AG

Supply shifts chapter 3

The five factors that shift the supply curve (I, POET)

  • Key idea: A shift in the supply curve occurs when factors other than the price of the good itself cause firms to alter the quantity they are willing to supply at every price.
  • The five factors (shifters) of supply:
    • Input prices
    • Productivity and technology
    • Prices of related outputs
    • Expectations
    • The type and number of sellers
  • Not a price change: A change in price does NOT shift the supply curve; it causes movement along the curve (change in quantity supplied).
  • Acronym to remember the shifters: I, POET
    • I = Input prices
    • POET = Prices of related outputs, Output related factors (productivity/technology), Expectations, Type and number of sellers
  • Quantitative relation (conceptual):
    • The supply relationship can be written as a function of price and the five shifters:
      Qs = f\left(P, P{inputs}, T, P_{related}, E, N\right)
    • Where:
    • $P$ = price of the good
    • $P_{inputs}$ = input prices (e.g., wages, materials)
    • $T$ = technology/productivity level
    • $P_{related}$ = prices of related outputs (in production)
    • $E$ = expectations about future prices
    • $N$ = number of sellers in the market
  • Intertemporal/market context: These factors affect marginal cost (MC) and thus the quantity firms are willing to supply at each price.

Shifts vs Movement Along Supply

  • Movement along the supply curve
    • Triggered only by a change in the price of the good itself ($P$).
    • Results in a change in quantity supplied, not a change in supply.
  • Shift of the supply curve
    • Triggered by any factor other than the price of the good itself (I, POET).
    • Results in a new supply curve, i.e., a different quantity supplied at every price.
  • Graphical intuition: Original supply $S1$ at prices $(P1, P2, …)$ becomes new supply $S2$ when a shifter changes; $S_2$ is either to the right (increase in supply) or to the left (decrease in supply).

Supply Shifter 1: Input Prices

  • Core idea: Higher input prices raise marginal costs (MC) for production; this reduces supply (shift left). Lower input prices reduce MC and increase supply (shift right).
  • Example (iPhone production): If the price of inputs (e.g., raw metals, labor) rises, firms’ MC increases, so quantity supplied at each price falls; the supply curve shifts left.
  • Illustrative data (conceptual):
    • Quantity of iPhones (millions per week) vs. Price: $1000, $800, $600, $400, $200
    • Old supply curve vs. New supply curve (leftward shift) indicates smaller quantities at each price when input costs are higher.

Supply Shifter 2: Productivity and Technology

  • Core idea: Productivity growth means producing more output with fewer inputs; MC falls, supply increases (shift right). Technology improvement or new machinery drives this shift.
  • Example (bakery): A new oven with three times more baking racks reduces marginal cost per unit, so the supply curve shifts right.
  • Illustrative data (conceptual):
    • Quantity of brownies (dozens per day) vs. Price: $5, $4, $3, $2, $1
    • Old supply curve vs. New supply curve shows an increased quantity at each price after adopting the new technology.

Supply Shifter 3: Prices of Related Outputs

  • Complements-in-Production (goods produced together):
    • When the price of a byproduct rises, producers may shift production toward the more valuable byproduct, increasing total production of the main product as well if produced together.
    • Example: Peanut butter and peanut oil are complements-in-production. If the price of peanut oil rises, the producer may produce more peanut oil and, since they are produced together, also produce more peanut butter. Result: the supply of peanut butter increases when the price of peanut oil rises.
    • Additional example: Asphalt is a byproduct of oil refining; leather is a byproduct of beef.
  • Substitutes-in-Production (alternative uses of resources):
    • If the price of one good produced with shared factors rises, producers shift resources toward that higher-priced good, reducing the supply of the other good.
    • Example: If the price of corn rises, corn becomes more attractive to produce; the quantity supplied of wheat falls.

Complements-in-Production: Peanut Example (fill-in interpretation)

  • Peanut butter is the main product; peanut oil is the byproduct (complements-in-production).
  • When the price of peanut oil rises, producers have an incentive to produce more peanut oil, which, because peanut butter and peanut oil are produced together, also increases peanut butter production.
  • Conclusion: A rise in the price of a complement-in-production increases the supply of the main product as well.

Practice Example: Complements-in-Production (Louisiana beef and leather)

  • Leather is a byproduct of beef production.
  • An increase in beef price (due to Keto-demand effects) makes leather more valuable as a byproduct resource; leather supply shifts to the right (increases).
  • Equilibrium effect: Leather supply increases; price may adjust downward, and quantity of leather increases.

Substitutes-in-Production: Corn and Wheat

  • If the price of corn rises, resources shift toward corn production, decreasing wheat production.
  • Result: The supply of wheat shifts to the left (decrease).

Practice Example: Substitutes-in-Production (Corn and Wheat data)

  • If the price of corn increases, farmers reallocate resources toward corn, reducing wheat supply at each price.
  • This is observed in the accompanying data showing shifts in the supply curves for corn and wheat.

Supply Shifter 4: Expectations

  • If producers expect the price of their product to rise next year, they may store some of today’s supply to sell later at the higher price; current supply decreases (shift left).
  • Conversely, if prices are expected to fall, producers may release more now (shift right).

Supply Shifter 5: Type and Number of Sellers

  • New sellers entering the market increase total quantity supplied at every price, shifting the supply curve to the right.
  • Sellers leaving the market decrease total quantity supplied at every price, shifting the supply curve to the left.

Practice Example: Delta Airlines (Supply shifts)

  • a) Fall in jet fuel price: lowers input costs; shifts supply of flights to the right (increase in supply).
  • b) New software for better aircraft allocation: lowers marginal cost; shifts supply to the right.
  • c) New labor contract raising wages: raises input costs; shifts supply to the left (decrease in supply).

Key take-aways: What shifts a supply curve?

  • Increase in supply = shift to the right (more is supplied at every price).
  • Decrease in supply = shift to the left (less is supplied at every price).
  • Five factors shift the supply curve (I, POET):
    • Input prices
    • Productivity and technology
    • Prices of related outputs
    • Expectations
    • Type and number of sellers
  • Important caveats:
    • A change in price does not shift supply; it causes a movement along the curve.
    • The effect of a price change in a related output depends on whether the outputs are complements in production or substitutes in production.

Shift versus Movement Along Supply (summary)

  • If only the price of the good changes, we move along the existing supply curve (change in quantity supplied).
  • If any other factor changes, the entire supply curve shifts (change in supply).

Parallels Between Demand and Supply (high-level mapping)

  • Your objective:
    • Demand: maximize economic surplus
    • Supply: maximize profit
  • Quantity decision rules:
    • Buyers: Rational Rule for Buyers
    • Sellers: Rational Rule for Sellers
  • Curves:
    • Demand curve = marginal benefit (MB)
    • Supply curve = marginal cost (MC)
  • Slope directions:
    • Demand curve: typically downward due to diminishing marginal benefits
    • Supply curve: typically upward due to increasing marginal costs
  • Market curves:
    • Market demand = sum of all individual demand curves at each price
    • Market supply = sum of all individual supply curves at each price
  • Price changes:
    • Rise in price → movement along demand curve (lower quantity demanded)
    • Rise in price → movement along supply curve (higher quantity supplied)
    • Falls in price have the opposite effects
  • Curve shifts (driven by non-price factors):
    • Demand shifts due to non-price factors (not covered here in detail for demand)
    • Supply shifts due to I, POET (as above)

Concept Check (quick answers)

  • 1. The distinction between a normal and an inferior good: A. when income increases, demand for a normal good increases while demand for an inferior good falls.
  • 3. The distinction between substitutes and complements: C. when income increases, demand for a substitute good increases while demand for a complementary good falls.
  • 4. Law of demand explanation: D. A and C only (price rise lowers quantity demanded due to substitution effect and purchasing power effect).

Practice Example: Gasoline (marginal cost and supply decision)

  • Given the data, the price is $3.99 per gallon.
  • Marginal costs (per gallon) at quantities:
    • 10: $1.99
    • 14: $2.99
    • 20: $3.99
    • 30: $4.99
    • 42: $5.99
  • The quantity that a rational seller should be willing to supply at price $3.99 is where MC ≤ price. The largest quantity with MC ≤ 3.99 is 20 million gallons per week.
  • Therefore, the correct quantity is 20 million gallons per week.

Practice Example: Pumpkins (complements/substitutes in production)

  • A farmer finds that producing more pumpkins also yields more decorative pumpkins; this indicates they are complements in production.
  • Answer: complements-in-production.

Practice Example: Henderson Lumber (byproduct consideration)

  • When housing demand collapses and housing prices fall, the price of boards falls as well.
  • The byproduct sawdust supply will likely: decrease (less production of boards leads to less sawdust).
  • Answer: quantity of sawdust supplied decreases (i.e., supply of sawdust decreases).

Practice Example: Four Supply Curves (organic wheat input in bread)

  • A rise in the price of an input used to produce bread (organic wheat) would shift the supply curve left (less supply) and a fall would shift it right (more supply).
  • The graph exercise shows identifying which graph corresponds to such a shift; the key idea is that input price changes shift the supply curve, not the demand curve.

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