self-equilibrating. Furthermore, as long as all of the benefits of
consuming go to the buyer and the costs to the seller, the equi-
librium quantity and price maximize the net benefits of trade in
that good to society. This is shown if Figure 6.
16
Figure 6: A graph from (Cowen and Tabarrok, 2011, ch. 4): Surplus drives
price down, shortage drive prices up. Markets tend to be self-equilibrating
provided there is sufficient competition.
17
Who competes with whom?
Common Fallacy “Sellers want higher prices and buyers want
lower prices so buyers and sellers compete against one an-
other.” This is False!
Fact Sellers compete against each other, which causes prices to
fall.
Fact Consumers compete against each other for access to goods;
this causes prices to rise.
“If the price of a good that you want is high, should you
blame the seller? Not if the market is competitive. Instead, you
should blame other buyers for outbidding you.” (Cowen and
Tabarrok, 2011, p.49)
18
Gains from trade are maximized at equilib-
rium prices and quantities
This statement requires a little qualification. There are some
things that have to go right for markets to maximize gains
from trade. These conditions suggest goods that carry signif-
icant spillover costs or benefits may not be optimal. Or, goods
for which you are unable to prevent non buyers (referred to as
free riders) from consuming once the good is provided (pub-
lic goods). Still, most goods don’t carry large spillovers and
technology and property rights are making it easier to charge
free-riders for consumption.
• Provided there is sufficient competition among buyers and
among sellers
• Buyers get all of the benefits that are associated with the
good.
• Sellers bear all of the costs associated with producing the
good.
The conclusion is based on the supply and demand model that
shows the market price maximizes the total surplus from trade.
This is illustrated in Figure 7.
19
Figure 7: A graph from (Cowen and Tabarrok, 2011, ch. 4): Maximizing
gains from trade in free markets. This demonstrates one dimension of what
Adam Smith was talking about when he referred to an “Invisible Hand.”
20
Shifting Curves
A picture is worth a thousand words? Probably. See Figure 8.
Be sure you know how to describe the difference between
changes in demand and changes in quantity demanded. Likewise
for supply.
Describing changes
Change in Quantity Demanded Move along a given demand
curve. This is caused by a change in price.
Change in Demand This shifts the demand curve. This is
caused by changes in income, population, prices of other
goods, expectations, or tastes and preferences.
Change in Quantity Supplied Move along a given supply curve.
This is caused by a change in price.
Change in Supply This is a shift in the supply curve. This is
caused by changes in technology, input prices, taxes, subsi-
dies, entry or exit from the industry, or changes in oppor-
tunity costs.
21
Figure 8: A graph from (Cowen and Tabarrok, 2011, ch. 4): Shifting supply
and demand and determining the effects on equilibrium prices and quantities.
22
Bibliography
Cowen, Tyler and Alex Tabarrok (2011), Modern Principles of
Economics, 2nd edn, Worth, New York.
23