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Chapter 3: Supply and Producer Choice – Vocabulary

Individual Supply

An individual business's supply decision focuses on the quantity it plans to sell at each price, holding other factors constant (ceteris paribus). The individual supply curve graphically represents this, typically showing a higher quantity supplied at higher prices.

Ceteris Paribus

This means "holding other things constant." It isolates the effect of price changes on quantity supplied. Changes in non-price factors (e.g., input costs, technology) shift the entire supply curve.

Law of Supply

The Law of Supply states that as price rises, quantity supplied tends to rise; as price falls, quantity supplied tends to fall. This results in an upward-sloping supply curve ("Supply to the Sky!").

Market Supply vs. Individual Supply

The market supply curve is the total quantity supplied by all sellers at each price. It is derived by summing the individual supply curves of all firms in the market at each price (horizontal summation).

Perfectly Competitive Market

In a perfectly competitive market, sellers are price-takers because they sell identical goods, there are many buyers and sellers, and entry/exit are easy. Firms decide only how much to produce at the given market price.

Core Principles Guiding Selling Decisions

Selling decisions are guided by:

  1. Marginal Principle: Focus on decisions for one additional unit.

  2. Cost-Benefit Principle: Sell if benefits (P) outweigh costs (MC).

  3. Opportunity Cost Principle: Consider the next best alternative use of resources.

  4. Interdependence Principle: Choices are affected by other factors.

Marginal Benefits and Marginal Costs (MB and MC)

  • Marginal benefit (MB) of selling an extra unit is the market price (MB = P).

  • Marginal cost (MC) is the additional cost of producing one more unit (variable costs only in the short run). MC = \frac{\Delta VC}{\Delta Q}.

  • Rational Rule for Sellers: Sell units as long as P \ge MC, continuing until P = MC.

The Supply Curve and the Marginal Cost Curve

For a perfectly competitive firm, its supply curve is its marginal cost curve (above the shutdown point). This means the supply curve directly reflects the marginal cost of producing each quantity.

Why the Supply Curve is Upward Sloping: Diminishing Marginal Product

The upward slope of the supply curve is due to rising marginal costs as output increases. This rise is often caused by diminishing marginal product (MP) in the short run, where adding more of a variable input (e.g., labor) to fixed inputs eventually yields less additional output per unit (MP_L = \frac{\Delta TP}{\Delta L} decreases).

Marginal Product: Short Run vs. Long Run

  • Short run: Fixed inputs lead to diminishing MP and rising MC.

  • Long run: All inputs are variable, but diminishing returns can still occur due to coordination or scale challenges.

The Market Supply Curve Is Upward-Sloping

Market supply slopes upward because a higher price incentivizes existing firms to increase production and new firms to enter the market, thereby increasing the total quantity supplied.

Movement Along the Market Supply Curve

A change in price causes a movement along the existing supply curve (change in quantity supplied). Changes in non-price factors cause the entire supply curve to shift.