So I’m in my second week of AP Economics, and everything seems to be going smoothly. One thing I just came across in my reading which isn’t really explained in detail has been bugging me. I was reading about supply & demand curves, and while the law of demand (inverse relationship between price and quantity demand) makes sense, I don’t really see how the law of supply works. Demand makes sense- the more something costs, the less people buy of it. But why is it that the higher the price of something, the greater the quantity of supply? I don’t really see the correlation. Why in theory does a company produce more of a good as the price rises? Because they get more revenue from the higher prices so they can produce more?
And from a slightly different perspective, it isn’t only about a single company wanting to produce more. If the current market price is higher, more companies are able to supply at that given price, even their production costs aren’t optimal.
It’s what a producer is willing to produce at a price point. If I’m a farmer who sells both pigs and chickens and the price of chickens increases, then I’m going to produce more chickens and less pigs.
But why? Why does a company want to create more of a good when they raise the price of the good? I don’t see an incentive for them in the situation- I don’t see why they’d want to create more of a good when they charge $10 then when they charge $5.
To look at the question from a slightly altered perspective… given a relatively decent price, a supplier wants to produce and sell as many items of the product as they can, up to a point. There always reaches a level where producing vast quantities of the item becomes more expensive… you have to buy more factories in a market where the price of factories has already been driven up, etcetera. For any given price, there’s a quantity that represents the most that you’d be willing to produce, at which you can still make a half-decent profit. That’s the question that generally makes up the supply curve, as it is.
The ‘supplier’ is actually made up of a number of different businesses, transporters and retailers and so on - and each of them experience higher than usual costs per unit at super-high sales volumes, too. So all that needs to be factored in.
Then there’s the question of the short-term supply curve, (how many the suppliers can produce almost immediately after a sudden change in prices - without being able to set up new factories, etcetera,) versus the long-term supply curve. Economics can get tricky, even with these supposedly ‘basic’ concepts.
Think about a banana grower producing 20,000 bananas a year on her most fertile land nearest the road. One year the price goes up. She goes to the village and hires workers who are lazier than the ones she has already, but she can afford it. She cultivates land that is not as fertile, but now it is profitable at the higher price. It takes more time to take the bananas (time=money) to the road for shipment, but now it is profitable. When the price goes up, the supply goes up in the short term. That’s how economists think about microeconomics. In the long term it’s a different story and you will learn about that later.
It’s starting to make more sense, thanks. It seems that the supply curve is a lot less simple than the demand curve. To me, at least.
I’m a very analytical thinker.
This is a bit easier to understand if you imagine some examples. An excellent example is the minimum wage.
Let us suppose that the equilibrium price of unskilled labour - in other words, what you’d pay unskilled workers if there was no minimum wage - was $5 an hour. (I live in Canada so my dollars are cheaper than yours.) Some people would be happy to work for $5 an hour. Others would not - some people without skills would see $5 an hour as being not worth their time, and would prefer to go to school, or get work training, or stay at home with the kids, or go on a backpack tour of Europe, or go on welfare, or whatever. So at $5, X number of unskilled workers will supply their labour, and Y number of unskilled labourers will not. So X is going to be where the supply curve intersects $5.
Now let us suppose that the government imposes a minimum wage of $7. Presumably everyone who wanted to work at $5 will continue to work at $7. However, you will now have Z people who DIDN’T want to work at $5 who are willing to quit work training, go off welfare, or leave the kids at home, and work for $7. The supply has increased. So the supply curve will be increased to X+Z where it intersects $7. The supply curve slopes up, see?
This is precisely identical in nature to the DEMAND curve. At $5, business will employ X people, since we agreed that was the equilibrium price. But at $7, they will employ fewer people, because there will probably be some jobs that were worth paying $5 to get done that aren’t worth $7. Employers will employ fewer people. So the demand curve slopes down. Different direction, but the same cause and effect.
Splanky, it might help conceptually if you use BIG numbers. For example, if oranges cost 10 cents each, then you have the current supply. What if oranges go up to $100 per orange? I dunno about you, but I’d pick oranges in the backyard and sell 'em on the street corner. All your buddies would do that too, and ipso facto the “supply” of oranges has suddenly spiked up. If the price stayed at $100/orange, then people would start searching for existing orange trees that were not being harvested. Thus move way up along the supply curve. [If planted new orange trees, that would be an upward shift in the supply curve.]
If that seems like a silly example, think about oil. A few years ago oil was less than $20/barrel, and now $50/barrel.
Thanks, you guys have all been quite helpful. I think I was looking at it wrong.
I visualized a “seller” as an entity that only produces one good. Maybe it’s my book’s fault- it explained supply as one guy selling ice cream. It kind of implies that all he makes is ice cream, so why would he decrease supply as the price decreases (that’s what I was thinking)? That makes it doubly worse- not only is he selling less ice cream, but he’s making less $$ per unit of ice cream. In a more logical situation he’d use some of his capital to produce a good that will bring in more money for him than ice cream.
Curiously enough, your intuitions are correct because people do not behave rationally. Remember, economics makes a number of fundamental assumptions one of which is that people will act in a rational manner to maximise their own utility. However, in a recent study on taxi drivers, it was shown that taxi drivers tended to work until they reached a certain target so they would quit early on good days and late on bad days. Now, rationally, what you would expect was that taxi drivers should work longer on good days in order to maximise profits and break off earlier on quieter days (ie: supply going up as “price” goes up where price is the average earning per hour) but it seems in this case at least to have failed. Fortunately for economists, when looking at the economy as a whole, the thing balances out and generally does obey the supply curve formula.
Another aspect is that the ‘supplier’ is extremely rarely a single company. If the price for ice cream is low, you’re probably going to only have a few suppliers staying in the market, bigger ones who can afford to crank it out cheaply. When the price is better, there’s going to be more little guys coming into the business and adding in their productive values.
Remember that the guy making ice cream is going to go and take a job at the widget factory, or something, if he can’t make a decent living in the ice cream biz.
And as far as being a long semester… I dunno. Probably depends a little on the curriculum and such. The one economics course I took in college, I’m pretty sure that the professor didn’t actually want us displaying any particularly original thought or understanding of the material, not when it diverged from the letter of what he was teaching. Getting a good mark in his course was largely the time-honored art of regurgitating lectures on queue into assignments and finals.
And yes, I think I actually came out with a fair degree of understanding. :]
Yup, and in that case it made perfect sense. The market supply made a lot more sense to me than an individual business’ supply. My book made a distinction between the two. I should probably mention that all of this came from my reading of the textbook, which my teacher says he hates. I read the first 8 chapters just because I find it interesting. He hasn’t lectured us on supply curves yet. I doubt this’ll be a tough semester for me. Consumer/Producer surplus and tax revenue, for example, makes a lot of sense to me. I have a pretty firm grasp on what the areas under curves represents because I’m in my second year of Calculus this year.
