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1 Econ5103 Business Economics Lecture Notes 3

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2 Part A Perfectly competitive supply: the cost side of the market
3 Learning Objectives State the law of supply Describe how a firm in a perfectly competitive market decides how much to supply at each price Apply the profit-maximising rule Explain the relationship between the law of diminishing returns and SR cost curves Construct a market supply curve from individual supply curves Use theory of supply to predict the firm behaviour Define and calculate producer surplus and analyse welfare effects

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4 The opportunity cost Example: How much time should Harry spend recycling soft drink containers?
5 The opportunity cost Harry is choosing between washing dishes for \$6/hour and collecting containers at 2 cents each Opportunity cost of collecting cans is \$6/hour Applying the cost-benefit principle: 1 hour collecting cans = (600)(.02) = \$12 Benefit (\$12) > Opportunity cost (\$6) 2nd hour benefit (\$8) > Opportunity cost (\$6) 3rd hour benefit (\$6) = Opportunity cost (\$6)

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6 The opportunity cost Question: What is the lowest refund that would induce Harry to spend at least 1 hour/day recycling? Solution: 600 containers x 1 cent = \$6 = opportunity cost of washing dishes
7 The opportunity cost Harry’s additional earnings from searching the additional hour will be ( 29 6 \$ = Q p ) ( Q p The smallest refund that will lead Harry to search another hour must satisfy the equation: = 400 p (400)= \$6 p = 1.5 cents (\$0.015) ΔQ

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8 Harry’s individual supply curve for  recycling services
9 Individual and market supply curves The quantity that corresponds to a given price on the market supply curve is the sum of the quantities supplied at that price by all individual sellers

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10 Market supply curve Horizontal summation of individual supply curves Upward sloping Reasons for upward-sloped supply curve: costs tend to rise with expanded production each individual exploits his most attractive opportunities first different potential sellers face different opportunity costs
11 Supply in perfectly competitive  markets Profit: The total revenue a firm receives from the sale of its product minus all costs – explicit and implicit – incurred in producing it Profit maximising firm: A firm whose primary goal is to maximise the difference between its total revenues and total costs, or profit Perfectly competitive market: A market in which no individual supplier has any influence on the market price of the product Price taker: A firm that has no influence over the price at which it sells its product

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12 Characteristics of perfectly  competitive markets 1. All firms sell the same standardised product 2. The market has many buyers and sellers each of which buys or sells only a small fraction of the total quantity exchanged 3. Sellers are able to enter and leave a market as they like 4. Buyers and sellers are well informed 1-12
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