All about Supply

MGEC Lecture 3

2023-24

MGEC Lecture-3 2023-24

The most famous picture in Economics

MGEC Lecture-3 2023-24

The supply curve

▶ as the price of a good goes up, its quantity supplied increases

MGEC Lecture-3 2023-24

The supply curve

▶ as the price of a good goes up, its quantity supplied increases

MGEC Lecture-3 2023-24

Short run production
Production with one variable input

MGEC Lecture-3 2023-24

From production to costs

AP: Averege Product, MP: Marginal Product, AVC: Average Variable cost, MC: Marginal cost

MGEC Lecture-3 2023-24

From production to costs
Adding in fixed costs

MGEC Lecture-3 2023-24

Relationship between MC and AC

▶ If MC < AC , AC is falling
▶ If MC > AC , AC is rising
▶ MC = AC at minimum AC

MGEC Lecture-3 2023-24

Why is the firm’s supply curve upward sloping

▶ The MC curve is the supply curve.

▶ MC of each successive unit is greater than the last one ⇒ Each
successive unit must be sold at a higher price to cover the higher cost
of production ⇒ upward sloping supply curve.

MGEC Lecture-3 2023-24

Why is the firm’s supply curve upward sloping

▶ Firms always produce in the region where MC is increasing, and above

the AVC.
▶ Why?
▶ At any quantity q where MC is decreasing or below AVC:
▶ the firm can decrease its average cost by producing more.
▶ therefore, not an efficient use of resources.

MGEC Lecture-3 2023-24

Why is the firm’s supply curve upward sloping

▶ Firms always produce in the region where MC is increasing, and above

the AVC.
▶ Why?
▶ At any quantity q where MC is decreasing or below AVC:
▶ the firm can decrease its average cost by producing more.
▶ therefore, not an efficient use of resources.

MGEC Lecture-3 2023-24

The supply curve

MGEC Lecture-3 2023-24

The supply curve
Tabular representation

P Q = S(P)
30 0
35 10
40 20
45 30

Q = S(P) = 2P - 60

MGEC Lecture-3 2023-24

Market Supply Curve

▶ Similar to market demand, we can derive a market supply curve.

MGEC Lecture-3 2023-24

Shifts in Supply Curve

▶ A supply curve is relevant only for a certain level of technology and

price of inputs (and everything else constant).
▶ At a different level of technology and the price of inputs, we obtain a
different supply schedule.

MGEC Lecture-3 2023-24

Supply Curve Shifts

How does it shift when input price increases?

MGEC Lecture-3 2023-24

Supply Curve Shifts
How does it shift when input price increases?

MGEC Lecture-3 2023-24

Supply Curve Shifts

How does it shift when technology gets better?

Marginal cost goes down, so the supply curve shifts right.

MGEC Lecture-3 2023-24

Shifts supply curve

What might be potential reasons for the supply curve to shift?

▶ change in input costs
▶ technological changes
▶ change in number of suppliers
▶ resource allocation towards other goods (change in opportunity costs)
▶ expectations about future prices

MGEC Lecture-3 2023-24

Shifts supply curve

What might be potential reasons for the supply curve to shift?

▶ change in input costs
▶ technological changes
▶ change in number of suppliers
▶ resource allocation towards other goods (change in opportunity costs)
▶ expectations about future prices

MGEC Lecture-3 2023-24

Elasticity of supply
Mathematically speaking

▶ Elasticity is the % change in quantity supplied due to a % change in

price

∆Q
▶ ϵs = % Change in quantity supplied Q
% Change in price = ∆P
P

▶ Elasticity ̸=Slope of supply curve

MGEC Lecture-3 2023-24

Elasticity of supply
Supply is more elastic if...

▶ Easy to increase production without increasing the per unit cost

▶ Small share of market for inputs

▶ Local supply (as opposed to global)

▶ Long run
▶ There are capacity constraints for firms in the short run which may
prevent them from responding to price changes!
▶ But these constraints could disappear in the longer run

▶ Ultimately, boils down to how much costs increase while increasing

production.

MGEC Lecture-3 2023-24

Producer Surplus

▶ We defined consumer surplus (CS) earlier.

▶ Is there an equivalent for producers? How do we define it?

MGEC Lecture-3 2023-24

Producer Surplus

MGEC Lecture-3 2023-24

Producer Surplus

▶ It is the area below the price and above the supply cure.

MGEC Lecture-3 2023-24

Total surplus

MGEC Lecture-3 2023-24

Bring back the demand curve...

MGEC Lecture-3 2023-24

Putting Demand and Supply Together

MGEC Lecture-3 2023-24

Excess Demand

▶ Excess Demand: At the prevailing price, quantity demanded is greater

than quantity supplied.
▶ What happens when there is excess demand?
▶ There is upward pressure on prices

MGEC Lecture-3 2023-24

Putting Demand and Supply Together

MGEC Lecture-3 2023-24

Excess Supply

▶ Excess Supply: At the prevailing price, quantity supplied is greater

than quantity demanded.
▶ What happens when there is excess supply?
▶ There is downward pressure on prices.

MGEC Lecture-3 2023-24

The Invisible Hand

Consider an “invisible hand” whose job is to keep adjusting the trading

price. The hand
▶ ‘pushes down’ prices when there is ‘excess supply’
▶ ‘pushes up’ prices when there is ‘excess demand’

MGEC Lecture-3 2023-24

Equilibrium dynamics

MGEC Lecture-3 2023-24

No excess supply or excess demand

▶ What happens now?

▶ Nothing, and this is the equilibrium.

MGEC Lecture-3 2023-24

No excess supply or excess demand

▶ What happens now?

▶ Nothing, and this is the equilibrium.

MGEC Lecture-3 2023-24

Equilibrium

MGEC Lecture-3 2023-24

Shifts in demand and supply curves

MGEC Lecture-3 2023-24

Shifts in demand and supply curves

▶ Think back to the coconuts article.

▶ What’s behind the recent increase in the price of coconut oil?

MGEC Lecture-3 2023-24

Simultaneous shifts in demand and supply curves

▶ An increase in demand for coconut oil and a decrease in supply of

mature coconuts for production of oil, simultaneously.
▶ The impact on equilibrium price and quantity is no longer
straightforward, and depends on the relative change in demand and
supply.

MGEC Lecture-3 2023-24

Simultaneous shifts in demand and supply curves

Supply Supply
Increases Decreases
Demand Price: Price: up
Increases ambiguous Quantity:
Quantity: ambiguous
up
Demand Price: down Price:
Decreases Quantity: ambiguous
ambiguous Quantity:
down

MGEC Lecture-3 2023-24

Surge pricing in Uber

▶ Variation in demand for rides on Uber, both over time and space
▶ Similarly, variation in supply of rides, both over time and space
▶ Mismatch (excess supply/demand) will cause dissatisfaction, both
among riders and drivers.
▶ How does Uber solve excess supply/excess demand situations?

MGEC Lecture-3 2023-24

Surge pricing in Uber

▶ Uber takes microeconomics very seriously!

▶ Surge pricing
▶ Using price as an instrument for matching demand and supply
▶ Ensures the correct surge increase will be just sufficient to match
demand and supply

MGEC Lecture-3 2023-24

Demand for Uber spikes following sold-out concert

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”

MGEC Lecture-3 2023-24

Uber driver partner supply increases to match spike in
demand

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”
MGEC Lecture-3 2023-24
Vital signs of surge pricing in action on March 21, 2015

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”

MGEC Lecture-3 2023-24

Demand for Uber spikes - NYE 2015

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”

MGEC Lecture-3 2023-24

Completion rates - NYE 2015

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”

MGEC Lecture-3 2023-24

Vital signs without surge pricing - NYE 2015

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Source: Hall, Kendrick, and Nosoko (2015) “The Effects of Uber’s Surge Pricing: A Case Study”

MGEC Lecture-3 2023-24

Unpacking what happened

MGEC Lecture-3 2023-24

Unpacking what happened

MGEC Lecture-3 2023-24

Unpacking what happened

MGEC Lecture-3 2023-24

Unpacking what happened

MGEC Lecture-3 2023-24

Unpacking what happened

MGEC Lecture-3 2023-24

The magic of markets

▶ Market prices determined by the interaction of buyers and suppliers

▶ Prices reflect the value of a good to consumers
▶ Prices reflect the cost to society of making that good
▶ In this way, the price acts as a signal telling the producers what to
produce and how much of the good to produce.
▶ So that nothing is wasted (or) All that is produced is consumed.

MGEC Lecture-3 2023-24

Recap

▶ After a point, the marginal product of a variable factor decreases:

▶ Marginal cost of production increases
▶ Supply curve is upward sloping
▶ Supply curve may shift due to changes in input costs, technology,
number of suppliers, and expectations.
▶ Producer surplus is the net benefits to producers from transactions.
▶ Prices move to equate quantity demanded with quantity supplied.

MGEC Lecture-3 2023-24

Practice Problem 1

A survey indicated that chocolate is the most popular ice cream flavor. For
each of the following, indicate the possible effects on demand, supply, or
both as well as equilibrium price and quantity of chocolate ice cream.
▶ A severe drought causes dairy farmers to reduce the number of
milk-producing cattle in their herds by a third. These dairy farmers
supply cream that is used to manufacture chocolate ice cream.
▶ Latest research suggests that chocolate does, in fact, have significant
health benefits.
▶ The discovery of cheaper synthetic vanilla flavoring lowers the price of
vanilla ice cream.
▶ New technology for mixing and freezing ice cream lowers
manufacturers’ costs of producing chocolate ice cream.

MGEC Lecture-3 2023-24

Practice Problem 2

Consider a market where supply and demand are given as the following:
Demand Curve: QD = 20 − 2P Supply Curve: QS = 2P
▶ Calculate the market equilibrium price and quantity
▶ Calculate the consumer surplus at equilibrium
▶ Calculate the producer surplus at equilibrium

MGEC Lecture-3 2023-24