Appendix C
Show Me the Money
Copyright © 2011 Pearson Canada Inc.
Show Me the Money
The Law of Supply
LEARNING OBJECTIVES
 Explain why marginal costs are ultimately
opportunity costs
 Define sunk costs and explain why they do not
influence smart, forward-looking decisions
 The relationship between price and quantity
supplied
 Change in quantity supplied and a change in
supply, and factors that change supply
 Elasticity of supply
WHAT DOES IT REALLY COST?
COSTS ARE OPPORTUNITY COSTS
Businesses must pay higher
prices to obtain more of an
input because opportunity costs
change with circumstances.
Marginal costs of additional
inputs are ultimately
opportunity costs — best
alternative use of the input.
COSTS ARE OPPORTUNITY COSTS
 Marginal cost
additional opportunity cost of increasing
quantity supplied

changes with circumstances

increases as you increase quantity supplied
 Look at the production possibility boundary
FORGET IT, IT’S HISTORY
SUNK COSTS DON’T MATTER FOR FUTURE CHOICES
Sunk costs that cannot be reversed are not part of
opportunity costs. Sunk costs do not influence smart,
forward-looking decisions.
SUNK COSTS DON’T MATTER FOR FUTURE CHOICES
 Sunk costs
past expenses that cannot be recovered
 same no matter which fork in the road you
take, so no influence on smart choices
 not part of opportunity costs
MORE FOR MORE MONEY: THE LAW OF SUPPLY
If the price of a product/service
rises, quantity supplied
increases.
Businesses increase production
when higher prices either create
higher profits or cover higher
marginal opportunity costs of
production.
LAW OF SUPPLY
Quantity supplied
quantity a producer actually plans to supply at a given price
Fig. B.1
Your Supply of Hours Worked
Price
Quantity Supplied
(minimum willing to accept)
(hours)
$ 10
10 - 20
$ 20
35
$ 30
55
Supply
businesses’ willingness to produce a particular
product/service because price covers all
opportunity costs
Increasing marginal opportunity costs arise because
inputs not equally productive in all activities
continued…
Fig. B.3 PPF Parlour Maximum Combinations &
Marginal Opportunity Costs
Combination Fingernails
Piercings Marginal Opportunity Cost
(fingernails given up)
A
B
15
14
0
1
C
12
2
D
9
3
E
5
4
F
0
5
(15 – 14)
1
(14 – 12)
1
(12 – 9)
1
(9 – 5)
1
(5 – 0)
1
= 1
= 2
= 3
= 4
= 5
Fig. B.4
Increasing Marginal Opportunity Cost
Fig. B.5
PPF Parlour’s Supply of Piercings
Price
Quantity Supplied
(marginal opportunity cost or
minimum willing to accept)
$ 20
1
$ 40
2
$ 60
3
$ 80
4
$100
5
Market supply
sum of supplies of all businesses willing
to produce a particular product/service
Law of supply
if the price of a product/service rises,
quantity supplied increases
Fig. B.6
Market Supply of Piercings
Price
Quantity Supplied
(marginal opportunity cost or
minimum willing to accept)
$ 20
100
$ 40
200
$ 60
300
$ 80
400
$ 100
500
WHAT CAN CHANGE SUPPLY?
Supply changes with changes in
 technology
 prices of inputs
 prices of related products/services produced
 expected future prices
 number of businesses
continued…
Supply increases with
 improvement in technology
 fall in price of an input
 fall in price of a related product/service
 fall in expected future price
 increase in number of businesses
Fig. B.7
Market Supply of Piercings Before & After a
Technology Improvement
Price
Quantity
Quantity
(marginal opportunity
Supplied
Supplied
cost or minimum
willing to accept)
(before improvement)
(after improvement)
$ 20
100
200
$ 40
200
400
$ 60
300
600
$ 80
400
800
$ 100
500
1,000
Fig. B.8: Market Supply of Piercings with More Businesses
Price
Quantity
Quantity
(marginal opportunity
Supplied
Supplied
cost or minimum
willing to accept)
(100 businesses)
(200 businesses)
$
20
100
200
$
40
200
400
$
60
300
600
$
80
400
800
$ 100
500
1,000
HOW FAR WILL YOU JUMP FOR THE MONEY?
PRICE ELASTICITY OF SUPPLY
Elasticity of supply measures
how responsive quantity supplied
is to a change in price,
and depends on the difficulty,
expense, and time involved in
increasing production.
PRICE ELASTICITY OF SUPPLY
Elasticity of supply measures how much quantity
supplied responds to a change in price
Elasticity of supply =
% change in quantity supplied
% change in price
Inelastic supply
small response in quantity supplied when price rises
–
example — supply of mined gold
–
elasticity of supply < 1
Elastic supply
large response in quantity supplied when price rises
–
example — snow shoveling services
–
elasticity of supply > 1
continued…
Elasticity of supply influenced by
–
availability of additional inputs —
more available inputs, more elastic supply
–
time production takes —
less time, more elastic supply
Elasticity of supply allows accurate projections
of future outputs and prices, helping businesses
avoid disappointed customers