Supply 14:29

Baetjer explains the “supply” half of “supply and demand.”

Transcript

Howard Baetjer: All right, we continue now with the second lecture of three in the apparatus of supply and demand. On this one, we’re focused on supply. We’re going to consider what supply means, look at the graphical representation of it, distinguish supply from quantity supplied, which may sound familiar. Well, a lot of this is parallel, [00:00:30] just flip 90 degrees, and we’ll talk about what changes in supply mean, and then consider factors that change the overall supply, okay?

Let’s start right in with the basic insight about the law of supply to show you that, those who are new to economics, that a lot of what’s in economics is really familiar. What’s unfamiliar is the terminology and the apparatus, the graphical apparatus. [00:01:00] Let’s take this question, would the suppliers, the sellers of something be more eager to sell? Would they want to sell more at higher prices or at lower prices?

Students: Higher prices.

Howard Baetjer: Higher prices. That’s the law of supply. Other things being equal, at higher prices, people are willing to sell more of a good than at lower prices as long as other things remain equal. Supply then refers to the actual and potential sellers in a market and [00:01:30] the prices they are willing to accept. Once again, we’re relating prices and quantities. It’s really a little more than that, because when we’re just talking about supply, we don’t have any prices yet.

On that vertical axis, what you want to think about when you’re thinking about supply, the value dimension there is the value of the opportunities forgone. That is its costs. In a supply curve, you got cost on the vertical axis, and quantities [00:02:00] on the horizontal axis. People are willing to undergo a higher cost at higher prices. That goes along with the upward sloping supply curve according to the law of supply. Now, what determines the minimum price each seller will be willing to accept?

Student: His cost?

Howard Baetjer: You have sellers in the market, what determines the minimum price they’re willing to accept is?

Student: [00:02:30] His cost.

Howard Baetjer: His cost of bringing it to market and making it available, okay? You need a higher price in order to cover a higher cost. Supply, you think of a supply curve as a seller cost curve. A supply curve is a cost curve. That’s good to get in your notes. It’s a marginal cost curve, because it represents the opportunity cost of bringing to market each additional unit.
[00:03:00] Different sellers will have different costs, of course. We’ll take an example of a market for corn in a moment. What are some of the things that can determine a farmer’s costs, say, of bringing corn to market? What are some of the things that can determine a farmer’s costs for bringing a number of bushels across the market?

Student: The cost of clearing land, of fertilizer, of transportation, of [00:03:30] if he’s selling it himself, space in a marketplace.

Howard Baetjer: Good, all those are good, yeah. The quality of a soil, how much fertilizer he needs to use, the quality of his rainfall, how much do he need to irrigate. All these would be resources that he needs to use, resources which could be used doing something else. There’s an opportunity cost to them, the cost to the farmer of bringing goods to market. All right, so the supply curve represents the cost [00:04:00] to some farmer of bringing each additional unit of corn in our example to the market.

If you will take a look at the table that I gave you of farmers, Hiram, Irving, Jonas, and Kurt, remarkable how that goes along with the letters of the alphabet, isn’t it? H, I, J, and K. The cost of producing the, again, I simply made up the farmers and I made up their costs, and this should make sense to us, different farmers [00:04:30] will have different costs. Hiram, it cost him $2 to produce per bushel for each of his 100 bushels, cost $3 to produce 100 bushel … Sorry, the first 100 bushels, $3 to produce the second 100 bushels, and that might be because in order to produce more, he’s got to produce it on less fertile land. He’s got to spend more on fertilizer. It’ll be more costly to get that second 100 bushels out of the ground. $7 for the third.

[00:05:00] As you see in the table, I just made up costs for these four imaginary farmers, but it’s representative of the reality. There are different sorts of farmers and suppliers of all different sorts of things spread out all over the landscape and because of the fertility of their soil or transportation costs or the difficulty of hiring workers who will work on it. There are all sorts of different reasons why cost will be different, and different people do have different costs.

How do we represent this very [00:05:30] complex reality to ourselves so that we can think about it simply? We do it with supply, with the supply curve. Like with demand where we lined up the potential buyers according to the most they are willing to pay, with the supply curve, we line up the potential suppliers according to their cost, from the lowest cost producer to the next lowest cost to the next lowest cost, and so on. You see that represented in the second figure that I’ve given [00:06:00] you there which represents the cost of bringing to market each additional 100 bushels.

Are you clear? Do you have questions on that or is that pretty clear? Okay, so we’re lining them up in our imagination. Again, by convention, the values go on the vertical access. That’s prices. We talked about the value to the buyer. Here, we’ve got the costs to the sellers, remembering that costs are the values of the opportunities forgone. [00:06:30] We’ve got opportunity cost or price on the vertical axis and quantities on the horizontal axis. The upward slope reflects the law of supply. Other things being equal, at higher prices, people will be willing to supply more.

Again, I urge you, when you’re thinking about supply and demand graphs, when you’re thinking about economics, populate the curves in your imagination. Don’t think of it as a line on a page [00:07:00] or a whiteboard. Think of it as representing people, producers of some kind, farmers saying, “Here, I’ve got corn to sell,” and the vertical level shows the minimum price he’s going to hold out for before he will part with his bushels of corn, okay? Populate the curves in your imagination.

Next thing is similar to what we did with demand. There are two kinds of information represented on [00:07:30] a supply curve. If we start with the cost per bushel and go across to that supply curve, what does the supply curve tell us about any particular cost? Supposed we have, say, a cost of $8. Take a look at your graph, what does the supply curve tell us about the cost of $8?

Student: 900 bushels will be supplied at that cost.

Howard Baetjer: 900 bushels will be supplied at that cost, can be supplied for less than that cost. In terms [00:08:00] of prices rather than cost, we’d say, “At the price of $8 …” Finish this sentence for me someone, at the price of $8 …

Student: 900 bushels will be supplied?

Howard Baetjer: Perfect, 900 bushels will be supplied, or you could say, “At a price of $8, the quantity supplied is 900 bushels.” That’s one kind of information. If you start with the cost per bushel or the price on the vertical axis, you across to the supply curve, it’ll give [00:08:30] you the quantity supplied at that price. Suppose we start with the bushels, what does the supply curve tell us about each additional bushel? Arbitrarily, here, what does it tell us about the 700th bushel? We go up from 700. We run into that point there with Kurt, who is at …

Student: Cost of 6.

Howard Baetjer: The $6 mark? [00:09:00] Sure. The supply curve tells us for any bushel of corn, any additional, any marginal bushel, it’s cost of production. That 700th bushel cost $6 to produce, okay? Again, I’m repeating for review purposes. A supply curve gives us two kinds of information. At any price, it gives us the quantity supplied. For any quantity, it gives us its cost of production, okay? That’s what we mean by supply.

Now, let’s get [00:09:30] to that distinction between supply and quantity supplied, distinction between supply and quantity supplied. What quantity would be supplied at the price of $6?

Student: 700, sir.

Howard Baetjer: 700, good. What would be the quantity supplied at the price of $10?

Student: 1,000.

Howard Baetjer: 1,000, [00:10:00] good, okay. Quantity supplied makes sense at any price. Now, let’s make the distinction, or let me set it up another way. What happens to the quantity supplied as price rises from $3 to $6? As price rises from $3 to $6, what happens to quantity supplied?

Student: 60 …

Howard Baetjer: It increases by 600 bushels, from 100 to 700. Now, listen carefully. As price rises from $3 to $6, what happens [00:10:30] to the supply?

Student: Constant.

Howard Baetjer: It’s constant, nothing happens. It’s fixed, okay? The supply is the entire set of relationships. Represented on the graph, the supply is the whole curve, okay? As price changes, quantity supplied will change, but not the supply curve. That’s just sitting there, still on the page. Everybody’s cost of production stays the same. [00:11:00] As price changes, we got to change in quantity supplied, but no change in supply.

Now, let’s think about changes in supply. In the example that I’ve given you, I imagine one other farmer coming in to the market, a guy named Lawrence, who is able to supply 100 bushels at a cost of only $1, a second one at a cost of $2, yes, and he can produce a third 100 bushels at a cost of [00:11:30] $6 per bushel. The curve shifts to the right as shown. Are you with me everybody?

Student: Mm-hmm (affirmative).

Howard Baetjer: Okay. Let’s make sure we understand how to interpret an increase in supply, interpreting it as a rightward shift. Thinking of it as a rightward shift, what changes? At any price, what changes?

Student: [00:12:00] They supply more.

Howard Baetjer: Good, the quantity supply changes, okay? For example, at $4, that increase in supply means what has changed? At $4, what has changed?

Student: We’ll have 500 bushels supplied instead of 300.

Student: 300.

Howard Baetjer: Instead of 300, so quantity supplied increases out there. At a price of $8, quantity supplied increases from 900 [00:12:30] bushels to 1,200 bushels, okay? An increase in supply, understood a rightward shift, is a greater quantity supplied at any price. Let’s interpret it now as a downward shift because the new supply curve is down below the old one, right? The increased supply, it’s out there to the right, but it’s also below. What has gone down on the value dimension, understanding that supply, that new supply curve there, that downward shift in supply [00:13:00] as a downward shift, what has decreased?

Student: Cost per bushel.

Howard Baetjer: Cost per bushel, the cost of production has decreased. A downward shift in supply and increase in supply will mean a decrease at the cost of production. That should make sense, because one of the main things that increases supply is better technologies that reduce costs, okay? Good?

Some factors that can change supply, as this example illustrates, the number of sellers, obviously, [00:13:30] it’s going to change it. You have more people coming to market offering the same product. That will intend to increase supply. Another very important … Well, you tell me, what’s another of the most important determinants of supply, one of the factors that can change supply?

Student: Innovation?

Howard Baetjer: Innovation, good for you. That’s maybe the most important in our time, innovation, new technologies which reduce the cost.

Student: Subsidies also.

Howard Baetjer: Pardon me?

Student: Subsidies, subsidize.

Howard Baetjer: Subsidies do, we’re going to [00:14:00] constrain our discussion here to factors in an open market, and subsidies are a non-market phenomenon, but you’re quite right. Subsidies reduce the … Well, no. They don’t reduce the actual cost of producing something. It reduce what the cost that the farmer feels because he’s given some of the taxpayers money.

Better technology can [00:14:30] increase supply, and the other main factor is input prices, the prices of resources. If labor gets less expensive, supply will increase. If, in the case of a farmer, fertilizer gets less expensive, supply will increase.

Irrigation gets less expensive and so on. Our three main factors, number of sellers, input prices, and technology. Those are going to be the main factors that affect supply and can shift the entire [00:15:00] supply curve, okay?