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The Law of Supply - Demand and Supply (2/4) | Principles of Microeconomics - YouTube
Channel: Inspirare
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Let’s move on and talk about the law of
supply.
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What does it actually mean for a firm to supply
a good or service?
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Three criteria must be met.
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Firstly, the firm must have the resources
and technology to produce it.
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The resources and technology available to
a firm act as a constraint on how much it
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can produce.
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The firm must be able to make a profit, or
at least break even, from supplying the good.
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If it makes losses from producing a good then
there’s no incentive to do so.
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The firm must also plan to produce and sell
this good.
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If all of these criteria are met, then we
can say that a firm supplies a good or service.
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The quantity supplied of a good or service
is the amount that the producers plan to sell
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during a given period at a given price.
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Keep in mind that the quantity supplied is
not necessarily the same as the quantity sold.
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We’ll learn why this is the case when we
study equilibrium theory in the next lecture,
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but for now just know that the quantity sold
to end consumers and the quantity supplied
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by firms are not always the same thing.
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The law of supply describes the positive relationship
between the price and the quantity supplied
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of a good or service.
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Essentially, this means that as price increases,
the quantity supplied of a good increases,
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and that as price decreases, the quantity
supplied of a good decreases.
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Both price and quantity supplied move in the
same direction.
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You might be wondering why increases in prices
cause increases in the quantity supplied.
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Can’t firms just increase the quantity at
any price to increase their profit margins?
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Well, not really.
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The incremental cost required to produce an
additional unit, or the marginal cost of an
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additional unit, increases.
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Think about it this way.
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If a factory wants to increase its output
in the short run, the only factor of production
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that it can change to do so is labour.
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As more and more people work in this factory,
each worker has a smaller and smaller work
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area, making it harder for them to produce
an additional unit of the good.
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Thus, they need to work longer hours to make
the same good.
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This means that you will be paying them more
to make the same good.
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Thus, the cost of producing an additional
unit of a good goes up.
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Companies want to at least cover the costs
of production, therefore the market price
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must equal the cost of production for the
company to even think about producing the
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good, and this is why the quantity supplied
of a good or service increases as the price
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of that good increases.
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The supply curve is just a graphical representation
of the entire relationship between the price
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of a good and its quantity supplied.
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We can determine the quantity supplied at
any given price by simply taking a point on
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the curve, and checking the price and quantity
that correspond with that point.
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We can interpret the supply curve as a minimum-supply-price
curve.
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This essentially describes a curve that shows
the lowest price at which firms are willing
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to sell an additional unit of a good.
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We just talked about how the marginal cost
of production increases as we produce a greater
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quantity, and so the company wants to cover
at least its costs of production, if not make
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a profit on top of that, for each good that
it produces.
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Thus, the supply curve shows us the price
required to induce a firm to produce each
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given quantity of that good.
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Just as we saw in the lecture about demand
theory, we can observe shifts in the supply
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curve as well.
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We say that supply changes when any factor
that influences selling plans, of course,
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other than price, changes.
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This causes the quantity supplied at any given
price to either increase or decrease, depending
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on what the situation is.
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Note that when we say that supply has increased,
we shift the curve down and to the right,
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and when we say that supply has decreased,
we shift the curve up and to the left.
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The first factor that affects supply is the
prices of factors of production.
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In order to think about this intuitively,
let’s consider the supply curve as the minimum-supply-price
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curve again.
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If the price of labour, for example, increases,
then the firm spends more on each unit produced,
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and thus would require a higher selling price
to induce it to supply more of a given good,
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thus the supply curve would shift up and to
the left.
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If the price of a factor of production increases,
then the supply curve would shift to the left.
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In the same way, if the price of a factor
of production decreased, then supply would
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increase and the curve would shift down and
to the right.
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Just as a side note, from now on I’ll just
say that the supply curve shifts to the left
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and/or right even though I really mean up
and to the left or down and to the right.
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It’s just easier to say.
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The second factor that can influence supply
as a whole is the prices of complements and
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substitutes in production.
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Complements in production are two goods that
can be produced together.
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As an example, let’s consider beef and cowhides.
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Both beef and cowhides come from cows.
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Let’s say that we’re looking at the market
for beef, and we are told that the price of
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cowhides just went up.
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If this is the case, then the quantity supplied
of cowhides would increase.
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In essence, more cows are being killed for
their cowhides.
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Excuse the imagery, but now we have all these
dead cows lying around, so firms use them
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to produce beef.
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Essentially, the supply of beef has increased
because the price of cowhides has increased.
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It works both ways – if the price of cowhides
were to fall, then the supply of beef would
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fall, thus shifting the curve to the left.
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Substitutes in production are goods that can
be produced by using the same resources.
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Think about energy drinks and energy bars.
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A firm has to split up its resources between
energy drinks and energy bars.
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It’s not like cowhide and beef where both
goods come from the same cow.
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If the price of energy drinks increases, then
the firm wants to increase its quantity supplied
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of energy drinks.
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Thus, it will reduce the supply of energy
bars and use those resources to produce energy
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drinks.
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In this case, the supply of energy bars shifts
to the left.
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It works both ways; if the price of energy
drinks decreases, then the supply of energy
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bars would increase.
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Expected future prices should be pretty intuitive.
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If I, as a firm, expect to earn more in the
future from selling a good, then I would hold
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off on selling right now and sell my goods
in the future instead at higher prices.
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Thus, today, the supply of the good would
decrease.
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Conversely, if the expected future price of
a good fell, then the supply of that good
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today would increase.
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Firms would rather sell the good today when
its price is higher to make greater profits.
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The number of suppliers should also be quite
intuitive.
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If we have more firms producing the good,
then regardless of what the price is, we will
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have a greater quantity produced.
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Thus, as the number of suppliers increases,
so does the supply.
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If the number of suppliers decreases, then
the supply of the good decreases.
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Technology is a factor which doesn’t really
ever decrease supply, rather it almost always
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increases it.
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If some new technology is developed which
makes a firm more efficient at producing a
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good, then it can supply more of that good
with a given quantity of resources, effectively
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reducing its costs of production.
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Thus, supply would increase.
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We need to keep in mind the difference between
the quantity supplied of a good and its entire
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supply.
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When we say that the quantity supplied has
changed, we are referring to a movement along
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the supply curve.
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This can only be induced by a change in the
price of that good.
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When we refer to a change in supply, we are
talking about a shift of the entire curve.
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A shift of the entire supply curve represents
a change in the quantity supplied at all possible
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prices, and is caused by the factors that
we discussed in the previous slide.
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