6.0 representing the power of the invisible hand
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6.0 Representing the Power of the Invisible Hand. 6.1.1. Many nations of the world have switched to markets They are convinced that markets will help nations realize greater wealth by making production more efficient. 6.1.2. Marginal cost – how much it costs to make the next unit - PowerPoint PPT PresentationTRANSCRIPT
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6.0 Representing the Power of the Invisible Hand
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6.1.1
Many nations of the world have switched to markets
They are convinced that markets will help nations realize greater wealth by making production more efficient
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6.1.2
Marginal cost – how much it costs to make the next unit
Average cost – generic measure of cost, total cost of production divided by total units produced
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Unit of Output
MC ACCalculating
AC
1st 100 100 100/1
2nd 90 95 190/2
3rd 80 90 270/3
4th 70 85 340/4
5th 80 84 420/5
6th 90 85 510/6
7th 100 87 610/7
8th 110 90 720/8
9th 120 93 8409
10th 130 97 970/10
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6.1.3
Average 27 goals a season
This year you score (at the margin) 35
What happens to average?
It goes up
Margin pulls average along
If margin is higher than average, it pulls it up, and vice versa
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6.1.4
$
Figure 6.1.1- Marginal Cost cuts Average Cost at the Minimum Point along AC curve
Units of Output
MC
AC
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MC always intersects AC at the bottom or minimum of the AC curve
Marginal always pulls average in its direction
This relationship between MC and AC will be an important part of efficiency
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6.1.5
For a firm in the product market,
A profit is when total revenue exceeds total costs
A loss is when total costs exceed total revenue
Breaking even is when total costs and total revenue are the same
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Total revenue-
Money it takes in from sale of a product
TR = p X Q
5 cars at $20,000 each = $100,000 total revenue
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Total cost-
Amount of money a firm spends on the process of producing
TC = AC X Q
Produces 5 cars at an average of $17,000 each = $85,000 total cost
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- Stands for profit
TCTR
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In this example,
The firm is making $15,000 profit
$100,000 - $85,000 = $15,000
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6.1.6FIRM MARKET
Figure 6.1.2 - The Firm and the Market - Identifying Profit
$
AC1
Q
p
D
Q
MC, Supply Curve
p1
Q1
D1
p1
S1
AC
PROFIT
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Market price is p1
Firm will produce Q1 because that is where MC (supply) is
The average cost at Q1 is AC1
Total revenue = p X Q
Total cost = AC X Q
Think of each of these as rectangles
TR > TC
Profit = TR -TC
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6.1.7
Profit is revenue above costs
Costs include normal returns
Profit is gravy, it’s nice,
but not necessary to stay in business
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Profits mean
that market is a good place to be
Under perfect competition,
firms have no power and all have equal access to information
Profits attract competitors
Market supply shifts out, price falls
profits are driven to zero
Only costs are covered
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FIRM MARKET
Figure 6.1.3 - Competition, Market Entry, and the Squeezing of Profits
$
p1
Q
p
D
Q
p1
Q1
MC
AC2, p2
Q2
D2p2
S2
S1Shift in S
Fall inMarketPrice
AC
AC1
D1
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6.1.8
Profit is a powerful yet ephemeral signal
It is a magnet that attracts competitors, yet the irony is that
the competition drives profits away
Firms only get normal returns under perfect competition
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6.1.9
when profits have been driven to zero by competition
p = MC = ACat the bottom of the average curve lineMaximum productivity, minimal average
costThis is the most efficient point of
production
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The self-interested behavior of seeking profits leads to the
most efficient outcome
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6.1.10
Perfect competition forces firms to adopt the
most efficient, lowest cost technique
If they don’t, they get left in the dust, as customers move elsewhere,
given our nice assumption of equal access to markets and info
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6.2.1
Not only do markets encourage efficiency,
they also encourage creativity and inventiveness
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6.2.2
If perfect competition has a firm producing at the bottom of its average cost curve,
it can go on just making normal returns
How can you do better?
You must innovate and become more efficient than your competitors
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Such innovation
will lower your cost structure
you could make a profit while others are breaking even
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6.2.3
Another way to beat the market is to create a new market niche
First firm in with a new product can make big profits if the market likes it
“Build a better mousetrap”
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6.2.4
Competitors will mimic you
Market price will fall, profits will disappear
Markets are always driving people to think of new products,
or better versions of old products,
or more efficient ways of producing
Markets are engines for material progress, which can benefit all
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The magic of markets
under perfect competition, firms will be amazingly efficient and innovative
A nation can get the most from its resources
This is the power of the invisible hand
6.2.5
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a just distribution
Markets are amoral
They just coordinate choices giventhe distribution of social endowment among
people
individual preferences
the state of technology
However, efficiency doesn’t necessarily mean