Explorations in Economic Supply, Part I
Concepts covered: law of supply, fixed and variable resources, fixed and variable costs, law of diminishing returns, change in technology, change in resource prices.
If you don't know about the demand for goods, please start with the EcEdWeb demand analysis.
Your friend Bob, who could barely afford to buy bluejeans (see the demand analysis), decides he wants to be an entrepreneur and buy a plant to produce bluejeans. Company L does quite well, right? So why not get "into jeans" himself? After a brief market analysis, Bob makes his first good decision: not to attempt to differentiate his product by specializing in fuchsia colored denim jeans. So blue denim jeans it will be, and he has many things to think about before opening the doors on this production operation! He has asked you to be his business partner and to help him examine some of the decisions that have to be made. Although you both have some important investment decisions and expected return calculations to make about the purchase of the plant and equipment itself, those are beyond our concerns here. For more information about small businesses, you can check out one of the sites about this topic, for example, Small Business Exchange or Online, Inc,.
In these web pages, we'll restrict the analysis to your decisions about how many pairs of jeans you would be willing to supply, i.e., offer for sale. What determines how many pairs you might produce and offer for sale each month from this plant? As in the investigation of demand for bluejeans, there are several considerations that the buyer or demander will take into account. Likewise, you as producer and seller must also consider several things when making the decision about how many pairs of bluejeans to offer for sale.
As in the demand analysis, the price of the product will be one of the most important determinants of how many you offer for sale. Why? Let's start with a common sense approach. Your objective is to earn a profit ("maximize profits"), where profits are the difference between your total revenue and total cost. Since the sale price of a good is your revenue, a higher price encourages you as seller to produce and offer for sale more pairs of jeans. This "Law of Supply" is common sense, but there are also some specific reasons for the positive relationship between quantity supplied and produce price. The most important reason has to do with productivity and the unit costs of producing and selling jeans, which we will analyze in Part II.
Are there other conditions that might affect how much you offer for sale? What are the other influences or determinants of supply? What if TECHNOLOGY CHANGES--for example, you discover a new device for sewing machines that increases productivity (increases the number of bluejeans that can be made per hour)? Or perhaps you have to pay higher RESOURCE PRICES (e.g. wages). If the jeans had a special government TAX or SUBSIDY, that would also influence the supply relationship. If your EXPECTATIONS ABOUT THE PRICE of jeans is that they will be much higher next month, that would influence how many you offer today. Finally, if you produced other goods (e.g. shirts) using the same resources, the PRICE OF THE OTHER GOODS PRODUCED would influence the supply of jeans. Sounds like all of these are important!
Summary so far:Price is an important determinant of the quantity of a good supplied. The "Law of Supply" states that the amount offered for sale rises as the price is higher. The quantity of pairs of jeans you are willing to offer for sale rises as their price is higher primarily because you need to cover the rising costs of production in your plant. Let's explore that in Supply, Part II.
In Part II, we will explore the relationships among productivity, costs, and price. We will develop a supply curve without considering changes in the other determinants of supply: technology, resource prices, taxes or subsidies, expectations, and the price of other goods produced by the same seller. We will "hold constant" these other determinants in Part II to highlight the role of the impact on costs as output changes. But of course these other influences do change, so in Part III, we take up the matter of changing the other conditions surrounding production: technology, resource prices, taxes or subsidies, expectations, and the price of other goods produced by the same seller.
For DiscussionConsider the major influences or determinants of supply to make decisions about how much to produce and offer for sale.
1. What are these determinants of the amount supplied?
2. What will happen to the quantity of jeans you will supply if the price goes down (and other determinants are constant)?
When you have finished, you are ready for the analysis section in Part II.
Maintained by Kim Sosin. Comment via EMail: ksosin at mail.unomaha.edu
Co-Director, UNO Center for Economic Education
Chair, Department of Economics
College of Business Administration
University of Nebraska at Omaha
Omaha, NE 68182