Economies Markets and

Decision Making in
International Contexts
Professor David Pickernell
Topic 5 : Supply Theory

University of South Wales

some key terms

Market
a set of arrangements by which buyers and sellers
are in contact to exchange goods or services

Supply
the quantity of a good sellers wish to sell at each
conceivable price

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1.2

Price

the supply curve shows the relation

between price and quantity supplied
holding other things constant

Quantity

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Other things
include:
input costs
(factors of
production
Prices of related
good
technology change
government
regulations
Changes in these
other things affect
the position of the
1.3
3

a shift in supply
S1

Suppose wages rise,

increasing producers costs

Price

S0

The supply curve

shifts to S1S1

P0
S1
S0
Q0
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Quantity
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1.4

Price Elasticity of Supply

Meaning of price elasticity of supply
PES = % Change in Quantity Supplied

% Change in Price

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1.5

Price Elasticity of Supply

Measuring price elasticity of supply
%QS / %P
elastic and inelastic supply

Determinants of price elasticity of supply

amount that costs rise as output increases
time period

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1.6

Price

market equilibrium

D0

P0

E0

D0
Q0

Quantity

Market equilibrium is
at E0 where quantity
demanded equals
quantity supplied
with price P0 and
quantity Q0
6

Price

a shift in demand
D1

If the price of a substitute

good increases ...

D0

P1

more will be demanded at

each price

E1

P0

E0

The demand curve shifts

from D0D0 to D1D1.
D0

Q0 Q1

D1

Quantity

The market moves to a

new equilibrium at E1.

a shift in supply
S1

Price

S0
D
E2

The supply curve

shifts to S1S1

P1
P0

Suppose safety
regulations are tightened,
increasing producers costs

E0
If price stayed at P0 there
would be excess demand

S1
S0

D
Q1 Q0

Quantity

So the market moves to a

new equilibrium at E2.

the production function

The amount of output produced depends
upon the inputs used in the production
process
A factor of production (input) is any good
or service used to produce output
The production function specifies the
maximum output which can be produced
given inputs
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1.10

short run vs. long run

The short run is the period in which a
firm can make only partial adjustment of
inputs

e.g. the firm may be able to vary the amount

of labour, but cannot change capital.

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The long run is the period in which a firm

can adjust all inputs to changed
conditions.
The long-run total cost curve describes
the minimum cost of producing each
output level when the firm is free to vary
1.11
all input levels.
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the law of diminishing

returns
Holding all factors constant except one, the
law of diminishing returns says that:
beyond some value of the variable input,
further increases in the variable input lead
to steadily decreasing marginal product of
that input.
e.g. trying to increase labour input without also
increasing capital will bring diminishing returns.

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1.12

the marginal product of labour

The marginal product of labour is the increase in output
obtained by adding 1 unit of the variable factor but
holding constant the inputs of all other factors.
Labour is often assumed to be the variable factor
with capital fixed.

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1.13

the short run

Fixed factor of production
a factor whose input level cannot be varied

Fixed costs
costs that do not vary with output levels

Variable costs
costs that do vary with output levels

STC = SFC + SVC

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1.14

Short-run Costs
Average and marginal cost
marginal cost (MC) and the law of diminishing returns
relationship between MC and TC curves
average fixed cost (AFC)
average variable cost (AVC)
average (total) cost (AC)
relationship between AC and MC

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1.15

Average and marginal costs

MC

AC

Costs ()

AVC

z
y
x
AFC

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Output (Q)

16

1.16

short run vs. long run

The short run is the period in which a
firm can make only partial adjustment of
inputs

e.g. the firm may be able to vary the amount

of labour, but cannot change capital.

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The long run is the period in which a firm

can adjust all inputs to changed
conditions.
The long-run total cost curve describes
the minimum cost of producing each
output level when the firm is free to vary
1.17
all input levels.
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Average cost

the long-run average cost curve

LAC

SATC2

SATC1

SATC4
SATC3

Each plant size

is designed for
LAC a given output
level

So there is a
sequence of SATC
curves, each
corresponding to
a different optimal
Output
In the long-run, plant size itself is variable, output level.
and the long-run average cost curve LAC is
found to be the envelope of the SATCs

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1.18

long-run costs
The average cost of production is total cost
divided by the level of output.

Average cost

Long-run average cost (LAC) is often assumed

to be U-shaped:
LAC

Output
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1.19

economies of scale

Average cost

Economies of scale or increasing returns to

scale occur when long-run average costs
decline as output rises:

LAC
Output
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1.20

decreasing returns to scale

Average cost

occur when long-run average costs rise

as output rises:

LAC

Output
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1.21

constant returns to scale

Average cost

occur when long-run average costs are

constant as output rises:

LAC

Output
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1.22

Topic 6 : Tasks
Task 1 The production function
Task 2 Low cost strategy
Task 3 The business model