, Learning Economics... Solved!: ceteris paribus
Showing posts with label ceteris paribus. Show all posts
Showing posts with label ceteris paribus. Show all posts


Defining the law of Supply and increasing marginal costs

Defining the law of Supply and increasing marginal costs
The law of supply is very similar to the law of demand, but focuses on the firm's perspective.  The law says that as prices go up, the firm is willing to supply more to the market.  This should make sense to all of us, because the more people are willing to pay, the more we are willing to sell!  Imagine if we were in charge of a hamburger stand.  If we could only sell hamburgers for a low price, we may not be motivated to make very many.  But as people are willing to pay more and more for hamburgers, we are willing to work harder to fulfill those orders, and even spend more money on better employees an equipment.  This is price and quantity have a positive relationship with respect to supply.

The genius of these two laws, is that since one slopes down, and the other slopes up, they will cross at one point.  This point is market equilibrium.  By using prices as an allocation device, and assuming that the law of demand and supply hold, we will always attain equilibrium where the amount sold, equals the amount bought, at a given equilibrium price.

The idea of the law of supply stems from the use of marginal costs.  Marginal cost, is the cost a firm faces on the next unit produced (eg. one more quantity, or on the margin).  Imagine you are a manager at a burger restaurant.  It costs you  $10 per hour for someone to make hamburgers, all of the other costs are assumed away for now (such as buildings, machines, meat, etc.).  If you want to make hamburgers for 1 hour, it will cost you $10, but if you want to make MORE hamburgers, you will have to pay more to keep your employee around.  But now your employee may want more money to stay around (think of overtime).  So instead of paying $10 per hour, you now may have to pay $12.  This is a very simple example of marginal cost theory, and the motivation behind the upward sloping supply curve justifying the law of supply!

After viewing this post, you may be interested in how to construct a supply curve.

It is also possible to construct the supply curve given a supply function. You will need to plug in different values for price and quantity into the supply function to help create a supply schedule. Once you have enough points and a completed supply schedule you can use the information to create a supply curve on the graph. However, if you feel confident with your algebra abilities you can plug in different quantity and price values into the supply function and use the results to plot the supply curve.

Defining the law of Demand, and diminishing marginal benefit/utility

Defining the law of Demand, and diminishing marginal benefit/utility
This is a fundamental rule of economics that should make sense to most people.  It basically states that as the price of something goes down, people will be willing to purchase more of it.  Of course, economics in theory is much easier than economics in reality, but lets consider some examples.

First think of the whole market for cars.  There are some people who would like to buy a car now, but are unable too because they are just a little too expensive.  By decreasing the price, these people are now able to afford cars, and therefore buy them.  So everything else equal (ceteris paribus) as the price goes down, more of the goods (cars) are going to be sold.  This idea is what makes the demand curve downward sloping, as shown in the graph below:

The downward sloping nature of the demand curve can also be related to diminishing marginal benefits (MB, or marginal utility MU) .  Imagine you are eating tacos, as you eat more tacos, your happiness from each additional taco is not as high as the previous one (your marginal benefit is decreasing).  Because you are not as happy with each taco, your willingness to pay goes down as the quantity of tacos consumed goes up.  This makes shows us that the demand curve has exhibits a negative relationship between quantity and price.

Another example could focus only on you, the individual.  Imagine going to the store and seeing t-shirts on sale.  If the t-shirt is $50, you may only buy one, but if it is on sale, you may buy one, or more than one.  If the price gets very low, say $10, then maybe you will buy three or ten!  The point is, as the price goes down, we are willing to purchase more of the good, with everything else equal.

It is important to keep in mind the everything else equal part of this discussion.  Some argue that a $30 t shirt and a $50 t shirt cannot be the same because of quality, or brand name issues.  This is where the theory and real world collide.  Economists make the simplifying assumption that is possible to have IDENTICAL products where the only difference is in price.  If this truly is the case, then we get the download sloping demand curve common in all of the textbooks.

Look here if you would like to see how to make a demand curve.

 REMEMBER:  D is for demand, and D is for down!