No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Four: Supply 90 SUPPLY CURVES Now we are ready to consider how supply curves are derived in actual markets. As always, we need to first think about an individual producer, and then we can aggregate to the overall market. As seen in Figure 4.1 , a producer will initially gain increased efficiencies in operations (lower monetary costs) as resource inputs can achieve gains from specialization. Resource inputs include land, labor, capital, and entrepreneurship (we will talk more about these in chapter 6). For now, all we need to understand is that these inputs are combined in various proportions to produce goods and services. As the scale of production increases, eventually less efficient (or essentially the same thing, more expensive) resource inputs will have to be used, resulting in increasing marginal costs of production. When a producer faces increasing marginal costs, the price must rise to encourage additional production. This leads to the Law of Supply : as the price of a good or service rises, the quantity supplied will rise. Let’s see how this works with one of my favorite lunch experiences. I’m a big fan of SUBWAY sandwiches since they are both tasty and relatively healthy, compared to the fat-laden double cheeseburgers my son likes to devour. Most of you have likely been in a SUBWAY, so let’s think about the production process we discussed in chapter 2. Let’s say you come in the restaurant and there are four customers ahead of you. If there is only one person behind the counter, the worker takes your order, selects the bread, meat, and cheese, then works down the counter adding veggies, cutting the sandwich, wrapping it, and then takes your money. The worker then starts over with the next customer. If there were two workers, they will almost always split the tasks rather than having one worker run a customer through the complete process. Why would they do that? As we saw in chapter 2, workers can be more efficient by specializing in a given function: what economists call gains from specialization. Very busy and efficient SUBWAY shops use one worker at each station. There is little movement back and forth C ($) Q (#) S Figure 4.1, Individual Supply Curve. An individual’s supply curve initially slopes downward in recognition of the gains from specialization. At some point, these gains will give way to increasing costs as production will have to use less efficient resource inputs in the production process. Law of supply: As the price of a good or service rises, the quantity supplied rises. SUNK COSTS ARE…SUNK! They are therefore irrelevant to choice and economic decisions. Decisions are made based on the marginal costs and benefits; sunk costs have no relationship to the marginal costs. What is done is done, or, don’t throw good money after bad!