6
Perfectly Chapter Competitive Supply
McGraw-Hill/Irwin
2009 The McGraw-Hill Companies, All Rights Reserved
Productivity Changes Over Time
Productivity is output per unit of input is output per unit of input We have seen that labor productivity in manufacturing has increased due to increased capital per worker or the invention of robots We have also seen that labor productivity in services has grown more slowly: Teaching Orchestras Barbers has grown more slowly: Teaching, Orchestras, Barbers, Doctors Manufacturing wages and service wages have increased at about the same rates. Why? Principle of Opportunity Cost: All would go to manufacturing manufacturing
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Buyers and Suppliers
When we study demand we know that the Cost-Benefit we study demand we know that the Cost Principle is behind decision making Buyers: buy one more unit? Only if the marginal benefit (marginal utility) is at least as great as marginal cost Sellers: sell one more unit? Only if marginal benefit (marginal revenue) is at least as great as marginal cost as great as marginal cost Opportunity Cost also matters: Buyers: hamburger or pizza? Sellers: recycle aluminum or wash dishes?
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Example: Recycling Services
Opportunity cost of Harry's time: cost of Harry time: Wash dishes for $6 per hour is his baseline Recycling aluminum cans is the alternative aluminum cans is the alternative Harry earns the deposit, 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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Recycling Services
Hours per Day 0 1 2 3 4 5
Total Number of Containers Found 0 600 1,000 1,300 1,500 1,600
Additional Number of Cans Found 600 400 300 200 100
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Recycling Services
Hours per Day Hours per Day 1 2 3 4 5 Additional Number of Cans Found 600 400 300 200 100 Revenue from Additional Cans $12.00 $8.00 $6.00 $4.00 $2.00
For the first two hours, Harry earns more recycling cans than washing washing For the third hour, there is a tie with washing dishes Harry's rule is to collect cans if the return is the same as washing dishes: Harry spends hours recycling dishes: Harry spends 3 hours recycling
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Recycling Services
Suppose the deposit goes up the deposit goes up to 4 per can Harry will spend 4 hours per day recycling per day recycling Suppose Harry's dishwashing wage increases to $7 Deposit stays at 2 each stays at each Harry collects cans for 2 hours a day Harry recycles more if if Can deposit increase Dish-washing wage decreases
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Hours per Day 1 2 3 4 5
Additional Number of Cans Found 600, $24 400, $16 300, $12 $12 200, $8 100, $4
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Reservation Price Per Can
What is the lowest deposit per at depos pe can that would get Harry to recycle for an hour? Question: What price makes his wage at recycling equal to his opportunity cost?
Additional Number of Cans Found 600 400 300 200 100
Hours per Day 1 2 3 4 5
pQ $6
1st
For hour p=6/600=1 cent For 2nd hour p=6/400=1.5 c. p=6/400=1 For 3rd hour p=6/300=2 cents For 4th hour p=6/200=3 cents For 5th hour p=6/100=6 cents
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Harry's Supply Curve
Reservation Price () 1 1.5 2 3 6 Number of Cans (000s) 6 10 13 15 16
Deposit (cents/can)
6
3 2 1 6 10 13 16 Recycled cans (100s of cans/day)
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Individual and Market Supply Curves
Harry has an identical twin, Barry
Harrys Supply Curve Deposit (cents/can) Barrys Supply Curve Market Supply Curve
6
6
6
3 2 1 10 13 16 15 Recycled cans cans (00s of cans/day) 6
3 2 1.5 1 10 13 16 15 Recycled cans cans (00s of cans/day) 6 1.5
3 2 1 0 12 20 26 Recycled cans (00s of cans/day) 32 30
1.5
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The Market Supply Curve pp with 1,000 Identical Sellers Price (cent/can)
Market Supply Curve
6
3 2 1.5 1
0
6
10
13
16
Quantity 15 (100,000s of cans/day)
McGraw-Hill/Irwin
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Why is the supply curve upward sloping? Why is the supply curve upward sloping? 1. Low-hanging fruit principle When can prices are low, it might pay to get those it th cans that are easiest to get. When prices rise, it will pay to search further away. When prices go up, people will supply more of the good. Differences among suppliers in opportunity cost Diff People facing unattractive employment opportunities may be willing to collect cans Those with more may be willing to collect cans. Those with more attractive options will collect cans only if the reservation price is relatively high. So when the price goes up more people will supply the goods goes up, more people will supply the goods.
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2.
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Profit Maximization
To explore the supply curve we need to make explore the supply curve we need to make assumptions on what firms do. 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 The Perfectly Competitive Market A market in which no individual supplier has significant influence on the market price of the product, i.e., each firm is a price taker.
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Perfectly Competitive Firms
Standardized Products Products Identical goods offered by many sellers No loyalty to loyalty to your supplier Many Buyers, Many Sellers Buyers Many Sellers Each has small market share No buyer or seller can influence price influence price Price takers
Perfectly Competitive Firms
Mobile Resources Mobile Resources Inputs move to their highest value use Firms enter and leave industries
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Informed Buyers and Sellers Informed Buyers and Sellers Buyers know market prices Sellers know all opportunities and technologies
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Examples Examples
Wheat market and many other agricultural products The product is standardized; product is standardized; Many buyers and sellers each of which buyers and sells only a small fraction; If an individual farms charge even 10 cents more per lb, he wont be able to sell any. Computer operating system Microsoft windows takes 90% of the market; windows takes 90% of the market; Even if its prices go up, say, by 50%, many will still buy it. So Microsoft is not a price taker.
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Different Market Structures Different Market Structures Perfectly Competitive: many firms. Price taker. Oligopoly: A few firms in the market. U.S. auto industry few firms in the market auto industry Duopoly: two firms in the market. Internet service in Stony Brook: Cablevision and Verizon. Monopoly: only one firm in the market. Price setter. Oriental grocery store in Stony Brook.
Market power (price-setting power)
Perfect competition
Oligopoly
Duopoly Imperfect competition
Monopoly
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Perfectly Competitive Firm's Demand
The price of a good is determined by the market supply price of good is determined by the market supply and market demand Buyers and sellers take price (P) as given A perfectly competitive firm can sell all it wants at the market price, so the demand curve is perfectly elastic Since the supplier is small, its output decision will not th it change market price. Each firm must decide how much to supply (Q). firm must decide how much to supply (Q). In contrast, imperfectly competitive firms have some control of price and they have to choose prices also.
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Perfectly Competitive Firm's Demand
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Concepts of Production and Costs
Production converts inputs into outputs converts inputs into outputs Technology is a recipe for production A factor of production is an input used in the factor of production an input used in the production of a good or a service Examples are land, labor, capital, and entrepreneurship The short run is the period of time when at least one of the firm factors of production is fixed, cannot be the firm's factors of production is fixed, cannot be varied The long run is the period of time in which all inputs are variable
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Concepts of Production and Costs Concepts of Production and Costs
Variable factor of production: an input whose quantity can be altered in the short run can be altered in the short run Fixed factor of production: an input whose quantity cannot be altered in the short run. We will start by examining the short run. We look at a model with a single product and two inputs, labor and capital. Capital is fixed, labor is variable We will determine the profit maximizing level of output for will determine the profit maximizing level of output for a perfectly competitive bottle manufacturer Capacity of the bottle-making machine is fixed because we look at the short run.
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Concepts Production of and Costs Concepts of Production and Costs Fixed cost (FC) is the sum of all payments for fixed cost is the sum of all payments for fixed inputs Variable cost (VC) is the sum of all payments for variable inputs Total cost = variable cost + fixed cost Marginal cost (MC) is the change in total cost th divided by the change in output
TC MC Output
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McGraw-Hill/Irwin
Example A company makes glass bottles Two factors of production Labor (variable) Capital (fixed): a bottle-making machine
Total employees/day
0 1 2 3 4 5 6 7
McGraw-Hill/Irwin
Total bottles /day
0 80 200
Observation: Output gains from gains from each additional worker begins to diminish from the diminish from the third employee
260 300 330 350
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362
Law of Diminishing Returns
The Law of Diminishing Returns With all inputs except one fixed, additional units of the variable input yield additional units of the variable input yield ever smaller amounts of additional output
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Law of Diminishing Returns
As with marginal utility, marginal product eventually with marginal utility marginal product eventually diminishes Lower marginal products are often caused by congestion Examples: increasing workers on a piece of land, increase workers for given number of machines increase workers for a given number of machines
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Find the Output Level that Maximizes Profit
Profit = Total revenue Total cost Total revenue 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 as marginal cost Decrease output if marginal benefit is greater than marginal cost
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The cost of the bottle making machine is $40/day (fixed cost). The cost of the bottle making machine is $40/day (fixed cost). The cost of labor is $12/worker (variable cost). The price is $0.35 per bottle so produce 300
Workers 0 1 2 3 4 5 6 7
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Bottles per Day 0 80 200 260 300 330 350 362
Fixed Costs ($/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) $0.15 0.10 0.20 0.30 0.40 0.60 1.00
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We now calculate profits We now calculate profits
Employees per day
Output (bottles/day)
Total revenue ($/day)
Total cost ($/day)
Profit ($/day)
0 1 2 3 4 5 6 7
McGraw-Hill/Irwin
0 80 200 260 300 330 350 362
0 28 70 91 105
40
-40
MB = .35 52 MC = .15 -24 MB = .35 64 MC = .10 6
MB = .35 76 MC = .20 15 MB = .35 88 MC = .30 17
115.50 MB = .35 100 MC = .40 15.50 122.50 MB = .35 112 MC = .60 10.50 126.70 MB = .35 124 MC = 1.00 2.70
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Shut-Down Decision of Competitive Firms
Firms can make losses in the short run can make losses in the short run Some firms continue to operate Some firms shut down firms shut down If we apply the Cost Benefit Principle to losses Continue to operate if your losses are less than if you shut down. Shut down if your losses are less than if you continued operating continued operating.
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Shut-Down Condition
The firm should shut down if revenue is less than firm should shut down if revenue is less than variable cost: P x Q < VC for all levels of Q The firm is losing money on every unit it makes If the firm shuts down, it only loses its fixed costs If the firm's revenue is at least as big as variable cost, th fi the firm should continue to produce Each unit pays its variable costs and contributes to fixed costs fixed costs Losses will be less than fixed costs
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AVC and ATC
Average values are the total divided by quantity values are the total divided by quantity Average variable cost (AVC) is AVC = VC / Q VC Average total cost (ATC) is ATC = TC / Q Shut-down if P x Q < VC P < VC / Q P < AVC Shut down if price is less than average variable cost down if price is less than average variable cost
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Profitable Firms
A firm is profitable if its total revenue is greater than its firm is profitable if its total revenue is greater than its total cost TR > TC OR P x Q > ATC x Q since ATC = TC / Q Another way to state this is to divide both sides of the inequality by Q to get P > ATC As long as the firm's price is greater than its long as the firm price is greater than its average total costs, the firm is profitable
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Workers per day 0 1 2 3 4 5 6 7
Bottles per day 0 80 200 260 300 330 350 362
Average Variable variable cost Total variable cost cost cost ($/unit of ($/day) ($/day) output) 0 12 24 36 48 60 72 84 0.150 0.120 0.138 0.160 0.182 0.206 0.232 40 52 64 76 88 100 112 124
Average total cost total cost ($/unit of output)
Marginal cost ($/bottle)
0.650 0.320 0.292 0.293 0.303 0.320 0.343
0.15 0.10 0.20 0.30 0.40 0.60 1.00
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0.65 0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 80
Upward-sloping MC due to diminishing returns
MC
Cost ($/bottle)
ATC AVC
200
260 300
362
MC = AVC & ATC at their minimum their minimum points
McGraw-Hill/Irwin
330 350 Output (bottles/day)
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Graphical Profit Maximization
Market price is $0.20 per bottle price is $0 per bottle Produce where the marginal benefit of selling a bottle (price) equals the marginal cost 260 bottles per day
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Graphical Profit Maximization
At a price of $0.20, the firm produces 260 bottles price of $0 the firm produces 260 bottles Profit is TR TC or (P ATC) (P ATC) x Q On the graph, (P ATC) is profit per unit of output It is the distance between P = $0.20 and the ATC curve the ATC curve Profit is the area of the rectangle with height (P ATC) and width Q ($0.08) (260) = $20.80
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Price = MC at 260 bottles/day ATC = .12/bottle TR = P*Q = (.20)(260) = $52/day TC = ATC*Q = (.12)(260) = $31.20/day Profit = TR TC = (P-ATC)*Q = $20.80/day TR (P $20
MC
ATC AVC P
Cost ($/bottle)
0.20 0.12
Output (bottles/day)
260
Profit = McGraw-Hill/Irwin area of pink area
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Losses
Losses can also be shown on a graph can also be shown on graph When P < ATC, the firm loses (P ATC) per unit of output Total losses are the rectangle whose height is ATC is ATC P and whose and whose width is Q Losses = (ATC P) (Q) ($0.10 $0.08) (180) = $3.60
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An example of negative profit
Price = .08/bottle P = MC at 180 bottles/day (optimal quantity) ATC ATC = .10/bottle at that quantity at that quantity P < ATC by .02/bottle Profit = -.02 x 180 = -3.60//day
Cost ($/bottle)
MC
ATC AVC
0.10 0.08 180
P
Output (bottles/day)
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Firms supply curve The perfectly competitive firms supply curve is the part of the marginal cost curve that is higher than AVC
Firms Supply curve: Price ($/can) ($/can) Green curves
MC AT AV C C
0
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"Law" of Supply
Short-run marginal cost curves have a positive slope marginal cost curves have positive slope Higher prices generally increase quantity supplied But in the long run, all inputs are variable 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 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
Technology Input Prices Number of Suppliers Expectations Price of Other Products
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More output, need fewer resources If they fall, this decreases costs More suppliers in the market th Lower prices in the future prices in the future Lower prices for alternative products prices for alternative products
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Producer Surplus
Producer surplus is the difference between the market 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 market price
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Equilibrium P = $2 & Q = 4,000 $2 4,000 Producer surplus = (1/2)(4,000 gallons/day) (1/2)(4,000 gallons/day) ($2/gallon) = $4,000/day
Price ($/gallon)
3.00 2.50 2.00 1.50 1.00
S
Producer surplus = $4,000/day D
.50 0 1 2 3 4 5 6 7 8 9 10 11 12
McGraw-Hill/Irwin
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