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Chapter 4 Demand and Supply 69 $28,000 Exhibit 4-6 Shifts in Supply: A Car Example Increased supply means that at every given price, the quantity supplied is higher, so that the supply curve shifts to the right from S 0 to S 2 . Decreased supply means that at every given price, quantity supplied of cars is lower, so that the supply curve shifts to the left from S 0 to S 1 . Price $26,000 $24,000 $22,000 $20,000 $18,000 $16,000 p = 20,000 q = 18 million p = 20,000 q = 16.5 million p = 20,000 q = 19.8 million K L J M S 1 S 0 S 2 $14,000 $12,000 $10,000 8 13 16.5 18 19.8 23 Quantity Price Decrease to S 1 Original Quantity Supplied S 0 Increase to S 2 $16,000 10.5 million 12.0 million 13.2 million $18,000 13.5 million 15.0 million 16.5 million $20,000 16.5 million 18.0 million 19.8 million $22,000 18.5 million 20.0 million 22.0 million $24,000 19.5 million 21.0 million 23.1 million $26,000 20.5 million 22.0 million 24.2 million The cost of production for many agricultural products will be affected by changes in natural conditions. For example, the area of northern China which typically grows about 60% of the country’s wheat output experienced its worst drought in at least 50 years in the second half of 2009. A drought decreases the supply of agricultural products, which means that at any given price a lower quantity will be supplied; conversely, especially good weather would shift the supply curve to the right. Goods and services are produced using combinations of labor, materials, and machinery. When the price of a key input to production changes, the supply curve is affected. For example, a messenger company that delivers packages around a city may find that buying gasoline is one of its main costs. If the price of gasoline falls, then in the market for messenger services, a higher quantity will be supplied at any given price per delivery. Conversely, a higher price for key inputs will cause supply to shift to the left. When a firm discovers a new technology, so that it can produce at a lower cost, the supply curve will shift as well. For example, in the 1960s a major scientific effort nicknamed the Green Revolution focused on breeding improved seeds for basic crops like wheat and rice. By the early 1990s, more than two-thirds of the wheat and rice in low income countries around the world was grown with these Green Revolution seeds—and the harvest was twice as high per acre. A technological improvement that reduces costs of production will shift supply to the right, so that a greater quantity will be produced at any given price.
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