DOING WELL BY DOING GOOD: THE ECONOMICS OF SUPPLY RANDY RUCKER PROFESSOR DEPARTMENT OF AGRICULTURAL...

DOING WELL BY DOING GOOD: THE ECONOMICS

OF SUPPLY

RANDY RUCKER

PROFESSOR

DEPARTMENT OF AGRICULTURAL ECONOMICS AND ECONOMICS

JUNE 19, 2012

TEENAGE BABY SITTERS (AND OTHER ENTREPRENEURS): WHY DO

THEY DO WHAT THEY DO?

Help out Parents and Friends (social responsibility)

Like working with young children (personal satisfaction)

Parents have told them they have to learn responsibility by holding down a job

Earn income (make profits)

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FIRMS: WHY DO THEY DO WHAT THEY DO?

Make products they believe help people (social responsibility)

Owners and managers enjoy what they do (personal satisfaction)

Produce commodities that meet regulatory standards and legal requirements (obey laws and regulations)

Earn income (make profits)

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FIRMS: WHAT IS THE MAJORDRIVING FORCE BEHIND FIRM

BEHAVIOR?

Profits

Note: “Profits” is not a four letter word!!

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SUPPLY

What commodities will firms produce?

What quantities of those commodities will be produced?

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WHAT COMMODITIES WILL FIRMS PRODUCE?

Consumer preferences and buying behavior matter.

To sell their goods and make profits, firms will strive to produce goods that consumers want to buy.

John, a Laurel high school student, can make a “Save the Wolves” t-shirt or a “Go Locomotives” t-shirt (with the school logo) with the same amount of effort.

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WHAT COMMODITIES WILL FIRMS PRODUCE?

Suppose most of John’s potential customers are avid Locomotives fans (who don’t like wolves much).

Which of the two t-shirts will he spend the most time making?

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THE ROLE OF PROFITS IN FIRM DECISIONS

When an event occurs that increases a firm’s profits, that firm will increase the quantity of the commodity that it produces.

Examples: An increase in the price of the commodity the

firm produces

A decrease in the price of an input

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THE ROLE OF PROFITS IN FIRM DECISIONS

Alternatively, when an event occurs that decreases a firm’s profits, that firm will decrease the quantity that it produces.

Examples: A decrease in the price of the commodity the

firm produces

An increase in the price of an input

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WHAT ARE PROFITS?

Profit = Total Revenue - Total Cost (TR) (TC)

Total Revenue = Price x Quantity (P) (Q)

Total Costs = All costs incurred inproducing a product

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EVENTS THAT AFFECTPROFITS AND OUTPUT

Change in the Price of a Commodity If Price increases, then (at current output

levels) Total Revenue (P x Q) increases and profits increase. So the firm will produce more.

Similarly, if the price decreases . . .

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EVENTS THAT AFFECTPROFITS AND OUTPUT

Change in Quantity Supplied When output increases because price

has increased, economists say there has been a change in quantity supplied. Similarly if the price decreases . . .

These are represented as movements along the supply curve.

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THE CONCEPT OF SUPPLY

What is a supply curve?

This is a curve (or straight line) that shows the relationship between the price of a good and the quantity of the good that firms produce.

Along this curve other factors that affect profit are held constant.

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THE CONCEPT OF SUPPLY Based on the preceding discussion, we

expect this relationship to be positive.

That is, an increase in output price will lead to an increase in production. Similarly, for a decrease . . .

This is the “Law of Supply.”

Let’s walk through an example . . .14

THE SUPPLY SCHEDULE At different prices (holding other factors constant),

Jenny is willing to provide different amounts of lawn mowing services. (Assume she can mow one lawn per hour.)

Price per Lawn Number of Lawns Mowed (Quantity Supplied)

$ 4 0

$ 8 4

$12 7

$15 915

THE SUPPLY CURVE

0

2

4

6

8

10

12

14

16

18

0 1 2 3 4 5 6 7 8 9 10

Lawns Mowed per Day

Pri

ce P

er

Law

n

Jenny's Supply Curve

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CHANGES IN QUANTITY SUPPLIED

Once again, Change in the Price of a Commodity

If Price increases, then (at current output levels) TR (P x Q) increases and profits increase. So the firm will produce more. Similarly, if Price decreases . . .

Change in Quantity Supplied When output increases because price has

increased, an increase in quantity supplied results. Similarly, if output decreases . . . 17

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT

Change in Input Prices If an input price (e.g., gas) falls, then Jenny’s

costs of mowing lawns fall and her profits will increase.

So, at any given price she is willing to mow more lawns.

Similarly, if an input price increases . . .

This is a Change in Supply.18

A CHANGE IN THE SUPPLY SCHEDULE At a lower price for gas, Jenny will be willing

to mow more lawns.

PriceLawns Mowed

(Initial Situation: High Gas Price)

Lawns Mowed (New Situation: Low Gas Price)

$ 4 0 2

$ 8 4 6

$12 7 9

$16 9 1119

CHANGE (OR SHIFT) IN SUPPLY

0

2

4

6

8

10

12

14

16

18

0 2 4 6 8 10 12

Lawns Mowed per Day

Pri

ce P

er

Law

n

Initial Supply Curve

New Supply Curve

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OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT AND

CAUSE CHANGES IN SUPPLY Changes in Technology:

If new technologies enable firms to use resources more efficiently, then

their costs will fall,

their profits will increase,

and (at any given output price) they will produce more output.

That is, Supply will increase.21

OTHER EVENTS THAT AFFECT PROFITS AND OUTPUT AND

CAUSE CHANGES IN SUPPLY

Changes in the Number of Sellers: If more firms enter the market, then at any

given price more output will be produced: Supply will increase.

“Supply will increase” means that the supply curve shifts.

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OTHER EVENTS THAT AFFECTPROFITS AND OUTPUT AND CAUSE CHANGES IN SUPPLY

Examples: The continuing development of farm

machinery has decreased the cost of producing corn (and lots of other commodities). This increases the supply of corn.

An import ban on U.S. beef into Japan is lifted. More U.S. sellers now have access to the Japanese beef market. The supply of U.S. beef to Japan increases.

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OTHER EXAMPLES OF CHANGESIN SUPPLY (WITH GRAPHS)

Examples: What happens to the world supply of

wheat if China and Russia have extremely favorable growing conditions for wheat?

Graphically . . .

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The World Supply of Wheat

An Increase in the Supply of Wheat due toFavorable Weather in China and Russia

Price($/Q)

Q (bushels/year)

P0

Q0

S0

S1

Q1

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Other Examples of Changes in Supply (with Graphs)

Examples: What happens to the supply of

peanuts if there is a drought in the Southeastern United States?

Graphically . . .

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The Supply of Peanuts

A Decrease in Supply Due to a Drought in Georgia

Price($/Q)

Q

(Pounds/year)

P0

Q0

S0

Q1

S1

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OTHER EXAMPLES OF CHANGES IN SUPPLY (WITH GRAPHS)

Examples: What happens to the supply of peanut

butter if the price of peanuts goes up?

Graphically . . .

Note that a change at one level of the production process works its way through to other levels.

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The Supply of Peanut Butter

A Decrease in Supply Due to an Increase in Peanut Prices

Price($/Q)

Q

(Pounds/year)

P0

Q0

S0

Q1

S1

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SUMMARY Key Concepts:

Firm objectives, total revenues, total costs, profits,

supply schedule, supply curve, and the law of

supply

Key Idea: Firms are primarily motivated by the search for

profits. Events that cause profits from producing

a commodity to increase cause production of the

commodity to increase. Similarly, events that

cause profits to decrease . . . 30

SUMMARY Change in Quantity Supplied:

A change in the price of a commodity causes a movement along the supply curve, or a change in quantity supplied.

Change in Supply: An event other than a change in the price of a

commodity causes a shift in the supply curve, or a change in supply. − Input prices, technology, the number of

firms, etc.31

QUESTIONS?

COMMENTS:

Doing Well by Doing Good? Meaning?

Profits is not a four letter word What is the nature of your

relationship with Albertsons (or Town & Country, or Safeway, or . . .)?

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