1 perfectly competitive supply: the cost side of the market perfectly competitive supply: the cost...
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Perfectly Competitive Supply:
The Cost Side of the Market
Perfectly Competitive Supply:
The Cost Side of the Market
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Buyers and SellersBuyers and Sellers
Buyers“Should I buy another unit?”Answer: If the marginal benefit exceeds
the marginal costSellers
“Should I sell another unit?Answer: If the marginal revenue exceeds
the marginal cost of making it
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Upward-Sloping Supply Curves
Upward-Sloping Supply Curves
The Low-Hanging Fruit PrincipleSuppliers first use the resources easiest-to-
find So, the price of the output must go up in
order to compensate for using harder-to-find resources
I.E., costs tend to rise when producers expand production in the short-run (some inputs are fixed in the short-run)
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Fig. 6.1An Individual Supply Curve for
Recycling Services
Fig. 6.1An Individual Supply Curve for
Recycling Services
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Fig. 6.2The Market Supply Curve for
Recycling Services
Fig. 6.2The Market Supply Curve for
Recycling Services
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Profit MaximizationProfit MaximizationProfit
The difference between the total revenue it receives from the sale of its product minus all costs, explicit and implicit
Note: this includes opportunity cost, and is therefore different than profit in a traditional accounting sense
Profit-maximizing firmA firm whose primary goal is to maximize profits
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Types of MarketsTypes of Markets
One firm = 2-12 firms many firms many, many firms
Monopoly Oligopoly Monopolistic Perfect
Competition Competition
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Firm Decisions to Max Profit
Firm Decisions to Max Profit
What to produce (what market)?How much to produce?What inputs to use?What price to charge?
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Perfect CompetitionPerfect CompetitionPerfectly Competitive Market
A market in which no individual supplier has significant influence on the market price of the product
Many firms all selling the same product. Product is “standardized”
A Price taker is a firm thatHas no influence over the price at which it sells its
productSells only a fraction of the market outputCan sell as much output as it wishes
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Perfectly Competitive Firm Perfectly Competitive Firm
Given that there are many firms all selling the exact same product, what does the demand curve for any one firm’s good look like?
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Fig. 6.4The Demand Curve Facing Perfectly
Competitive Firm
Fig. 6.4The Demand Curve Facing Perfectly
Competitive Firm
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Production in the Short RunProduction in the Short Run
Factors of ProductionAn input used in the production of a good or
service
Short RunA period of time sufficiently short that at least
some of the firm’s factors of production are fixed
Long RunA period of time of sufficient length that all the
firm’s factors of production are variable
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Law of Diminishing ReturnsLaw of Diminishing Returns
Fixed factor of productionAn input whose quantity cannot be altered in the
short run. E.g. square footage of factory spaceVariable factor of production
An input whose quantity can be altered in the short run. E.g. labor
Law of Diminishing ReturnsIf one factor is variable and all others are fixed: the
increased production of the good eventually requires ever larger increases in the variable factor
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Law of Diminishing Marginal Returns
Law of Diminishing Marginal Returns
Q
Labor
MPL
Point of diminishing marginal returns
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Implications for Marginal Costs
Implications for Marginal Costs
Since productivity (MPL) typically first increases and then decreases (at the point of DMR), what will marginal costs do?
When productivity is rising, marginal costs should be falling.
When productivity is falling, marginal costs should be rising.
Unit costs measures are inversely related to productivity measures
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Choosing OutputChoosing Output
How much to produce?The goal is to maximize profit
Profit = TR – TCA perfectly competitive firm chooses to
produce the output level where profit is maximized
Cost-Benefit Principle A firm should increase output if marginal
benefit (revenue) exceeds the marginal cost
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Choosing OutputChoosing Output
Cost-Benefit PrincipleIncrease output if marginal benefit exceeds the
marginal cost
For a perfectly competitive firmMarginal benefit = marginal revenue = price
Cost-Benefit Principle for a Price TakerKeep expanding as long as the price of the
product is greater than marginal costChoose the output where P = MC
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Profit Maximizing ConditionProfit Maximizing Condition
Profit = TR – TCMax Profit with respect to Qd Profit / dQ = (dTR/ dQ) – (dTC/dQ) = 0 therefore maximum profit occurs where MR
= MC
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Shut Down?Shut Down?
Perfectly competitive firms should produce where MR (P) = MC, unless price is very low
If total revenue falls below variable cost, the best the firm could do is shut down in the short run
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Fig. 6.5The Firm’s Marginal Cost of Production
Fig. 6.5The Firm’s Marginal Cost of Production
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Fig. 6.6Price = Marginal Cost: The Perfectly Competitive Firm’s Profit-Maximizing
Supply Rule
Fig. 6.6Price = Marginal Cost: The Perfectly Competitive Firm’s Profit-Maximizing
Supply Rule
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Perfectly Competitive Firm’s Supply CurvePerfectly Competitive Firm’s Supply Curve
The perfectly competitive firm’s supply curve is itsMarginal cost curve
At every point along a market supply curvePrice measures what it would cost
producers to expand production by one unit
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Profit MaximizationProfit Maximization
P
ATC
MC
Q* Quantity
10 = P* D = MR
ATC = Total Cost / Q so, TC = ATC x Q
P > ATC means profit > 0
8
100
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Suppose Price Falls to Min ATC
Suppose Price Falls to Min ATC
P
ATC
MC
Q* Quantity
7 = P* D = MR
P = ATC means profit = 0
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Suppose Price Falls below Min ATC
Suppose Price Falls below Min ATC
P
ATC
MC
Q* Quantity
7 = P* D = MR
P < ATC means profit < 0
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Producer SurplusProducer Surplus
Producer Surplus (PS) is the difference between the firm’s minimum willingness to accept (MC) and what they actually accept (P), summed over all units produced.
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Producer Surplus and Supply
Producer Surplus and Supply
Graphically then, PS is the area below the price line and above the supply curve, up to Q*
Here, PS = $100
=½(base)(height)
= ½(20)(10)
20 Quantity
P
30
10PS
S
D
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exercisesexercises
A profit maximizing perfectly competitive firm must decide:
A. only on what price to charge, taking output as fixed. B. both what price to charge and how much to produce. C. only on how much to produce, taking price as fixed. D. only on which industry to join, taking price and output as fixed. E. only on how much revenue it wishes to collect.
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exercisesexercises
To produce 150 units of output, the firm must use 3 employee-hours. To produce 300 units of output the firm must use 8 employee-hours. Apparently, the firm is:
A. more profitable. B. experiencing diminishing marginal returns. C. in the long run. D. not using any fixed factors of production. E. failing to profit maximize.
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exercisesexercises Which of the following factors of production is likely to be fixed
in the short run? A. The location of the firm.
B. The number of employee-hours. C. The amount of electricity consumed. D. The amount of paper used. E. The amount of RAM installed in the network server.
When the marginal return to the variable factor of production is diminishing, the marginal cost curve is
A. upward sloping. B. convex. C. parallel to the vertical axis. D. downward sloping. E. concave.