2.1: Overview and Objectives
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Supply arises from the business decisions of producing firms. The term “firm” is used broadly to refer to any producing enterprise and includes farms. The law of supply states that the quantity supplied to the market increases as a a product’s market price increases. After a brief overview of the law of supply and the market supply schedule, this chapter examines two types of decisions at the level of the producing enterprise that give rise to the law of supply.
- The first revolves around the decision to participate in the market. The primary goal here is to establish that: (a) a higher output price induces additional firms to enter the market, and (b) when the output price is low, some firms will find it in their interest to exit the market. The decision to participate in the market is one reason for the law of supply. In examining the entry and exit decision, you will see that the price that induces new firms to enter the market will often be higher than the price at which existing firms will exit. This observation is not essential to the law of supply but does have implications for marketing arrangements that will be considered later in the course.
- The second type of decision pertains to the output choices of existing firms. In many situations, the firm has some flexibility to alter the volume it produces once it has entered the market. You will see that a firm’s profit maximizing output choice is positively related to the market price. This is a second reason for the the law of supply. Existing firms will supply more to the market at higher prices and less to the market at lower prices.
Having analyzed these two decisions, you will be in a position to characterize the market supply schedule as an aggregate reflecting choices of many individual firms. As is the case with the demand schedules you studied in Chapter 1, There are a number of variables that shift the market supply schedule and which are described in this chapter.
The next portion of the chapter examines demand for inputs used in production. Many agricultural products are demanded as inputs in downstream production activities. For example, corn is an input used in the production of livestock, ethanol, vegetable oil, high fructose corn syrup and a number of other downstream products. Demands for inputs arise out of the supply decisions of profit maximizing firms. Thus, even though the chapter has “supply” in its title, it is also very much about input demand. The firm’s problem will be characterized by choosing inputs to produce the output that maximizes profit. The solution to this problem provides input demand equations that depend on the own-price of the input, the prices of other inputs, and the price of the output.
Finally, this chapter introduces the concept of producer surplus. The market supply schedule is used to compute producer surplus at a prevailing market price. This represents total economic profits in excess of production costs accruing to the producing industry and is used as a measure of producer welfare in the analysis of market outcome.