Theory of Supply

r services during the period. Profit is the revenue from selling the output minus the costs of inputs used. Costs should include opportunity costs of all resources used in production. Opportunity cost of a commodity is the amount an input can obtain in its best alternative use (best use elsewhere). In particular, costs include the owners time and effort in running a business. Costs also include the opportunity cost of the financial capital used in the firm. Aiming to get higher profits, firms obtain each output level as cheaply as possible. Firms choose the optimal output level to receive the highest profits. This decision can be described in terms of marginal cost and marginal revenue. Marginal cost is the increase in total cost when one additional unit of output is produced. Marginal revenue is the corresponding change in total revenue from selling one more unit of output. As the individual firm has to be a price-taker1, each firms marginal revenue is the prevailing market price. Profits are the highest at the output level at which marginal cost is equal to marginal revenue, that is, to the market price of the output. If profits are negative at this output level, the firm should close down. An increase in marginal cost reduces output. A rise in marginal revenue increases output. The optimal quantity also depends on the output prices as well as on the input costs. Of course, the optimal supply quantity is affected by such noneconomic factors as technology, environment, etc2 . Making economic forecasts, it is necessary to know the effect of a price change on the whole output rather than the supply of individual firms. Market supply is defined in terms of the alternative quantities of a commodity all firms in a particular market offer as price varies and as all other fac