Lectures in Economics 5

Lectures following Rüdiger Dornbusch’ works (5)

At a higher equilibrium point there is a higher price and a greater quantity of fish sold. We can use Table 3-2 just as easily as Figure 3-5 to find the new equilibrium price of fish. We note that at the old equilibrium price of $3 there is now an excess demand, but at a price of $4, the quantity demanded (30 million pounds) is equal to the quantity supplied at that price. Hence from the table the new equilibrium price is $4, and the new equilibrium quantity of fish consumed is 30 million pounds, as we can also see from Figure 3-5.

The final result of a rise in the price of beef is an increase in the price of fish. Consumers do succeed to some extent in replacing the more expensive beef with fish-the total quantity of fish bought does go up but in doing so, they make fish more expensive. Under these circumstances, consumers feel that the world is against them. All foods will go up in price when the beef price rises, and there is a feeling that there is nowhere to turn for cheap food. That is actually what happens-and by using supply and demand analysis we can understand the reasons.
In the problems section we ask you to show how changes in income and an increase in the price of a complement affect the demand for a good and then how the change in demand in turn affects the equilibrium price and quantity.

6 BEHIND THE SUPPLY CURVE
In this section we will first explain the upward slope of the supply curve and the factors that are held constant in drawing it. Then we will show how changes in those factors shift the supply curve.
The supply curve shows the quantity of fish supplied rising as the price rises. The curve slopes upward because more resources have to be drawn into fishing in order to increase the quantity supplied. Fishermen have to work longer hours and will have to be rewarded for doing so by receiving overtime pay or higher wages. The firms in the industry will be able to pay these higher wages only if the price received for fish is higher. Or maybe more workers have to be attracted into the industry, and the wages paid in the industry have to rise. Again, firms will be able to pay higher wages only if prices are higher. Or perhaps the machinery used in the industry has to be worked harder, breaks down more often, and needs more maintenance. All these factors explain why the supply curve has an upward slope.

Shifts of the Supply Curve
In drawing a demand curve, we hold constant the prices of related goods, income, and tastes. On the supply side, too, there are three relevant factors affecting supply behavior. They are the technology of the firm; the costs of using the factors of production (machinery, labor, fuel, etc.), or input costs for short; and government regulation and taxation. A change in any of these leads to a shift of the supply curve-that is, a change in the quantity supplied at each price.

Technology
The supply schedule is drawn for a given technology. Therefore, changes in technology shift the supply schedule. Specifically, if technology improves, firms will be willing to supply a larger quantity of output at each price level. For example, the introduction of new sonar equipment makes it easier to track fish and therefore increases the catch a given boat can make per week. At each price of fish, firms will be willing to sell more fish, since a given crew and boat will be more productive in bringing in fish. Another improvement in technology that we can think of is the introduction of motherships to supply the individual boats in a fleet with maintenance and process the catch. This change makes it unnecessary for boats to return to the harbor every time a catch has been made or every time there is mechanical trouble.The improvement implies reduced costs or an increased quantity of supply.

FIGURE 3-6 EFFECTS OF AN INCREASE IN THE PRICE OF FUEL ON THE FISH MARKET.

The supply schedule in the cost of fuel raises production costs in fishing industry and therefore leads to a decline of fish supply. At each higher price the quantity of fish firms are willing to supply declines.The supply schedule shifts to SS’. At the initial equilibrium price there is now an excess demand. The equilibrium price rises.

Technology
Technology as one of the determinants of the quantity of supply must be understood very broadly.In agriculture, for example, it includes techniques and seeds.The invention of new seeds that are less vulnerable to disease orthe weather would clearly be an innovation that increases the quantity supplied at each price. So is the improvement of weather forecasting techniques that make it possible to achieve better timing of harvests or planting.

In industry, too, there is room for changes in technology to affect supply.The invention of robots and their use in the automobile industry to replace more expensive and less reliable human workers leads to cost reductions and quality improvements. These in turn make it possible for firms to increase the quantity supplied at each price.

Input Costs
Input costs are the second determinant of the supply schedule.The supply schedule is drawn for given prices of the inputs (machinery,land,labor) . The inputs affect production costs and therefore the quantity of output firms are willing to supply
at each price. Specifically,an increase in input prices will reduce the quantity of output of the fishing industry at each price. The higher wages will cause the prices shift the supply schedule to the right. The supply curve for fish reshifts when other input costs increase resulting from an increase in the price of fuel.Because fuel costs more, firms will only bring a given quantity to the market.

Government
The third determinant is government regulation. The supply curve shifts under the impact of government regulation.

Government may require to use expensive , nonpolluting equipment rather than less expensive, polluting machinery. As a result, the supply curve will shift to the left.
The scope for regulation to affect supply behavior is very wide. Safety regulations, for example, restrict the technology firms can use or require a minimum number of workers to perform a given task. Government regulations restricting less expensive and possibly more dangerous ways of producing will tend to raise the firms’ costs. Therefore, they will reduce the quantity of output firms are willing to supply at each price. In other words, to supply a given quantity of output, firms subject to restrictions and regulations will require a higher price. Thus regulation will tend to shift the supply schedule to the left.

The government also affects supply behavior through taxes and subsidies. If the government, for example, subsidizes producers by paying them a given amount per unit of output produced, this will have the effect of increasing the quantity supplied in the market at each price. Since the government is paying firms to produce, the firms are willing to sell more at each price, and the supply schedule shifts to the right. On the other hand, if the government imposes a tax on producers of certain goods-for example, cigarettes-then the producers will sell less at each price, since they now have to turn over to the government part of their receipts. Government regulation and taxation have a very important role in the operation of many markets in the U.S. economy. This is the case in agriculture and also in industry.

Other Determinants
On both the demand side and the supply side we have identified three factors that are held constant along a given schedule: the prices of related goods, income, and tastes on the demand side and input prices, technology, and government on the supply side.

These are the main factors included in the “other things being equal” category. But in any particular market there may be other relevant factors that are being held constant when the demand and supply curves are drawn. For instance, the weather affects the demand curve for umbrellas. In a rainy winter, the demand curve for umbrellas shifts to the right. The weather also affects supply curves. Other things being equal, bad weather shifts the supply curve of agricultural goods to the left, reducing the quantity supplied at each price.

In studying any particular market we isolate the factors that, in that market, may cause the supply and demand curves to shift. The factors we have mentioned are crucial in almost all markets.

The Effects of Shifts of the Supply Curve

We will now use demand and supply curves to study the effects of shifts of the supply curve on equilibrium price and quantity. The shifts result from changes in input prices or changes in technology. Suppose an increase in the cost of fuel used for fishing boats increases the costs of fishing and shifts the supply curve from SS to SS ‘ in Figure 3-6. The equilibrium in the fish market moves from E to E ‘. The price rises from Pa to P1, and the equilibrium quantity falls from Q o to Q,.4 Thus an increase in the price
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4 Note that Figure 3-6 is different from the earlier diagrams in this chapter in that we have not put the units on the vertical and horizontal axes. The reason is that we want only to ask whether a shift in supply caused by a cost increase increases or decreases the equilibrium quantity and price. We do not need to know the exact numbers that apply at E and E ‘. It is enough to call the prices Po and P, and to know that the price rises-we can see that P, is greater than Po. Similarly, we call the quantities Qo and Q” and we are not interested in the exact size of Qo and Q, . All we really need to know is that Q, is less than Qo, implying that an upward shift in the supply curve reduces the equilibrium quantity. It is not necessary for answering most of the interesting questions to put numerical values on the axes. Usually we want only to know whether some price or quantity goes up or down when there is a change.

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