WEEK TEN: THINKING LIKE THE SELLER AND SUPPLY
Demand Review
The goal was to understand how customers behave in response to factors businesses control, such as price.
Buyers aim to maximize net satisfaction (total satisfaction - cost).
Buyers purchase the quantity where marginal utility equals the price.
If marginal utility declines with consumption, prices need to decrease to encourage more purchases.
Introduction to Supply
Supply represents the quantity of a product a producer is willing to offer at a set price.
When producers lack control over market price, they decide how much to supply based on that price.
Overall supply is the total amount all producers offer at a given price.
Production and supply are used interchangeably.
Apple Seller Example
John, an apple seller in Canterbury High Street, cannot control apple prices.
He decides how many apples to supply based on the market price.
If the price is £1, John is prepared to supply 30 apples.
Supply Table Observations
At 50p, John supplies 10 apples.
At £1.50, he supplies 50 apples.
The market, not the seller, dictates the price; sellers react to it.
Supply Curve
The supply curve plots the relationship between market price and quantity supplied.
It is upward sloping.
The graph indicates how many apples John will supply at a given price.
Price is on the y-axis (independent variable), quantity supplied on the x-axis (dependent variable).
Quantity supplied changes in response to price changes.
Important Distinction:
Do not explain supply by discussing how price changes when the quantity changes.
Law of Supply
If the market price increases, sellers are generally willing to produce and supply more.
This is because increased value and consumer demand incentivize greater production.
Substitute and Complementary Goods
Substitutes: Products that can be used interchangeably (e.g., HP vs. Apple laptops).
Complementary: Goods that are used together (e.g., iPhone and Apple Watch).
Companies sometimes offer complementary goods as part of a package or at a discount.
Scenarios
If the market sets a lower price than the seller's desired price, the seller must adhere to the market price, assuming they cannot control it.
This often applies when products are indistinguishable from competitors' offerings.
In farmers' markets, apple sellers must price similarly unless they can demonstrate superior quality.
Seller's Goal and Cost of Production
The goal of a business is to maximize profit.
Production costs involve factors like labor and capital.
For John, costs include buying apples, transportation, and stall rental (£50/day).
Unlike utility, cost is a concrete, estimable value.
Marginal and Average Cost
Marginal cost: the added cost of producing one extra unit.
Example: Producing 10 apples costs £1; the 11th apple costs £1.15. The marginal cost of the extra unit is £1.15.
Average cost: Total cost divided by the number of units supplied.
Example: Supplying 20 apples costs £25, so the average cost is £1.25 per apple.
Profit Maximization
Sellers aim to equate marginal cost with marginal benefit (price).
The marginal principle is key; opportunity cost is less dominant.
Graphical Explanation
Total revenue is price times quantity supplied ().
Total cost is upward sloping but curved.
Profit is the difference between revenue and cost.
Sellers seek to maximize the gap between revenue and cost.
Diminishing Returns
Increased resources lead to diminishing returns, raising costs without proportionally increasing output.
Marginal revenue is the price for price-takers.
Marginal Cost and Profit
The greatest profit occurs where marginal cost (MC) equals marginal revenue (MR, which is the price).
Sellers supply up to the point where the market price intersects their marginal cost curve.
Table Example
Apples sell for £2.50 each.
Total revenue is calculated as price times quantity.
Profit peaks at a certain quantity of apples.
Graphical Representation
Revenue and cost curves illustrate profit potential.
The widest gap between revenue and cost indicates maximum profit.
Marginal cost can be derived, showing added cost per unit.
Cost Curves
Marginal cost initially decreases, then rises.
Average cost is flatter and also U-shaped.
Marginal cost rises faster than average cost.
Average cost is at its lowest where it intersects marginal cost.
Marginal cost is the added cost of making an extra unit.
Average cost is overall cost divided by units produced.
Supply Curve and Marginal Cost
Sellers consider points where price equals marginal cost.
Points where average cost is below price are avoided (losses).
Profit is price minus average cost.
The supply curve reflects the firm's marginal cost of production.
Demand curves show marginal utility; supply curves show marginal cost.
Additional Points
When MC equals price, it indicates the most profit, even if it's break-even.
In markets where sellers lack price control, long-term profits may be zero.
The intersection of total revenue and total cost represents break-even.
A negative supply relationship is rare.
Market Supply
Market supply is the sum of individual sellers' supplies.
It exhibits similar behavior to individual supply curves.
Factors Affecting Supply
Price of the product: Primary driver.
New legislation: Affects labor costs (e.g., minimum wage).
Technology: Improves production methods, reduces costs.
Expectations: Sellers may reduce supply if they anticipate future price increases.
Number of sellers: Influences market supply.
Shifts in the Supply Curve
Movement along the curve: Caused by price changes.
Shift in the curve: Caused by factors other than price, mainly production costs.
Technological improvements expand supply.
Rising raw material costs limit supply.
VAT and sales taxes also shift the curve, impacting the cost to consumers.
Supply is the marginal cost of production.