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Lecture_18_Firm_Supply - Lecture 18 Firm Supply c 2008...

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Lecture 18: Firm Supply c ° 2008 Je/rey A. Miron Outline 1. Introduction 2. The Market Environment 3. Pure Competition 4. The Supply Decision of a Competitive Firm 5. Two Exceptions 6. Pro°ts and Producer Surplus 7. The Long-Run Supply Curve of a Firm 7. Constant Long-Run Average Costs 1 Introduction We are now in a position to analyze the supply decisions of °rms. This is a step beyond examining the cost minimization or pro°t maximization problem. In the case of cost minimization, we simply asked how a °rm produces a given amount of output at the lowest cost. In the case of pro°t maximization, we ask what output and input choices the °rm makes for a given set of output prices and input prices. Now we want to characterize the relation between the output price and the amount produced. We will, for the most part, suppress input prices. This analysis will describe the supply curve of a competitive °rm based on the cost function and the assumption of pro°t maximization. We start by describing the environment in which a competitive °rm operates. 1
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2 The Market Environment A °rm must choose two things: how much to produce, and at what price to sell. In the absence of any constraints, the °rm would produce an in°nite amount and set an in°nite price. The °rm face constraints, however: technology and the market. The technological constraints are summarized by the production function and the cost function (these two are related, but the cost function contains additional information in the form of input prices). The fact that additional output re- quires additional costs does not per se prevent the °rm from increasing production arbitrarily, but it suggests that it must balance the costs against possible additional revenue. The market constraint is summarized by the demand curve: if the °rm sets a price p , it will only sell an amount x . We call the relationship between the price a °rm sets and the amount that it sells the demand curve facing the °rm . If there is only one °rm, the demand curve facing the °rm is the market demand curve. If there are two or more °rms, the demand curve facing the °rm is di/erent from the market demand curve. In particular, the °rm has to form a guess, expectation, or belief about how other °rms are going to behave. Those °rms are likely to be forming their own expectations; the original °rm has to then form expectations of the other °rms± expectations, and so on. So, things can get messy fast. We will address some of the more complicated market environments later. We start, however, with the simplest possible market environment: pure compe- tition. 3 Pure Competition We say that a market is purely competitive if each °rm assumes that the market price is independent of its own level of output.
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