Chapter 6

Behavior of Supply

6.1 INTRODUCTION

6.2 A MODEL OF SUPPLY BEHAVIOR: AN INDIVIDUAL FOR-PROFIT COMPANY

6.2.1 The Basic Model

In our analysis we will use the example of a lab (ABC Labs) that is owned by a pathologist and produces blood tests of a given level of quality. Assume ABC Lab’s revenues come from 2 sources: (1) reimbursement for patient services (termed patient or earned revenues) and (3) other sources (philanthropic or government grants, endowment funds, and other nonpatient-related sources). Initially assume all revenues are from reimbursement. Assume: ABC Labs is “price taker”, i.e., it has no influence on the price of its output. It receives $12 for each test performed. TR and MR for output levels from 0 to 10 are shown in Cols. 9, 10, Table 6-1, p. 128.

Assume TFC = $12 ($7 spent monthly on equipment rental and mortgage payment and $5 opportunity cost of pathologist if work in lab)

Fig 6-1, p. 130

Profits are at a maximum at 6 units of output ($24.50).

6.2.2 Nonpatient Revenues

The economic significance of a grant unrelated to output is that it provides a set amount of money whether output expenditures or contracts. Such a grant can be treated analytically in one of two ways, either as a fixed addition to revenue or as a fixed reduction from TC (a negative FC).

Neither patient revenues nor variable costs are affected. Maximum profit level of output remains at 6 units. Fixed subsidy only affects level of profits at every level of output.

6.2.3 Shifts in supply curve

Might occur because of higher input prices or higher quality of product being produced. On the other hand, an increase in the capacity of the firm to produce output, caused by additional capital expansion, will cause the MC and thus the supply curve to shift to the right.

6.3 MARKET SUPPLY

2 additional assumptions:

· There is a set number of suppliers in market

· No agreement on part of suppliers to restrict supply.

Fig. 6-4, p. 135

Market supply curve will shift to right (1) if, given number of producers, any factors cause individual supply curves to shift to right and (2) if the number of suppliers increases.

6.4 SUPPLY BEHAVIOR OF NONPROFIT AGENCIES: THE OUTPUT MAXIMIZATION HYPOTHESIS

Several approaches taken in forming hypotheses about supply behavior of nonprofit agencies. One is to regard the trustees as being in charge. Another is to regard salaried executives as people who maintain control, make hypotheses about their goals, and develop a model of organizational supply based on these goals.

Revenues are $12/test, but now the reimbursement may be made by a third party. Major difference between 2 examples is nonprofit lab seeks to maximize output rather than profits.

According to this model, output will be expanded to the point where the firm breaks even, i.e., where TR = TC. In Table 6.1, output will be eight units. As long as price is above minimum point on ATC curve, the S curve of the nonprofit agency that maximizes output is the ATC curve.

Assume a donor gives nonprofit lab a $25.00 subsidy unrelated to output. With this subsidy an output level of 9 will show a profit of $2.25 ($25 – 22.75). Lab would be in the red at 10, but could meet all its costs at 9.

6.5 SUPPLY DECISIONS INVOLVING QUALITY

Fig 6-5, p. 139 and 6-6, p. 140.

6.6 SUPPLIER BEHAVIOR OF NONPROFIT AGENCIES: THE ADMINISTRATOR AS AGENT MODEL