1 chapter 6: perfectly competitive supply derive a supply curve –opportunity cost the principle...
TRANSCRIPT
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Chapter 6: Perfectly Competitive Supply
• Derive a supply curve
– Opportunity cost The principle of increasing opportunity cost
– Seller’s reservation price
– Cost-Benefit principle Marginal benefit vs. marginal cost
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Individual’s Supply Curve
• An example– Opportunity cost of Harry's time
• Wash dishes for $6 per hour is his baseline• Recycling aluminum cans is the alternative
– Harry earns 2¢ per can
– How much labor should Harry supply to each activity?
• Harry should work at recycling as long as he is earning at least $6 per hour
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Harry’s Supply Curve
Recycling Services
Hours per Day
Total Number of Containers Found
0 0
1 600
2 1,000
3 1,300
4 1,500
5 1,600
Additional Number of Cans
Found
600
400
300
200
100
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Harry’s Supply Curve
Recycling Services
Hours per DayAdditional Number of
Cans FoundRevenue from
Additional Cans
1 600 $12.00
2 400 $8.00
3 300 $6.00
4 200 $4.00
5 100 $2.00
Harry's rule is to collect cans if the return in an hour is the same as washing dishes; The opportunity cost of collecting cans in an hour is the revenue given up from washing dishes - $6; Therefore, Harry should spend 3 hours in recycling cans.
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Harry’s Supply Curve
Reservation Price Per Can
Hours per Day
Additional Number of Cans
Found
1 600
2 400
3 300
4 200
5 100
• What is the lowest deposit per can that would get Harry to recycle for an hour?
• What price makes his wage at recycling equal to his opportunity cost?1st hour price is 1¢
2nd hour is 1.5¢
3rd hour is 2¢
4th hour is 3¢
5th hour is 6¢
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Harry’s Supply Curve
Reservation Price (¢)
Number of Cans (00s)
1 61.5 102 133 156 16
Recycled cans(100s of cans/day)
Dep
osit
(cen
ts/c
an)
6 10 13 16
6
3
2
1
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Individual and Market Supply Curves
Recycled cans (00s of cans/day)
Recycled cans (00s of cans/day)
Recycled cans (00s of cans/day)
016
6
16
6
32
6
6
1
6
1
12
1
13
3
2
1513
3
2
1526
3
2
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Harry’s Supply Curve Barry’s Supply Curve Market Supply Curve
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Profit Maximization
• Economists assume firms seek to maximize profits– Corresponds to buyers' maximizing utility
• Profit is total revenue minus total cost– Both explicit and implicit costs are included in
total cost
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Perfectly Competitive Firm
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Perfectly Competitive Firm's Demand
• Market supply and market demand set the price– Buyers and sellers takes price (P) as given
• Perfectly competitive firm can sell all it wants to sell at the market price– Since the supplier is small, its output decision
will not change market price– Each firm must decide how much to supply (Q)
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Perfectly Competitive Firm's Demand
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Profit Maximization – An Example
• In the example, the model has a single product and two inputs, labor and capital– Capital is fixed, labor is variable
• Determine the profit maximizing level of output for a perfectly competitive bottle manufacturer
• Capacity of the bottle-making machine is fixed
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Law of Diminishing Return
The Law of Diminishing Returns
With all inputs except one fixed,
additional units of the variable input yield
ever smaller amounts of additional output
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Law of Diminishing Return
• At low levels of production, the law of diminishing returns may not hold– Similar to the increase in a buyer's marginal utility from
a second unit
• As with marginal utility, marginal product eventually diminishes– Lower marginal products are often caused by
congestion• Workers per machine• Information flows
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Cost Concepts
• A fixed factor of production is an input whose quantity cannot be changed in the short run– Fixed cost (FC) is the sum of all payments for fixed
inputs• A variable factor of production is an input whose quantity
can be changed in the short run– Variable cost (VC) is the sum of all payments for
variable inputs• Total cost (TC) is the sum of all payments for inputs• Marginal cost (MC) is the change in total cost divided by
the change in output
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Profit Maximization - Data
Workers Bottles per Day
0 0
1 80
2 200
3 260
4 300
5 330
6 350
7 362
Fixed Costs ($/day)
$40
40
40
40
40
40
40
40
Variable Cost
($/day)
$0
12
24
36
48
60
72
84
Total Cost
($/day)
$40
52
64
76
88
100
112
124
Marginal Cost
($/bottle)
$0.15
0.10
0.20
0.30
0.40
0.60
1.00
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Profit Maximization
Profit = Total revenue – Total cost
• Since Total cost = Fixed cost + Variable cost
Profit = Total revenue – Variable cost – Fixed cost• The firm must know about both revenues and
costs in order to maximize profits– Increase output if marginal benefit is at least as great
as marginal cost– Decrease output if marginal benefit is less than
marginal cost
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Profit Maximization
• Firms maximize their profit when marginal benefit equals marginal cost;
• In a perfectly competitive market, marginal benefit is simply the market price, which is a constant;
• Fixed costs do not affect the marginal cost, since the change in fixed costs is zero.
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ATC, AVC, and MC
• Average values are the total divided by quantity– Average variable cost (AVC) is
AVC = VC / Q
– Average total cost (ATC) isATC = TC / Q
• Marginal cost (MC)– MC = ΔTC/ΔQ
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Cost Structure
Workers per day
Bottles per day
Variable Cost ($/day)
AVC ($ per
unit)
Total Cost
ATC ($ per
unit)
0 0 0 40
1 80 12 0.15 52 0.65
2 200 24 0.12 64 0.32
3 260 36 0.135 76 0.292
Marginal Cost ($/unit)
0.15
0.10
0.20
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Cost Structure – A graph
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Profit Maximization – A graph
• Market price is $0.20 per bottle– Produce where the marginal benefit of selling a bottle (price)
equals the marginal cost • 260 bottles per day
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Profit Maximization – A graph
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Production Loss – A graph
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Shut Down Decision
• Firms can make losses in the short run– Some firms continue to operate– Some firms shut down
If the firm shuts down in the short run, it loses all of its fixed costs;
The firm should shut down if revenue is less than variable cost: P x Q < VC for all levels of Q;
The firm should continue its business if revenue is at least larger than variable cost.
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Shut Down – A graph
MCATC
AVC
Price
Output (bottles/day)
Co
st (
$/b
ott
l e)
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"Law" of Supply
• Short-run marginal cost curves have a positive slope– Higher prices generally increase quantity supplied
• In the long run, all inputs are variable– Long-run supply curves can be flat, upward sloping, or
downward sloping
• The perfectly competitive firm's supply curve is its marginal cost curve– At every quantity on the market supply curve, price is
equal to the seller's marginal cost of production– Applies in both the short run and the long run
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Increases in Supply
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Producer Surplus
• Producer surplus is the difference between the market price and the seller's reservation price
• Reservation price is on the supply curve• Producer surplus is the area above the supply curve and
below the market price