MARGINAL ANALYSIS AND SUPPLY

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MARGINAL ANALYSIS AND SUPPLY

• PRINCIPLES OF MICROECONOMICS

Dr. Fidel Gonzalez Department of Economics and
Intl. Business Sam Houston State University
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OPPORTUNITY COST
MARGINAL ANALYSIS
Elasticity
Elasticity
SUPPLY
DEMAND
MARKET EQUILIBRIUM
CONSUMER SURPLUS, PRODUCER SURPLUS AND TOTAL
SURPLUS
MARKET EFFICIENCY
MARKET FAILURE
Pigouvian Taxes Quotas Coase Theorem Command and
control
EXTERNALITIES
TAXES
PUBLIC GOODS
COMMON GOODS
ARTIFICIALLY SCARCE GOODS
GAME THEORY
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Costs and supply
I have to grade the quizzes, homework and exams
for my classes and this is costly to me.
My cost of grading assignments is the opportunity
cost of my time.
Opportunity cost of my time I could do many
other things with my time, I could do my
research, play with my dog, and so on.
Assume that the opportunity cost of my time is
3.
I can only grade one assignment, so for each
extra assignment that I have to grade I new to
hire an assistant. If I hire an assistant it
costs me 5.
Total cost of grading an assignment my
opportunity cost payments to my assistant(s).
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The cost of grading one assignment is 3
The cost of grading two assignment is 8, my
opportunity cost of 3 plus the payment to my
assistant of 5.
What is the cost of grading three assignments?
When I grade three assignment I need to hire at
least a second assistant. However, now I have
three people working in my office me, the first
assistant and the second assistant.
Since my office is very small, when I have three
people, we are all very unproductive. We are
crowded, we do not have enough desk space, it is
hot and noise. We can only grade two and a half
assignments between three people.
The only way to grade the assignment is to hire a
third assistant. With the third assistant we are
even more crowded but at least we can grade the
three assignments.
The cost of grading three assignments 3 5 5
5 18
5
One assignment
I am the only grader
Cost 3

Cost 8
Two assignments
Two graders
3

8
5
Three assignments



Four graders


3
5
18
5
5

Cost 18
Seven graders



Four assignments



3
5
5
5


5
Cost 33


33
5

5

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Costs and supply
Now, I can get the total cost of grading one,
two, three and four assignments
I will be willing to grade as long as what I get
paid is equal to my total cost.
I am willing to grade one assignment for at least
3 because that will cover my opportunity cost.
3
I am willing to grade two assignments for at
least 8 because that covers my opportunity cost
and the payment to my assistant of 5.
8
I am willing to grade three assignments for at
least 18 because that covers my opportunity
cost and the payment to my three assistants of 5
each. My cost is 15 for the three assistants
plus 3 for my opportunity cost, that is 18
total.
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I am willing to grade four assignments for at
least 33 because that covers my opportunity
cost and the payment to my six assistants of 5
each. My cost is 30 for the six assistants plus
3 for my opportunity cost, that is 33 total.
33
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Costs and supply
The cost of grading the first, second, third and
fourth assignment, is the increase in the total
cost for an extra assignment graded, this is
called Marginal Cost.
Marginal Cost change in the cost to produce an
extra unit.
To grade the first assignment I must receive at
least 3.
3
If I am willing to grade the first assignment for
3 and grade two assignments for 8, then it must
be that I am willing to grade the second
assignment for 5, because my cost increase by 5.
3
5
8


If I am willing to grade the first assignment for
3, the second for 5 and grade three assignments
for 18, then it must be that I am willing to
grade the third assignment for 10, because my
cost increased by 10.
3
10
18



5
If I am willing to grade the first assignment for
3, the second for 5, the third for 10 and
grade four assignments for 33, then it must be
that I am willing to grade the third assignment
for 15, because my cost increased by 15.
3




5
10
15
33
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Costs and supply
The information from the previous slides is now
presented in a table
Below the table you can see the graph of the
marginal willingness to produce for the first,
second, third and fourth assignment.

The marginal cost to grade the first assignment
is 3
15
10
The marginal cost to grade for the second
assignment is 5
5
The marginal cost to grade the third assignment
is 10
3
The marginal cost to grade the fourth assignment
is 15
assignments
4
3
2
1
Finally, I can fit a straight line
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Supply and Marginal Cost
In general using a linear supply instead of the
step line we had before we have the following
We graphed the supply curve by graphing the
marginal cost.
P
SMC
P
For instance this point on the supply curve tells
me the marginal cost to produce the seventh unit
is 40.
40
QS
Q
7
Note that his supply curve is different that the
one obtained in the previous slide. Now, I am
using an ordinary supply curve.
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Supply and Marginal Cost
The quantity supplied is the amount of a good or
service that the producer is willing and able to
sell at a given price. For example, in the graph
when the price is seven the producer is willing
and able to sell 7 units.
P
The reason he is willing to sell 7 units at P40
is because the price is equal to the marginal
cost of producing the seventh unit.
SMC
P
Law of supply price and quantity supplied move
in the same direction.
40
Q
7
QS
We can see the law of supply by noting that the
slope of the supply curve is positive, meaning
that the QS increases when P goes up.
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Supply and Marginal Cost
As in the demand case, the equation of the
supply curve is called the inverse supply
equation.
The slope of the supply curve is 40/7 5.7
P
SMC
Hence, the equation of the supply curve is
P 5.7 QS
Inverse Supply Equation
Note that the y-intercept is zero
40
In order to obtain the Supply Equation we have to
solve the inverse supply equation for QS. That
way, the dependent variable (QS) is on the left
hand side.
7
QS
QS 0.175 P
Supply Equation
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Individual Supply

• We have covered the individual supply in three
  different ways
• In a Table.
• In a Graph.
• In an Equation.

Remember that the supply is equal to the marginal
cost of the producer.

• Next, we are going to cover the determinants of
  the individual supply
• Price of the good a change in the price changes
  the quantity supplied but not the supply
• Costs lower costs increase the supply and higher
  costs reduce the supply.
• Expectations if the price of good is expected to
  increase in the future then supply goes down
  today because producers do not want to sell the
  good for cheap today when they can sell it for
  more tomorrow. If the price is expected to go
  down in the future, supply will increase today
  because producers want to sell today at a higher
  price.
• Technology when technology improves firms can
  produce at a lower cost and therefore supply goes
  down.

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Movements along the supply and changes in the
supply
1) Price of the good it is very important to
distinguish between changes in the quantity
supplied and changes in the supply
Changes in the price of the good when the price
of the good changes the quantity supplied changes
but NOT the supply. That is, we move along the
supply curve but the curve does not change.
When the price changes from 40 to 50, the
quantity supplied changes from 7 to 8.75.
However, the supply curve does NOT change.
P
SMC
50
A change in the price of the good represents only
a movement along the supply curve
40
QS
7
8.75
Remember A CHANGE IN THE PRICE OF THE GOOD DOES
NOT CHANGE SUPPLY, IT ONLY CHANGES THE QUANTITY
SUPPLY. IT REPRESENTS A MOVEMENT ALONG THE SUPPLY
CURVE.
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Movements along the supply and changes in the
supply
Changes in the supply
Anything that affects the quantity supplied that
is NOT the price of the good will shift the
supply curve.
2) Costs if the cost of production increase the
supply will decrease and shift to the left. If
the cost of production decrease then supply will
increase and shift to the right.
For example, imagine that the price of milk goes
down. That will reduce the cost of producing ice
cream and therefore increase the quantity
supplied of ice cream at ALL prices.
P
SMC
Note that the producer is going to produce more
at every single price. For example, because milk
is cheaper now he can sell 8.75 gallons of ice
cream for 40 per gallon. Before, if he wanted to
sell 8.75 gallons we had to sell them for 50 per
gallon to cover his costs.
40
7
8.75
QS
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Movements along the supply and changes in the
supply
3) Expectations if the expected price in the
future goes down then the producer will produce
more today to take advantage of higher prices. If
the expected future price goes up then production
today will go down.
For example if future expected prices go down
supply today goes up and supply shifts to the
right.
For example if future expected prices go up
supply today goes down and supply shifts to the
left.
P
P
S
S
QS
QS
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Movements along the supply and changes in the
supply
4) Technology when the technology improves it is
cheaper to produce goods and services. A decrease
in the costs of the firm increases the amount of
goods and services that the firm is willing to
provide at a given price. When costs are lower
the firm can produce more at same cost.
Improvement in technology
P
S
QS
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Individual and Market Supply
So far we have talked about the individual
supply. That is, we have talked about the supply
of just one firm. We now consider the market
supply. The market supply for a good or service
is the sum of the of the individual quantity
supplied at each price for every
producer. Imagine that there are only three firms
in the market for Ice Cream Amys, Bobs and
Sims. The individual supply for each of them is
the following
Amys Supply
Bobs Supply
Sims Supply
Markets Supply
To get the market supply we add the quantity
supplied of each producer at a given price. For
example, when the price is 6 we add the QS for
Amys, Bobs and Sims for that price (123419).



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Individual and Market Supply
Graphically, in order to get the market supply we
add up the individual supply curve horizontally.
By adding the lines horizontally we obtain the
market supply. In the example below we consider
only two firms to make it easier to see. The red
line represents the sum of the two individual
supplies and therefore it is the market supply
Firms B supply
Firms A supply
Market supply
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Three ways to look at the market supply
Market Supply Equation the equation of the
market supply curve is the inverse supply
equation. Solving the inverse supply equation to
have QS on the left hand side we obtain the
market supply equation.
Market Supply
P
Inverse Market Supply Equation
Slope3
P 3QS 6
Solving the inverse supply equation for QS we
obtain the supply equation
18
6
Market Supply Equation
QS
QS 1/3 P - 2
4
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Three ways to look at the market supply

• Similar to the individual supply we can see the
  market supply in three ways
• Market Supply Schedule table with the price and
  the quantity supplied in the market.
• Market Supply Curve the graphical representation
  of the market supply schedule.
• Market Supply Equation the equation of the
  market supply curve is the inverse supply
  equation. Solving the inverse supply equation to
  have QS on the left hand side we obtain the
  market supply equation.

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Determinants of the Market Supply
The determinants of the market supply are almost
the same as the determinants of the individual
supply with the addition of one more
determinant. 1) Price of the good. 2) Costs 3)
Expectations 4)Technology 5) Number of sellers
the number of sellers is the only determinant of
the market supply that is not a determinant of
the individual supply. If the number of sellers
increases the market supply will increase. On the
other hand, if the number of sellers goes down
market supply decreases. The market supply will
shift in the same way as the individual supply
when each of these determinants change. In other
words, the analysis we made for the individual
supply also applies to the market supply with
addition of a fifth determinant Number of
sellers