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MB MC
Learning Objectives
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Explain how opportunity cost is related to the supply curve Individual supply curves (firms)and market supply curve (industrys) Profit maximization and Economic profit Some important Production and cost concepts Characteristics of perfectly competitive markets
Chapter 4: Elasticity
Slide 2
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Harry is trying to decide on how to divide his time between washing dishes for $6/hour and collecting soft drink containers which may be redeemed at 2 cents each. Earnings aside, Harry is indifferent between the two tasks. Harrys opportunity cost of one hour of recycling is the $6/hr that he could have earned washing dishes.
Chapter 6: Perfectly Competitive Supply Slide 3
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0 1 2 3 4 5
600
400 300
200
100
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Harry should recycle for the 1st three hours everyday and then do dishwashing. Why? Apply the costbenefit principle: MC = $6 MB = MRP (marginal revenue product) 1 hour MB = (600)(.02) = $12; MB>MC, so continue recycling 2nd hour MB = (400)(0.2) = $8; MB>MC; continue recycling 3rd hour MB = (300)(0.2) = $6; MB=MC; optimal reached; stop right here, dont recycle any more
Chapter 6: Perfectly Competitive Supply Slide 5
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What is the lowest redemption price that would induce Harry to recycle 1 hour/day? He needs to earn at leas $6 and his MP=600 containers. So he needs to be able to make at least 1 cent per container to break even with dishwashing. So Harrys Reservation Price (as a seller of recycled containers) for the first 600 containers is 1 cent.
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MB=MRP=pxMP must equal $6, where p=redemption price of recycled containers Reservation Price
1 hour recycling = p(600) = $6; p = 1 cent 2 hours recycling = p(400) = $6; p = 1.5 cents 3 hours recycling = p(300) = $6; p = 2 cents 4 hours recycling = p(200) = $6; p = 3 cents 5 hours recycling = p(100) = $6; p = 6 cents
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We introduce a second individual, Barry, with an identical supply curve as Harry. The market supply curve is the horizontal sum of all individual supply curves in the market.
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3 2
=
Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
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Slide 11
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Slide 12
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Individual (firm) supply curves are upward sloping because of the principle of increasing OC (as shown by the diminishing MP in Harrys case). Market (industry) supply curves are upward sloping for an additional reason that suppliers differ in their OCs; when redemption price is low suppliers with low OC supply the good; as redemption price increases, suppliers with higher OC join in. If Harrys OC rises to $8, his RP for the 1st 600 containers will rise to 1.33 cents.
Chapter 6: Perfectly Competitive Supply Slide 13
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Factor of production An input used in the production of a good or service Short run A period of time sufficiently short that at least some of the firms factors of production are fixed Fixed factor of production An input whose quantity cannot be altered in the short run like heavy machinery, land, etc Variable factor of production An input whose quantity can be altered even in the short run like labor, etc. Long run - period of time long enough such that all factors of production are variable.
Chapter 6: Perfectly Competitive Supply Slide 14
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Consider a small company that makes glass bottles For simplicity, assume silica is free Two factors of production Labor (variable) Capital (fixed) oA bottle-making machine
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Employees/day
0 1 2
0 80 200
-80 120
3
4 5
260
300 330
60
40 30
6
7
Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
350
362
20
12
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Fixed cost The sum of all payments made to a firms fixed factors of production Assume: the cost of the bottle making machine is $40/day (fixed cost). Variable cost The sum of all payments made to the firms variable factors of production The cost of labor is $12/worker (variable cost).
Slide 18
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Total Cost (TC) is also the sum total of Total Fixed Cost (TFC) and Total Variable Cost (TVC)
TC = TFC + TVC
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Marginal Cost (MC) is the change in total cost resulting from a one-unit rise in the level of output, holding everything else constant. Marginal Cost =
DTC DQ
DTFC
=
DTVC
+
DQ
DQ
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0 1 2 3
0 80 200 260
40 40 40 40
0 12 24 36
4
5 6
300
330 350
40
40 40
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60 72
88
100 112
0.30
0.40 0.60 1.00
362
40
84
124
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0 1 2
0 80 200
0 12 24 0.150 0.120
3
4 5 6 7
260
300 330 350 362
36
48 60 72 84
0.138
0.160 0.182 0.206 0.232
76
88 100 112 124
0.292
0.293 0.303 0.320 0.343
1.00
Slide 22
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Total revenue = PxQ Assume: bottles sell for $0.35 each. So if 100 bottles are sold, TR=$35. Average Revenue = (PxQ)/Q = P Average Revenue always equals price it is an identity; AR is just another name for P. So the AR per bottle is $0.35. Marginal revenue = Change in TR divided by change in Q. When P is constant, MR=P; when P is rising, MR>P and when price is falling MR<P.
Chapter 6: Perfectly Competitive Supply Slide 23
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Although firms may have other goals, most of the time private firms are in business because they want to maximize Total Profit. Total Profit = TR TC
TR = PxQ TC = Money Costs (explicit) + Opportunity Costs (implicit) In Economics, Total Profit is called Economic Profit
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Economic Profit
Goofy, the owner of a small business makes profit of $35,000 a year. He could also have earned $35,000 working as a consultant for a software firm. Goofys accounting profit is $35,000.
Goofys Economic Profit = $0.
We will see that firms make zero economic profits in many markets.
Slide 25
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Maximum Profit
To maximize total profit (P), one needs to set marginal profit to zero.
Marginal Profit
DP DQ
DTR
=
DTC
-
DQ
DQ
MB MC
0 1 2 3 4 5 6 7
0 28 70 91 105
MB = .35
40
-40
MB = .35
MB = .35 MB = .35
115.50 MB = .35 100 MC = .40 122.50 MB = .35 112 MC = .60 126.70 MB = .35 124 MC = 1.00
Slide 27
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Numerous buyers and sellers small market share so that no individual agent can affect the price; buyers and sellers are price takers. Homogeneous (standardized) product difficult to satisfy in reality; buyers are willing to switch to the seller offering the lowest price Mobile productive resources (freedom of entry and exit) Sellers can move with labor, capital, and other productive resources to the most profitable activity Buyers and sellers are well informed buyers know all relevant opportunities available to them
Chapter 4: Elasticity
Slide 28
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The individual firm takes the price as given. Individual agents are price takers. The firm can sell any amount of the product at given prices. The firm faces a perfectly elastic horizontal demand curve.
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Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
7/21/2013
Sudeshna C. Bandyopadhy
d: MR=AR
P* P*
Industry
Firm
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The firm maximizes profits. In the short-run, no new firms enter the industry and no existing firms leave the industry. The firm maximizes profit by setting MR=MC.
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Sudeshna C. Bandyopadhy
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ATC d: MR=AR
E P* 1 ATC*
2
q
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Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Firm
q*
7/21/2013
Sudeshna C. Bandyopadhy
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ATC* 2 P* E d: MR=AR
Firm
Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
q*
q
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Break Even when: Economic profit = 0. TR = TC. Min ATC (Point B).
MC
Min ATC
B d: MR=AR E
P*
Firm
q*
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Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
7/21/2013
Sudeshna C. Bandyopadhy
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Julias monthly mortgage and other fixed costs are $750 per month. If she rents to Paul, there will be additional costs (electricity, water etc. and depreciation) of $210 per month.
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Say TR=$500, TVC=300 and TFC=400. If the firm remains in business, loss is $200. If the firm shuts down, loss is $400. If TR>TVC, stay in business. If TR<TVC, shut down.
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Sudeshna C. Bandyopadhy
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If P>AVC, stay in business. If P<AVC, shut down. If P=AVC, indifferent between shutting down and staying open. Shut down point: Minimum point on the AVC curve.
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Shut Down when: TR<TVC. P < AVC. Shut Down Point: Min AVC: S.
AVC
P*
S d: MR=AR
Firm
q*
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Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
7/21/2013
Sudeshna C. Bandyopadhy
MB MC
A firms supply curve is its MC curve, above the shut down point, S.
AVC
P*
S d: MR=AR
Firm
q*
39
Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
7/21/2013
Sudeshna C. Bandyopadhy
MB MC
Short-run marginal cost curves have a positive slope Higher prices generally increase quantity supplied In the long run, all inputs are variable; so long-run supply curves can be flat, upward sloping, or downward sloping The perfectly competitive firm's supply curve is its marginal cost curve - applies in both the short run and the long run
Chapter 6: Perfectly Competitive Supply Slide 40
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Economic Naturalist
When recycling is left to private market forces, why are many more aluminum beverage containers recycled than glass ones? Aluminum containers can be easily processed for scrap aluminum and so fetch high redemption prices. Glass containers have limited resale value because raw materials needed to produce glass are very cheap.
Chapter 6: Perfectly Competitive Supply Slide 41
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Recycling is an activity with positive externalities. So in a market determined private equilibrium too little will be recycled. There is an equilibrium amount of litter that is likely to be greater than zero. This is because of scarcity and OC of resources used in getting rid of litter.
Slide 42
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60,000 citizens would collectively pay 6 cents for each container which equals marginal benefit Redemptions price
The local government pays 6 cents/contai ner. The optimal quantity of containers is 16,000/day where MC(.06) = MB
(cents/container)
3 2 1.5 1
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Slide 43
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Will all containers be removed from the environment at $0.06/container? No. Why is the optimal amount of removal 16,000/day? Because of the underlying cost benefit numbers; proceeding beyond 16,000 is wasteful. Will private individuals choose to remove 16,000 containers/day? No, because anyone that pays for litter removal bears the full cost but only a fraction of the benefit (6 cents/60,000) = 0.0001 cent per person.
Chapter 6: Perfectly Competitive Supply Slide 44
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Producer Surplus
Slide 45
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3.00
Price ($/gallon)
2.50
2.00 1.50 1.00
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Slide 46
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3.00
Price ($/gallon)
2.50
2.00 1.50 1.00 Producer surplus = $4,000/day
D
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Slide 47
End of Chapter
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