This chapter has introduced concepts essential to understanding the supply side of the market. You learned about the law of supply and that this law reflects profit maximizing decisions related to market entry, market exit, and the quantity of output. You learned about the supply schedule and variables that shift this schedule. In the process the chapter covered the assumption of a price-taking firm and introduced total, average, and marginal cost and revenue concepts. You also learned that profit maximization involves producing with a cost-minimizing combination of inputs. This provided an opportunity to introduce the idea of a production function and cover derived demands for inputs. Finally, you were introduced to the idea of producer surplus as a measure of the economic welfare of participants on the supply side of the market.
At the end of Chapter 1, it was mentioned that any economic system needs to address resource allocation problems (see Kohls and Uhl 1998). Again, relevant questions include:
- What to produce?
- How much to produce?
- How to produce?
- How to distribute production?
Chapter 1 presented an argument that the principles you learned about the demand side of the market related directly to the fourth question. The principles you just covered above about the supply side of the market directly address questions 1 to 3. The entry and exit decision is relevant to the first question. You learned that markets for products with high prices will attract entry by new firms. You also learned that at some point, existing firms will exit markets for products with low prices. In short prices answer the first question by directing firms into markets where output is valued highly and out of markets where it is not. As to the second question, the profit maximizing condition (\(P=MC\)) for a price-taking firm indicates that firms will place more on the market at higher prices and less on the market at lower prices. Finally, the prices of inputs help to answer the third question. Firms will adopt production methods that favor lower-priced inputs in order to minimize their costs of production.
There will be an opportunity to revisit these questions in Chapter 4, when the demand and supply sides of the market come together. However, before examining markets in equilibrium, it is necessary to introduce or review demand and supply elasticities. This is the topic of Chapter 3.
