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Supply: Benefits and Costs

What determines the amount of a good or service that people are willing and ready to sell during some period of time? A discussion of exchange suggested that people sell things because it is a way, indirect but effective, of obtaining other things that they prefer. Sellers intend to make a profit from their sales, and economists assume that they want their profits to be as large as possible. Because profit is the difference between benefits in the form of revenues and costs, anything that influences revenues or costs can influence the amounts sellers want to sell.

Revenue, the benefit that sellers get from producing and selling, is found by multiplying the price of the product by the amount sold. A change in price changes revenues and hence profits, so it is a major determinant of the amount sellers will want to sell. Because a higher price leads to higher profit, and a higher profit leads to a larger amount that sellers will want to sell, one expects that a greater quantity should be supplied when the price is higher. Thus, the relationship between quantity that sellers will sell and price should be direct or positive.

Although the positive relationship is almost always the case, there are a few exceptions. An example is labor; as wages go up, people may decide to enjoy their higher wages and work less. As a result, there is no law of supply that matches the law of demand.

The cost of something is what must be given up in order to get it. When costs are only monetary, they are easy to see. If the price of an input increases, the cost of the output will increase and, other things held constant, profits will decrease. The seller will then have to decide if shifting part of his resources and effort to other products will improve his well-being.

Production costs are determined not only by the prices of inputs, but also by technology. Technology represents the knowledge of how inputs (such as labor, raw materials, energy, and machinery) can be combined to produce the product. If this knowledge increases so that people find cheaper ways to make the same output, then, other things held constant, profit increases and we expect sellers to respond by producing more.

Costs may be nonmonetary as well as monetary. For example, a farmer takes the expected price of soybeans into account in deciding how much corn to plant. If soybeans are expected to sell for a high price, then the farmer may find that shifting some of his land from corn production to soybean production will increase profit. The decision to plant corn means that the farmer gives up the opportunity to plant soybeans (as well as giving up the money for seed, fuel, equipment, and labor). Because we have defined cost as what must be given up to get something, the prices of other goods that sellers could otherwise produce and sell must be part of the calculation of the cost of production.

There are other factors that can influence the amount of a product that sellers will sell, such as the number of sellers, expectations about the future, and whether or not there are by-products in production that are valuable. (An example of a valuable by-product is cottonseed in the production of cotton. A farmer who produces cotton also gets cottonseed, which yields cottonseed oil, a widely used vegetable oil.) But as in the discussion of demand, the emphasis in the discussion of supply is on the relationship between quantity and price. To focus on this relationship, all other factors must be assumed to be constant.

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Copyright Robert Schenk