http://ecedweb.unomaha.edu/Dem_Sup/supply.htm

Explorations in Supply, Part II

Goal of Part II: work out the supply curve (relationship between price and the quantity supplied) without considering changes in the other determinants of supply discussed in Part I (no changes in technology, resource prices, taxes or subsidies, expectations, and the price of other goods produced by the same seller). So suppose these other things don't change (until Part III). Under those circumstances, why would it take a higher price to encourage you to supply a higher quantity of goods?

Let's start with a bit more information about your potential bluejeans production operation and apply some basic economic cost ideas. If you go through with the purchase, you will have a plant (building) and some equipment--for example, sewing machines. This is the capital stock when your enterprise opens its doors. Economists separate supply analysis into the short run and long run: in the short run, your plant and equipment is a fixed or constant and thus is a limiting factor of your production. In the long run, none of the factors of production are fixed so you could expand or contract the size of the plant and equipment. Thus, the short run is not defined in terms of months or years, but as a period of time certain production conditions hold constant. Since you and Bob are considering a particular building and set of equipment for this analysis, your analysis should be "in the short run". Later, if things go well, you might want to expand, but for now we are limited to the given resources. Roughly speaking, the costs associated with these fixed resources are called fixed costs.

What else do you need to produce bluejeans? Of course--to produce the jeans, you'll need some employees to work with the equipment. Here you have more options. You figure that you can hire any number of employees that you might want at the same wage rate per hour. You could hire only one person, who would have to run around like a dervish from one piece of equipment to another trying to keep production going, or you could hire more employees to keep the plant running smoothly, or you could hire a whole crowd of employees to run the plant at highest capacity, perhaps even 24 hours per day. In this last case, you might have so many employees that they get in each other's way, not to mention the heavy wear and tear on the equipment from running continuously. Since your labor force is not "fixed" in number of employees, labor is a variable resources and labor cost is part of your variable cost.

These costs rise (beyond some point) as production increases because of the "Law of Diminishing Returns," e.g., the last unit of variable resource (worker) added to fixed plant and equipment is less productive than the unit added just before. This is not because of any lack of skills or other defect of the new worker. Also, it does not mean that this particular new worker produces less than the other workers produce after the new worker starts the job! The decline in marginal output occurs because each and all workers have less fixed capital (plant and equipment) to work with after more workers are added, beyond a certain point, of course. Now to the point about supply and price: Since the objective of the producer/seller is to earn a profit, the rising marginal cost per unit as more is produced causes the seller's required product price to rise.

If you would like to delve into some numbers illustrating the Law of Diminishing Returns and marginal costs, an addendum has been provided for you to digress to at this point. Otherwise (or if you went, welcome back), let's go on to show the supply data and the supply curve.

 

Supply Data
Price Quantity Supplied
$11.00 24
$12.00 27
$14.00 29
$20.00 30


This supply data is shown as a supply curve in the diagram. The curve shows what you've just figured out: a higher price is required for a higher quantity of output to be supplied, i.e., the Law of Supply. We could also say that the supply curve is positively sloped, showing a positive relationship between price and quantity supplied.

For Discussion

1. Why is the supple curve positively sloped? What do the Law of Diminishing Returns and productivity have to do with the supply curve? What does this mean for the relationship between price and quantity supplied?

When you have finished, you are ready to consider what happens when supply determinants other than price change, as discussed in Part III.


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