Section 3 Changes in Supply

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Objectives

After studying this section you will be able to:

1. Identify how determinants such as input costs create changes in supply.
2. Identify three ways that the government can influence the supply of a good.
3. Understand supply and demand in the global economy.
4. Analyze the effects of other factors that affect supply.

Section Focus

Changes in the costs of inputs can raise or lower the supply of a good at all prices. The number of firms in a market and the price and supply of other goods can also have an effect on the supply of a good.

Key Terms

• subsidy
• excise tax
• regulation

Just as several factors can affect demand at all price levels, a separate set of factors can affect supply. In this section, you will read about these factors that can affect supply, and the factors that shift an entire supply curve to the left or right.

New technology has lowered the costs of production in many markets.

Input Costs

Any change in the cost of an input used to produce a good—such as raw materials, machinery, or labor—will affect supply. A rise in the cost of an input will cause a fall in supply at all price levels because the good has become more expensive to produce. On the other hand, a fall in the cost of an input will cause an increase in supply at all price levels.

Effect of Rising Costs

Think of the effects of input costs on the relationship between marginal revenue (price) and marginal cost. A supplier sets output at the most profitable level, where price is equal to marginal cost. Marginal cost includes the cost of the inputs that go into production, so a rise in the cost of labor or raw materials will translate directly into a higher marginal cost. If the cost of inputs increases enough, the marginal cost may become higher than the price, and the firm may not be as profitable as it could be.

If a firm has no control over the price, the only solution is to cut production and lower marginal cost until marginal cost equals the lower price. Supply falls at each price, and the supply curve shifts to the left, as illustrated in Figure 5.12.

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