http://ecedweb.unomaha.edu/lessons/

Explorations in Supply, Addendem to Part II (draft)

As promised , here is the more detailed cost analysis behind the supply curve. Consider the following hypothetical table showing various numbers of employees, the total labor cost assuming a wage of $12 per hour, and the total output you expect these workers will produce:

# Employees Tot Labr Cost/hr Total Output Marginal Output Average Labor Cost Marginal Labor Cost
Number C Q Change in Q C/Q Ch. in C/Ch. in Q
10 120 20   $6.00  
11 132 24 4 $5.50 $3.00
12 144 27 3 $5.33 $4.00
13 156 29 2 $5.38 $6.00
14 168 30 1 $5.60 $12.00

Remembering that these figures are hypothetical, let's take a look. The 11th person hired increases labor cost/hour to $132 and output to 24 units. This is an average labor cost per unit (labor cost/output units) of $5.50 and a marginal cost per unit, the addition to cost per unit of output (change in cost divided by change in output), of $3.00. As more employees are added, both labor cost and output product rise. But at some point, because we are adding workers to a fixed size of plant and equipment, we find that adding one more worker does not increase output by as much. This is shown in the marginal product (or marginal returns) column by the falling marginal product.

The falling marginal product as labor is added shows the famous "Law of Diminishing (Marginal) Returns." As one more unit of a variable resource (labor) is added to a fixed resource (capital), beyond some point the additional (or marginal) output from the last unit of the variable resource will be lower. Here is the basic point: beyond some number of employees, each additional person you hire adds to the level of production per hour, but adds less to production than the person hired just before. Since the last person costs just as much as the person before but doesn't add as much to production, your cost per unit of producing jeans rises. Whereas the 11th worker added $3.00 to marginal cost per unit, adding the 14th worker adds $12 to these marginal production costs. Would you be willing to hire this last person? Well, sure, if you could get the "right" price for the jeans! That's why it takes a higher price to induce you to supply more goods.

Of course, you will have other production costs also, since you must buy the materials for the jeans. If these other production materials cost a constant $8 per pair, then adding $8 to the marginal cost column should show the minimum price you'd be willing to accept for producing and selling various quantities of blue jeans. In other words, this would be your supply data!

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

Now go back to Part II of the Supply Analysis to see the supply curve.

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