Lecture 4

Principles of Economics I Economics 101 Section 400 Class 4 Class 4 Readings Chapter 3 Specifically p75 ? 79: Supply side of the market Chapter 4 Specifically p 103-105 Next Class: Chapter 3 Specifically p67-75 Chapter 4 Specifically p.101-103 Class 4 Announcements Pooled Office Hours Schedule On CTools Discussion Section Schedule On CTools HW Assignment 2 Available on line Please spend some time on this prior to section Quiz 1 In section this week Class 4 Australia Fine wool (bales) Coarse wool (bales) 2 m 1 m Slope = rise/run = -1/2 Class 4 New Zealand Fine wool (bales) Coarse wool (bales) 0.5 m 0.75 m Slope = rise/run = -3/2 Class 4 Joint PPF Fine wool (bales) Coarse wool (bales) 2 m 1.75 m Opportunity cost of 1 bale of fine wool is ½ a bale of coarse wool Opportunity cost of 1 bale of fine wool is 3/2 bales of coarse wool Slope = rise/run = -1/2 0.75 m 2.5 m Slope = rise/run = -3/2 Class 4 If the relative price of fine wool is? Less than ½ a bale of coarse wool (i.e. if fine wool is very cheap), then Wool growers in both countries will produce only coarse wool More than 3/2 bales of coarse wool (i.e. fine wool is very expensive), then Wool growers in both countries will produce only fine wool Between ½ and 3/2 bales of coarse wool Wool growers in Aus. will produce fine wool Wool growers in NZ will produce coarse wool Class 4 Supply Decisions Suppose that Pcoarse = $500/bale If Pfine < $250/bale, (i.e. if the relative price is lower than ½), then no fine wool is supplied to the market If $250/bale < Pfine < $750/bale (i.e. relative price is between ½ and 3/2), then Australia supplies 2m bales to the market If Pfine > $750/bale (i.e. relative price is greater than 3/2) then both countries supply fine wool, for a total supply of 2.5m bales Class 4 The Supply Curve (when Pcoarse = $500/bale) Pfine ($/bale) Qfine (bales) 2m 2.5m $250 $750 Supply Class 4 The Law of Supply Increasing the price of a good tends to increase the quantity of that good supplied to the market Really a result of changes in the relative price of the good Class 4 The Supply Curve Identifies quantity supplied to the market for any given price of the good Derived from the marginal opportunity cost Dollar value of the marginal opportunity cost Marginal opportunity cost * price of the alternative good Supply curve is drawn for: Other goods prices given Technology given Input costs given Class 4 Changing Technology How does the supply curve change if we increase productivity in fine wool production in Australia? Reduces the opportunity cost of production in Australia Also increases the potential fine wool output in Australia Class 4 Australian fine wool productivity improves Fine wool (bales) Coarse wool (bales) 2 m 1.75 m Slope = rise/run = -1/2 0.75 m 2.5 m Slope = rise/run = -3/2 Class 4 Australian Fine Wool Productivity Improves Pfine ($/bale) Qfine (bales) 2m 2.5m $250 $750 Supply Class 4 Improving Technology Reduces marginal opportunity costs Shifts supply curve down/to the right ?Increase in supply? Intuitive: when resources become more productive when employed producing a good, production of that good is more profitable Class 4 Changing Input Prices How does the supply curve change if we increase the cost of inputs into fine wool production? Increases the opportunity cost of production Also reduces the potential fine wool output Class 4 Fine wool input prices increase Fine wool (bales) Coarse wool (bales) 2 m 1.75 m Slope = rise/run = -1/2 0.75 m 2.5 m Slope = rise/run = -3/2 Class 4 Fine wool input prices increase Pfine ($/bale) Qfine (bales) 2m 2.5m $250 $750 Supply Class 4 Increasing input prices Increase marginal opportunity costs Shift supply curve up/to the left ?Reduction in supply? Intuitive: when production becomes more costly, producers will supply less at any price Class 4 Changing Price of the alternative good How does the supply curve change if we increase the price of the alternative good? Doesn?t alter the opportunity cost of production Changes the value of the opportunity cost E.g. if Pcoarse increases to $600/bale Class 4 Increasing price of alternative good Fine wool (bales) Coarse wool (bales) 2 m 1.75 m Slope = rise/run = -1/2 0.75 m 2.5 m Slope = rise/run = -3/2 Class 4 Increasing price of an alternative good Pfine ($/bale) Qfine (bales) 2m 2.5m $250 $750 Supply $300 $900 Class 4 Increasing price of an alternative good Increases the nominal value of the opportunity cost Shifts supply curve up/leftwards ?Reduction in supply? Intuitive: when an alternative good becomes more valuable, producers tend to substitute productive resources toward that good Class 4 Joint PPF The joint PPF tends to be bowed out from the origin Good 1 Good 2 Generic Supply Curve Q1 P1 Supply Class 4 Increasing Supply: Shifting the Supply Curve Right Q1 P1 Improvement in production technology Reduction in input prices Reduction in price of alternative product Class 4 Reducing Supply: Shifting the Supply Curve Left Q1 P1 Deterioration in production technology Increase in input prices Increase in price of alternative product Class 4 What about changes in the price of the good itself? Q1 P1 Class 4 Warning Do not confuse: Increase in quantity supplied as a result of an increase in the price of the good Identified by a movement along the supply curve Increase in supply as a result of an improvement in production technology (for example) The supply curve shifts Class 4 Measuring Benefits to Producers Producers are motivated to maximize the value of their output: E.g. Australian wool growers produce fine wool when the value of the fine wool produced exceeds the value of coarse wool they could produce instead Depends on the relative productivity of resources in production of each good Also depends on the relative prices Class 4 Measuring Benefits to Producers Measure the value of output in dollars Value of the marginal unit is simply the price Compare this to the dollar value of the opportunity cost Read this from the supply curve Marginal unit of the good confers benefit equal to the difference between these two measures Class 4 Producer Surplus Pfine ($/bale) Qfine (bales) 2m 2.5m $250 $750 Supply P =$520 Producer Surplus Class 4 Producer Surplus Q P P* Q* Producer Surplus Class 4 Changes in Producer Surplus Q P P0 Q0 Increase in Producer Surplus P1 Q1 Class 4