Book Information / Sample Chapter(s) (PDF) - Textbook Media

70 Chapter 4 Demand and Supply
Government policies can affect the cost of production and the supply curve through
taxes, regulations, and subsidies. For example, the U.S. government imposes a tax on
alcoholic beverages that collects about $8 billion per year from producers. There is a
wide array of government regulations that require firms to spend money to provide a
cleaner environment or a safer workplace. A government subsidy, on the other hand,
occurs when the government sends money to a firm directly or when the government
reduces the firm’s taxes if the firm carries out certain actions. For example, the U.S.
government pays more than $20 billion per year directly to firms to support research and
development. From the perspective of a firm, taxes or regulations are an additional cost
of production that shifts supply to the left, leading the firm to produce a lower quantity
at every given price. However, government subsidies reduce the cost of production and
increase supply.
Summing Up Factors That Change Supply
Natural disasters, changes in the cost of inputs, new technologies, and the impact of
government decisions all affect the cost of production for firms. In turn, these factors
affect firms’ willingness to supply at a given price. Exhibit 4-7 summarizes factors that
change the supply of goods and services. Notice that a change in the price of the product
itself is not among the factors that shift the supply curve. Although a change in price
of a good or service typically causes a change in quantity supplied along the supply
curve for that specific good or service, it does not cause the supply curve itself to shift.
Because demand and supply curves appear on a two-dimensional diagram with only
price and quantity on the axes, an unwary visitor to the land of economics might be
fooled into believing that economics is only about four topics: demand, supply, price,
and quantity. However, demand and supply are really “umbrella” concepts: demand
covers all of the factors that affect demand, and supply covers all of the factors that
affect supply. The factors other than price that affect demand and supply are included
by using shifts in the demand or the supply curve. In this way, the two-dimensional
demand and supply model becomes a powerful tool for analyzing a wide range of
economic circumstances.
Exhibit 4-7 Some Factors That Shift Supply Curves
The right-hand panel (a) offers list of factors that can cause an increase in supply from S 0
to S 1
. The left-hand panel (b)
shows that the same factors, if their direction is reversed, can cause a decrease in supply from S 0
to S 1
.
Price
Favorable natural conditions for
production
A fall in input prices
Improved technology
Lower product
taxes/ less costly
regulations
S 0
S 1
Price
Poor natural conditions for
production
A rise in input prices
A decline in technology
(not common)
Higher product taxes/
more costly
regulations
S 1
S 0
Quantity
(a) Factors that increase supply
Quantity
(b) Factors that decrease supply