ECON CH 5-1

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ECON CH 5-1

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Review the vocabulary words for this section. Look for them as we work through this section. You will be tested on them later

The law of supply predicts that higher prices lead to more production.

If you were running a business, what would you do if you discovered that customers were suddenly willing to pay twice as much for your product? If you were like most entrepreneurs, you would try to produce more in order to take advantage of the higher prices. Even if you used the higher prices as a way to work fewer hours while earning the same income, you could be sure that someone else would jump into the market and start selling the same good.

The Law of Supply
Supply is the amount of goods available.
How do producers decide how much to
supply? According to the law of supply, the
higher the price, the larger the quantity
produced. Economists use the term quantity
supplied to describe how much of a good is
offered for sale at a specific price.

The law of supply develops from the
choices of both current and new
producers of a good. As the price of a
good rises, existing firms will produce
more in order to earn additional revenue.

At the same time, new firms will have an
incentive to enter the market to earn a
profit for themselves. If the price of a good
falls, some firms will produce less, and
others might drop out of the market. These two movements—individual firms
changing their level of production and
firms entering or exiting the market—
combine to create the law of supply.

What does the law of supply predict?

a.	higher prices will lead to less production	c.	more supply will lead to higher prices
b.	higher prices will lead to more production	d.	supply has no effect on production or demand

How is the law of supply different from the law of demand?

a.	An increase in price equals an increase in supply and a decrease in demand	c.	A decrease in price equals an increase in supply and a decrease in demand
b.	An increase price equals a decrease in supply and demand	d.	There is no difference in the law of supply and demand

What term do economists use to describe how much of a good is offered for sale at a specific price?

a.	price ratio	c.	quantity demanded
b.	price demanded	d.	quantity supplied

Why do firms produce more when prices rise?

a.	They want to share their wealth	c.	They want to earn more money
b.	They want to make prices fall	d.	They do not want to overproduce

Higher Production

If a firm is already earning a profit by
selling a good, then an increase in the
price—ceteris paribus—will increase the firm’s profits. The promise of higher revenues for each sale also encourages the firm to produce more. Consider the pizzeria you read about in Chapter 4. The pizzeria is probably making a reasonable profit by selling a certain number of slices a day at the market price. If the pizzeria weren’t making a profit, the owner would soon try to raise the price or switch from pizzas to something more profitable.

If the price of pizza rises, but the firm’s cost of making pizza stays the same, then the pizzeria will earn a higher profit on each slice of pizza. A sensible entrepreneur would try to produce and sell more pizza to take advantage of the higher prices.

Similarly, if the price of pizza goes down, the pizzeria will earn less profit per slice or even lose money. The owner will choose to sell less pizza and produce something else, such as calzones or sandwiches, that will yield more profit.

In both cases, the search for profit drives the supplier’s decision. When the price goes up, the supplier recognizes the chance to make more money and works harder to produce more pizza. When the price falls, the same entrepreneur is discouraged from producing as much as before.

If a company were selling a product and suddenly the price of the product increased, what action would the company likely take?

a.	They would decrease supply to increase demand	c.	They would produce less of the product (decrease supply)
b.	They would produce more to lower the price	d.	They would produce more of the product (increase supply)

What motivation drives the behavior of business persons?

a.	taking less risk	c.	making more money
b.	taking more risk	d.	increasing price

Market Entry
Profits appeal both to producers already in
the market and people who may decide to
join the market. As you have seen, when
the price of pizza rises, a pizzeria stands out
as a good opportunity to make money. If
you were considering opening a restaurant
of your own, a pizzeria would look like a
safe bet. In this way, rising prices draw new
firms into a market and add to the quantity
supplied of the good.

Consider the market for music. In the
late 1970s, disco music became popular
among young people. The music industry
quickly recognized the popularity of disco,
and more and more groups began releasing
disco recordings. Even some groups that
once performed soul music and rhythm
and blues chose to record disco albums.
New entrants crowded the market to take
advantage of the potential for profit. Disco,
however, proved to be a short-lived fad. By
the early 1980s, disco music was gone from
the radio, and stores couldn’t sell the
albums on their shelves.

This pattern of sharp increases and
decreases in supply occurs again and again
in the music industry. In the early 1990s,
“grunge” music emerged from Seattle to
become widely popular among high school
and college students across the country.
How did the market react? Record labels
soon hired many grunge groups. Music
stores devoted more and more space to this
style of music. Within a few years,
however, grunge lost its appeal, and many
groups disbanded or moved on to new
styles. Other styles of music, such as salsa,
achieved new popularity.

In each of the examples above, many
musicians joined the market for a particular
style of music to profit from a trend.
Their actions reflected the law of supply,
which says that the output or quantity
supplied of a good increases as the price of
the good increases.

Grunge Fashion

You are a young man who has some money and is thinking about starting a business in sporting goods. You notice that there has been a sharp decline in the prices of bogy boards and skate boards, while the price of surf boards has remained about the same. You also notice that there has been a rise in the price of snow boards over the past year. Since your goal is to make lots of profits, which item are your likely to feature in your new sporting goods store?

a.	bogy boards	c.	snow boards
b.	surf boards	d.	skate boards

In the discussion above, what do we learn about music?

a.	Young people can’t make up their minds about the type of music they like.	c.	Musicians tend to play the most popular form of music because like any other business person they want to make money
b.	It is better to become a classical musician because classical music is always with us.	d.	Hip Hop, Disco, Grunge, Rap, Rhythm and Blues, and Heavy Metal are not good forms of music because their popularity does not last

This supply schedule lists how many slices of pizza one pizzeria will offer at different prices.

The Supply Schedule
Similar to a demand schedule, a supply
schedule shows the relationship between
price and quantity supplied for a specific
good. The pizzeria discussed earlier might
have a supply schedule that looks like the
one in Figure 5.2. This table compares two
variables, or factors that can change. These
variables are the price of a slice and the
number of slices supplied by a pizzeria. We
could collect this information by asking the
pizzeria owner how many slices she is
willing and able to make at different prices,
or we could look at records to see how the
quantity supplied has varied as the price
has changed. We will almost certainly find
that at higher prices, the pizzeria owner is
willing to make more pizza. At a lower
price she prefers to make less pizza and to
devote her limited resources to other, more
profitable, items.

Like a demand schedule, a supply
schedule lists supply for a very specific set
of conditions. The schedule shows how the
price of pizza, and only the price of pizza,
affects the pizzeria’s output. All of the other
factors that could change the restaurant’s
output decisions, such as the costs of tomato sauce, labor, and rent, are assumed
to remain constant.

10.

What does this chart tell you about the pizzeria owner’s decisions?

a.	He will produce more slices as the price increases.	c.	He will make the same amount of money no matter what the price is
b.	He will produce fewer slices as the price increases	d.	Pizza restaurant owners are not good business people

11.

Many factors can influence the supply of pizza. The supply schedule shows only one factor. What is it?

a.	cost of tomato sauce	c.	rent
b.	labor	d.	price of pizza

A Change in the Quantity Supplied
Economists use the word supply to refer to
the relationship between price and quantity
supplied, as shown in the supply schedule.
The pizzeria’s supply of pizza includes all
possible combinations of price and output.
According to this supply schedule, the
pizzeria’s supply is 100 slices at $ .50 a
slice, 150 slices at $1.00 a slice, 200 slices
at $1.50 a slice, and so on. The number of
slices that the pizzeria offers at a specific
price is called the quantity supplied at that
price. At $2.50 per slice, the pizzeria’s
quantity supplied is 300 slices per day.

A rise or fall in the price of pizza will
cause the quantity supplied to change, but
not the supply schedule. In other words, a
change in a good’s price moves the seller
from one row to another in the same
supply schedule, but does not change the
supply schedule itself. When a factor other
than the price of pizza affects output, we
have to build a whole new supply schedule
for the new market conditions.

12.

What do we call the number of slices of pizza at a specific price?

a.	supply demanded	c.	quantity demanded
b.	quantity supplied	d.	ratio of price to demand

13.

What does the economist have to do when a factor other than the price of pizza affects output?

a.	go back and rely on demand	c.	nothing can affect supply other than price
b.	build a new supply schedule for the new condition	d.	divide the price by the supply times 100 and create a new schedule

A market supply schedule represents all suppliers in a market.

Market Supply Schedule
All of the supply schedules of individual
firms in a market can be added up to create
a market supply schedule. A market supply
schedule shows the relationship between
prices and the total quantity supplied by all firms in a particular market. The information
in a market supply schedule becomes
important when we want to determine the
total supply of pizza at a certain price in a
large area, like a city.

The market supply schedule for pizza
resembles the supply schedule at a single
pizzeria, but the quantities are much larger.
Figure 5.3 shows the supply of pizza for a
hypothetical city.

This market supply schedule lists the
same prices as those in the supply schedule
for the single pizzeria, since all restaurants
will charge prices within the same range.
The quantities supplied are much larger
because there are many pizzerias in the
community. Like the individual supply
schedule, this market supply schedule
reflects the law of supply. Pizzerias supply
more pizza at higher prices.

14.

In figure 5.2 you saw the supply schedule for an individual pizzeria, such as Little Caesar’s. What if you wanted to create a supply schedule for all of the Little Caesar’s in San Diego? What would we call that new supply schedule for an entire city?

a.	market supply schedule	c.	supply vs price schedule
b.	supply schedule	d.	demand schedule

15.

In figure 5.2 you saw the supply schedule for an individual pizzeria, such as Little Caesar’s. What if you wanted to create a supply schedule for all of the Little Caesar’s in San Diego? How would this new supply schedule for a city differ from an individual Little Caesar’s store?

a.	The quantities supplied would be much larger	c.	The prices would be much larger
b.	The quantities demanded would be much larger	d.	The prices would be much smaller

Supply curves always rise from left to right, as predicted by the law of supply. As price increases, so does the quantity supplied.

The Supply Graph

When the data points in the supply
schedule are graphed, they create a supply
curve. A supply curve is very similar to a
demand curve, except that the horizontal
axis now measures the quantity of the good
supplied, not the quantity demanded.
Figure 5.4 shows a supply curve for one
pizzeria and a market supply curve for all the pizzerias in the city. The data used to draw the two curves are from the supply schedules in Figures 5.2 and 5.3. The prices

shown along the vertical axes are the same
in both graphs. However, the quantities of
pizza supplied at each price are much larger
in the market supply curve.

The key feature of the supply curve is
that it always rises from left to right. As
your finger traces the curve from left to
right, it moves toward higher and higher
output levels (on the horizontal axis) and
higher and higher prices (on the vertical
axis). This illustrates the law of supply,
which says that a higher price leads to
higher output.

16.

Why do supply curves always rise from left to right.

a.	because price and quantity supplied rise together	c.	because supply and demand fall together
b.	because price rises while supplies fall	d.	because supplies rise while price falls

17.

In a supply curve the horizontal axis measures _____ while in a demand curve the horizontal axis measures _____ .

a.	supply - supply	c.	supply - demand
b.	demand - demand	d.	demand - supply

Supply and Elasticity
In Chapter 4, you learned that elasticity of
demand measures how consumers will
react to a change in price. Elasticity of supply is based on the same concept. Elasticity of supply is a measure of the way suppliers respond to a change in price.

Elasticity of supply tells how firms will respond to changes in the price of a good. The labels elastic, inelastic, and unitary elastic represent the same values of elasticity of supply as those of elasticity of demand.

When elasticity is greater than one, supply is very sensitive to changes in price and is considered elastic. If supply is not very responsive to changes in price, and elasticity is less than one, supply is considered inelastic. When a percentage change in price is perfectly matched by an equal percentage change in quantity supplied, elasticity is exactly one, and supply is unitary elastic.

18.

What does elasticity of supply measure?

a.	how suppliers respond to a change in demand	c.	how demand affects price
b.	how suppliers respond to a change in price	d.	how consumers react to a change in supply

19.

Elastic, inelastic, and unitary elastic represent the same values of elasticity of supply as those of elasticity of demand.

true

false

20.

When a percentage change in price is perfectly matched by an equal percentage change in quantity supplied, elasticity is exactly one and supply is

a.	unitary elastic	c.	inelastic
b.	elastic

21.

If supply is not very responsive to changes in price, and elasticity is less than one, supply is considered

a.	elastic	c.	unitary elastic
b.	inelastic

22.

When elasticity is greater than one, supply is very sensitive to changes in price and is considered

a.	elastic	c.	unitary elastic
b.	inelastic

Elasticity of Supply and Time
What determines whether the supply of a good will be elastic or inelastic? The key factor is time. In the short run, a firm cannot easily change its output level, so supply is inelastic. In the long run, firms are more flexible, so supply is more elastic.

Elasticity of Supply in the Short Run
An orange grove is one example of a
business that has difficulty adjusting to a
change in price in the short term. Orange
trees take several years to mature and grow fruit. If the price of oranges goes up, an
orange grower can buy and plant more
trees, but he will have to wait several years
for his investment to pay off. In the short
term, the grower could take smaller steps
to increase output. For example, he could
use a more effective pesticide. While this
step might increase his output somewhat, it
would probably not increase the number of
oranges by very much. Economists would
say that his supply is inelastic, because he
cannot easily change his output. The same
factors that prevent the owner of the
orange grove from expanding his supply
will also prevent new growers from
entering the market and supplying oranges
in the short term.

In the short run, supply is inelastic
whether the price increases or decreases. If
the price of a crate of oranges falls, the
grove owner has few ways to cut his supply.
He invested years ago in land and trees, and
his grove will provide oranges no matter
what the price is. Even if the price drops
drastically, the grove owner will probably
pick and sell nearly as many oranges as
before. The grove owner’s competitors have
also invested heavily in land and trees and
won’t drop out of the market if they can
survive. In this case, supply is inelastic
whether prices rise or fall.

While orange groves illustrate a business
in which supply is inelastic, other businesses
benefit from more elastic supply.
For example, a business that provides a
service, such as a haircut, is highly elastic.
Unlike oranges, the supply of haircuts is
easily expanded or reduced. If the price
rises, barber shops and salons can hire
workers quickly.

In addition, new barber shops and
salons will open, and existing businesses
might stay open later in the evening. This
means that a small increase in price will cause a large increase in quantity supplied,
even in the short term.

If the price of a haircut drops, some
barbers will close their shops earlier in the
day, and others will leave the market for
jobs elsewhere. Quantity supplied will fall
quickly. Because haircut suppliers can
quickly change their operations, the supply
of haircuts is elastic.

23.

What is the key factor that determines if the supply of a good will be elastic or inelastic?

a.	supply	c.	time
b.	demand	d.	substitutes

24.

Because companies can’t easily change production quickly, supply is

a.	elastic	c.	varied
b.	inelastic	d.	costly

25.

When companies have more time to change production, supply becomes more

a.	elastic	c.	plentiful
b.	inelastic	d.	costly

26.

In the short run, automobile factories tend to be _____ while donut shops tend to be _____ .

a.	inelastic - elastic	c.	inelastic - inelastic
b.	elastic -inelastic	d.	elastic - elastic

Elasticity in the Long Run
Like demand, supply can become more
elastic over time. Consider the example of
the orange grower who could not increase
his output much when the price of oranges
rose. Over time, he could plant more trees
to increase his supply of oranges. These
changes will become more effective over
time as trees grow and bear fruit. After
several years, he will be able to sell many
more oranges at the high market price.

If the price drops and stays low for
several years, orange growers who survived
the first two or three years of losses might
decide to give up and grow something else.
Given five years to respond instead of six
weeks, the supply of oranges will be far
more elastic. Just like demand, supply
becomes more elastic if the supplier has a
long time to respond to a price change.

27.

When companies have enough time to change their production demand and supply can become

a.	inelastic	c.	more costly
b.	elastic	d.	more scarce

28.

If supply is inelastic, how will supply react to a small increase in price?

a.	there will be a big change in supply	c.	supply will change but very little
b.	supply will not change at all	d.	price has no effect on supply

29.

Which two actions, taken by firms comprise the law of supply? (pick 2)

a.	new firms entering the market to take advantage of higher prices paid	c.	firms cut back on production to save money
b.	firms increasing supply to maximize profits	d.	new firms going out of business

a.	quantity supplied	f.	variable
b.	market supply schedule	g.	market supply curve
c.	supply	h.	supply schedule
d.	elasticity of supply	i.	supply curve
e.	law of supply

30.

a chart that lists how much of a good a supplier will offer at different prices

31.

the amount a supplier is willing and able to supply at a certain price

32.

a graph of the quantity supplied of a good by all suppliers at different prices

33.

the amount of goods available

34.

a measure of the way quantity supplied reacts to a change in price

35.

tendency of suppliers to offer more of a good at a higher price

36.

a graph of the quantity supplied of a good at different prices

37.

a factor that can change

38.

a chart that lists how much of a good all suppliers will offer at different prices