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There are often two ways of interpreting the demand and supply curves.

The market

The demand curve consists of all buyers -- some who value the good more than the market price, and some who value it less. For more quantity to be produced, you have to lower the price so that those who value it less will buy. It makes sense that it is downward sloping.

Similarly the supply curve consists of all producers -- some who can produce the good at a lower cost than the market price, and some who can't. In this case, for more quantity to be produced, you have to raise the price so that those less efficient firms will be motivated to produce. It makes sense that the curve is upward sloping.

Marginal benefits and costs

Now we look at the curves in the context of one producer and one consumer. The demand curve of the consumer is downward sloping because of marginal utility. This makes sense to me.

What doesn't make sense to me is that the supply curve is upward sloping because marginal costs increase. Why is it that it costs more to make the next toy than it did the last?


If I've had any misconceptions or misunderstandings, please point them out to me. Thank you for the help!

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What doesn't make sense to me is that the supply curve is upward sloping because marginal costs increase. Why is it that it costs more to make the next toy than it did the last?

The supply curve depicts the short time supply curve.

If resources are abundant, low cost producers can easily increase production by building another factory that is at least as efficient as the exisiting ones. However, building a new factory takes time. In the mean time the slack will be met by increased production from higher-cost producers and overtime work, both of which have higher costs.

If there is a lasting increase in demand, the most efficient manufacturers will build additional factories that can produce at a low cost and thereby increasing supply, shifting the supply curve to the right.

If resources are scarce, then increasing production will mean that you have to use resources with higher cost. Higher wages for workers, using farm land that yields smaller harvests, mine lower quality ore and so on.

The cost increase can be offset by technological advances or lowering of other factor costs. Take the shale oil industry, where improved drilling technology has greatly increased the production per drilling rig. Also, the factor cost has fallen for labor and drilling services. The combined effect has reduced the cost from ca \$70 per barrel to ca \$40 per barrel. This has allowed US shale oil producers to increase production despite oil prices dropping from \$120 to \$50 per barrel. However, there is no guarantee that this can offset the entire cost increase; increased demand can result in permanently higher prices.

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