lec 4 part 2 ACDC Economics: Supply and Market Equilibrium Study Guide

Introduction to Supply and the Law of Supply

• Primary Subject: The concept of supply is explored through the lens of dairy farmers, shifting from the previous focus on milk demand.

• Defining the Cowboy Metaphor: There is a humorous distinction made regarding terminology; dairy farmers, who work with cows, are colloquially suggested to be the true "cowboys," while traditional cowboys who work with horses should perhaps be termed "horse boys."

• Verbatim Definition of the Law of Supply: The Law of Supply states that there is a direct relationship between price and the quantity supplied.

• The Incentive Mechanism: When the price for milk increases, there is an increase in the quantity of milk produced. This occurs because a higher price provides a specific incentive for dairy farmers to produce more as they seek to achieve higher profit margins.

• Slope of the Curve: Consequently, a supply curve is described as "upward sloping."

The Dynamics of the Supply Curve: Movements vs. Shifts

• Movements Along the Curve: When there is a change in the price of the good itself, it results in a movement along the existing supply curve. This is specifically referred to as a change in the quantity supplied ($Q_s$).

• Shifting the Curve: Factors other than price cause the entire supply curve to shift.     * Increase in Supply: Represented by a shift of the curve to the right.     * Decrease in Supply: Represented by a shift of the curve to the left.

• The Clarification on Price Changes: An explicit warning is provided for students: an increase in price does not change the "supply" (the curve itself); it only affects the "quantity supplied."

The Five Shifters of Supply

There are five primary determinants, or shifters, that cause the entire supply curve for a product like milk to change:

• 1. Change in the Price of Inputs or Resources:     * Key resources are required for production. For example, dairy cows are an essential resource for milk.     * If there is a significant increase in the price of dairy cows, the cost of production rises, causing the supply of milk to decrease (shift to the left).

• 2. Number of Producers:     * The total output depends on the number of firms in the market.     * If the number of dairy farmers increases unexpectedly, the overall supply of milk increases (shift to the right).

• 3. Change in Technology affecting Productivity:     * Technological advancements improve efficiency.     * Example: Introducing new, advanced milking machines allows for faster production, which causes the supply for milk to increase and the curve to shift to the right.

• 4. Government Involvement (Taxes and Subsidies):     * Subsidies: This occurs when the government wants firms to produce more, so they provide them with financial assistance. A subsidy gives producers money to produce, which causes the supply curve to shift to the right.     * Taxes: A tax functions as the opposite of a subsidy. It takes away money from the producers. Since they have less capital to produce goods, the supply shifts to the left and decreases.

• 5. Future Expectations:     * If a producer anticipates that they can earn a higher profit on their products in the future (e.g., in a few weeks), they will "hold back" supply in the present.     * This reduces current supply so they can supply a larger quantity later at the expected higher price.

Market Equilibrium and the "Market Clearing" Price

• Visualizing the Market: Supply and demand curves are combined on a single graph to identify market conditions.     * Demand Curve: Described mnemonically as going "to the dirt" (downward sloping).     * Supply Curve: Described mnemonically as going "up to the sky" (upward sloping).

• Market Equilibrium Definition: Equilibrium occurs at the specific point where the supply and demand curves intersect. This is also known as the "market clearing price and quantity."

• Numerical Example of Equilibrium:     * Equilibrium Price: $\$3$     * At $\$3$, the quantity demanded ($Q_d$) exactly equals the quantity supplied ($Q_s$).

Market Disequilibrium: Surpluses and Shortages

When the market price is not at the equilibrium point, the market is in disequilibrium, resulting in either a surplus or a shortage.

• The Surplus Scenario:     * Price Condition: Occurs when the price is set above equilibrium, such as $\$5$.     * Consumer Behavior: At $\$5$, consumers do not want to buy as much milk; the quantity demanded is only $10$ gallons.     * Producer Behavior: At $\$5$, the high price incentivizes producers to increase production; the quantity supplied is $50$ gallons.     * Surplus Definition: A surplus exists when the quantity supplied ($Q_s$) is greater than the quantity demanded ($Q_d$).     * Surplus Calculation:         * $\text{Quantity Supplied} - \text{Quantity Demanded} = \text{Surplus}$         * $50 \text{ gallons} - 10 \text{ gallons} = 40 \text{ gallons}$     * Market Correction: Unless there is government intervention, a surplus is self-correcting. Producers with excess milk that no one is buying will put the milk on sale, lowering the price until it reaches equilibrium.

• The Shortage Scenario:     * Price Condition: Occurs when the price is set below equilibrium, such as $\$1$.     * Consumer Behavior: At a low price like $\$1$, consumers want to buy a large amount; the quantity demanded is $80$ gallons.     * Producer Behavior: At this low price, producers have little incentive to produce; they only provide $10$ gallons.     * Shortage Definition: A shortage exists when the quantity demanded ($Q_d$) is greater than the quantity supplied ($Q_s$).     * Shortage Calculation:         * $\text{Quantity Demanded} - \text{Quantity Supplied} = \text{Shortage}$         * $80 \text{ gallons} - 10 \text{ gallons} = 70 \text{ gallons}$     * Market Correction: Similar to a surplus, a shortage will fix itself unless "something weird" (like intervention) is happening in the market, as prices will naturally be bid up by consumers.