more on supply today: supply curves, opportunity cost, perfect competition, and profit maximization
Post on 19-Dec-2015
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More on supply
Today: Supply curves, opportunity cost, perfect competition, and
profit maximization
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In previous lectures…
…we have studied demand Today, we start supply Some concepts from demand carry
over to supply Horizontal addition Surplus
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Core principles, revisited It is important to think like an economist
when looking at supply Opportunity cost: Important in decision
making Cost-benefit analysis: Economic profit
includes not only explicit costs, but also implicit costs
Costs can be fixed or variable Some firms may operate at a loss in the short run MB = MC rule (except under shutdown condition)
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Today
Idea of perfect competition Very little or no market power by any
firm Individual supply to market supply Opportunity costs The first steps to profit
maximization
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Perfect competition
For all discussion until Ch. 8 (monopoly), assume that all markets are perfectly competitive, unless mentioned otherwise
In perfect competition, there are many firms, each of which produces a very small percentage of the good in question
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Perfect competition
Each firm has no significant control over price charged under perfect competition
Perfectly competitive markets do not necessarily occur when product differentiation occurs This will also be addressed in Ch. 8
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Perfect competition Since each firm has
no control over price, each firm is called a price taker
In this example, market equilibrium is $5
Each firm can sell as much of the good it wants at $5/lb.
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Perfect competition
How much will each firm sell? Theory
Each firm will sell the output that maximizes profits
Basic idea related to theory Sell another unit if profit goes up
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The steps to profit maximization
Profit = Total revenue – Total cost = Total revenue – Variable
Cost – Fixed Cost Opportunity costs are included in
the total cost when calculating economic profit
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Opportunity cost Always think “what is the best use of
my time?” Assume that you have 10 hours per
week for jobs Building widgets, which sell for $1 each Working at an I.V. coffee shop for $10/hr.
Assume that material costs for widgets and walking costs to I.V. are negligible
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Opportunity cost
Should I only build widgets, since I am making positive profits for each widget produced? Maybe For each widget I build, I must work
less at the coffee shop Similar logic applies to working at
the coffee shop
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Supply of widgets and coffee shop work
How much should I work at each job?
To make the most money, of course
Remember that marginal analysis is important in making the most money
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Widget production function
Hours of widget production
Total number of widgets built
Additional widgets built
0 0
15
1 15
13
2 28
11
3 39
9
4 48
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Why diminishing marginal productivity?
Assume that widget production is labor-intensive
You will pick your most productive work hour each week to be the first hour of work on widgets You use the best opportunities to be
the most productive
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How many widgets should I build?
Again, we use marginal analysis in maximizing your earnings for your 10 hours available for work each week
I should build widgets as long as: MB ≥ MC (in dollars)
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How many widgets should I build?
MB of 1st hour of work: $15 MB of 2nd hour of work: $13 MB of 3rd hour of work: $11 MB of 4th hour of work: $9 MC of each hour of widget building
is the $10 lost in wages from working at the coffee shop
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How many widgets should I build?
Is MB ≥ MC? 1st hour? Yes, since $15 > $10 2nd hour? Yes, since $13 > $10 3rd hour? Yes, since $11 > $10 4th hour? No, since $9 < $10
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How many widgets should I build?
You should build widgets for 3 hours/week, earning $39 from widgets
You should work 7 hours/week, earning $70 from work
Total earnings: $109/week Marginal analysis Maximize
earnings
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Deriving individual supply From previous example:
If price of widgets goes up, I would want to spend more time building widgets
As price goes up, quantity supplied increases If price of widgets goes down, I would want
to spend less time building widgets As price goes down, quantity supplied decreases
We have justified an upward-sloping supply curve
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Market supply
Horizontal addition from individual supply to market supply
We did this already with demand
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Moving on…
Today, we will not start analyzing the costs necessary to analyze profit maximization
We will look at this on Wednesday
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Long run
By definition, the long run is such that all costs are variable
Analysis in the long run is easier than in the short run In the long run, profits are maximized
to be either positive or at zero
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Fixed costs in the short run The short run is defined such that some
costs must be spent, whether or not a firm operates The costs that must be spent are fixed costs
Fixed cost examples could include: Rent Capital (e.g. manufacturing equipment) Contract laborers
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Simplified analysis
Although there may be many fixed costs and many variable costs, we will study a simple case One fixed cost: Building rent One variable cost: Labor costs
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Graphical approach? A graphical
approach is best used with continuous cost functions
We will start with a discrete example on Wednesday