# Tilting Supply Curves and Playing Fields

July 24, 2012

“We go out and we buy a lot of products made in China. That’s how we celebrate Labor Day.”   David Letterman, 2010

Last time at Econ 101, the Supply Curve was developed and described:  firms will Supply a certain Quantity (Qs) at a given Price.  As you’d expect, they are Willing to Supply more (Qs increases) as Price increases.  Think of yourself as the firm and consider how Willing to Sell you are when hearing aid prices are \$500 versus \$3000.  That’s the hi HealthInnovation crisis in a nutshell:  those guys are Willing to Sell at a lower Price than you are, so bingo, we get two points on our Supply Curve.  At Point #1, (Price = \$500),  Qs  is whatever hi HealthInnovation is willing to sell, because you’re not in the game at that Price. But at Point #2, (Price = \$3000) Qs hgoes up because you and other competitors are now Supplying product, in addition to hi HealthInnovation.  This is what we call “sliding up and down the Supply Curve.”{{1}}[[1]]Before you righteously (and correctly) object, please know that I am aware of the service versus product issue packed in that nutshell, but that is for a different post.  We’ll just stick with Supply for now.[[1]]

Just as external sources shift Market Demand Curves, there are external forces that affect Supply Curves, which is different from sliding up and down a single curve.  The key thought here is that while

Fig 1. Shifting Supply Curves. At a given Price, Left shift = less Quantity Supplied. Shift; Right shift = more Quantity Supplied.

the Supply Curve shows a positive relationship between a set of potential Qs offered at different Ps, a change in a Factor other than Price causes a supply shift.  In other words, there are lots of Supply Curves for a set of Prices.  The curves are all positive, but they land in different places along the Quantity axis, as shown in Figure 1.  When the Supply Curve moves left or right, it means there has been an actual change in Supply (as opposed to a change in Price).  Rightward shifts of the curve mean that Supply is increasing.  That is, firms’ willingness to sell at a given Price increases.  Leftward shifts mean firms are less willing to sell at a given Price.   Table 1 details different sources that shift Supply Curves.  Note that NONE of the sources are controlled by Suppliers.  Some help Suppliers, some hurt.

For example, assume a technological advance in office management software that increases office productivity–perhaps even replacing an employee. Firms that adopt the technology lower their marginal costs, which increases their respective Qs, thereby making them more competitive in the marketplace.  The more competitive the firm, the more likely it is to weather negative forces, including weather, and increasing costs in other areas.  In bad times, those firms are the ones that will remain in the marketplace.

Another example takes off on the Letterman joke at the beginning of this post.  If China experiences torrential floods or other natural disastors, the steady stream of hearing aid components coming out of China is likely to be halted for a while.  In other words, an “input” is affected, which temporarily increases the cost of production for hearing aid manufacturers.  As a consequence, Supply shifts leftward.  Likewise, if Chinese farmers can’t make a go of it and swarm into urban areas looking for employment, cost of labor goes down, which translates to more production for the same cost to the component makers.  With the decrease on cost of that “input,” Supply shifts rightward, meaning that hearing aid manufacturers are Willing to Sell at lower Price.  At least that’s how it works in a competitive market.{{2}}[[2]]Yes, I know this is a naive assumption, but models have to start simple and then build in more variables.  I promise, we will add the economic concept of Monopolistic Pricing in a later post.[[2]]

Of course, the idea of a purely competitive market in which Price is the only variable allowed to shift is just a theoretical construct.{{3}}[[3]]Economists always qualify these discussion with the phrase “ceterus paribus” — Latin for “all other things held constant.”[[3]] Lots of things are going on at once, including constant shifting of the sources in Table 1.  All of which means that there is no real Price, but the relationship between P and Qs in the marketplace can be examined with regard to the firms that comprise the market and the external forces that affect the firms… and therefore the market.

 Non-Price Determinants of Supply Effect Supply Curves Shifts Technology Technological improvements lower production costs, increasing willingness to sell at a lower Price Right — more willing to sell Weather Cataclysmic weather can prevent manufacturing, limit availability of components or labor Left — less willing to sell Price of Inputs Increased cost of labor, components, capital: production costs increase Decreased cost of labor, components, capital: production costs decrease Left — less willing to sell Right — more willing to sell # of Firms more competitors, more sales, more supply fewer competitors, fewer sales, less supply Right — more willing to sell Left — less willing to sell Expectation of Future Prices If firms expect Price will rise, they will wait If firms expect Price to decrease, they will sell more now Left — less willing to sell Right — more willing to sell Government Taxes, Subsidies Regulation If business taxes increase, costs increase If firm(s) receives government subsidy (e.g., VA), costs decrease If FDA reduces regulation (e.g., PSAP position), lower costs, more competitors Left — less willing to sell Right — more willing to sell Right — more willing to sell

But check out the last entry in Table 1.  This is where we begin to leave the free market and lose our level playing field.  It is this that is bothering RR, at least in part.  It is common knowledge that the hearing aid manufacturers’ largest US customer is the Veterans Administration.  The VA has what we call “purchasing power” because its Demand is so large that it can influence manufacturers’ wholesale prices.  Ditto for Costco.  Now, construct a Supply Curve in your head for the manufacturers — assuming that they are in a competitive market and don’t completely control Price.  All other things being equal, you’d think they would be less Willing to Sell higher volumes as Price decreased.  But things aren’t equal because this customer is huge.  Selling costs to a single customer are much less than they are when selling to many customers.  With significantly reduced marginal costs, the manufacturers’  Qs to the VA or Costco goes way up, allowing them to maximize profit, as described above.

So, to recap and answer RR’s Question at last (he probably wishes he’d never asked!):

Q:  “Does it really cost \$600 or more for the manufacturer to ship a hearing aid to me versus to Costco or the VA?” Sincerely, RR

A:  Yes, RR.  It probably does cost the manufacturers a lot more to ship hearing aids to you vs Costco and the VA.  Probably not \$600 (they too like to make a profit).  But a lot anyway.”
Stay tuned for another post or two explaining why the playing field gets more competitive but more tilted every year — at least for the little guys.

photos courtesy of britton manasco and web shells
1. I was an early buyer of stock in Hearx when they started out in the 80’s. Stayed with them when they had the 1 for 10 reverse. Just found out the other day when my broker notified me of an under \$300.00 to my account that I was bought out with no previous notice. I’ve lost a number of thousands of dollars that I gave to Dr. Brown when he needed it. A very nice way to treat stockholders who were told over the years that there were no profits. One of the people who helped him raise money for his company, Jerry Wenger even ended up with a stilt in jail. I lose money and Dr. Brown will come out smelling like a rose.

Hubert Katz Bowie, Md