Unformatted text preview: PADP 6950: Founda1ons of Policy Analysis Supply Angela Fer1g, PhD Cost Curves We need to learn about cost curves to understand where the supply curve comes from 1 Average Fixed Cost AFC = FC/Q At Q=0, AFC= because divided by 0 Downward sloping as make more, FCs stay same and Q rises Growing flaOer at the beginning, FCs are a big part of each unit's cost Average Variable Cost AVC = VC/Q Intercepts y-axis at 0, no cost un1l first unit Mostly upward sloping AVC goes up with units because of diminishing marginal product; related to the shape of the produc1on func1on 2 Average Total Cost ATC = AFC + AVC u-shaped curve Short-run vs. Long-run ATC ATC is flaOer in the LR more flexibility in LR to adjust output Example: Factory costs $30, workers cost $10 each, factory gets crowded # Factories # Workers 1 1 1 1 2 0 5 10 15 15 Output 0 10 15 16 25 TC ATC 3 Long-run ATC & returns to scale If LR ATC is downward sloped, economies of scale (increasing returns to scale) If a firm is more produc1ve when larger (pharmaceu1cals) If LR ATC is flat, constant returns to scale If firm doubled all inputs, output will be doubled If LR ATC is upward sloped, diseconomies of scale (decreasing returns to scale) If firm is less produc1ve when larger (quality hospital) Marginal Costs MC = TC/Q MC=AVC when moving from Q=0 to Q=1 When MC is below AVC or AC, AVC or AC must be falling When MC is above AVC or AC, AVC or AC must be rising Example: test grades Assume average grade is 90 (AG) Next test is 80 (MG) what happens to AG? Next test is 100 (MG) what happens to AG? 4 Graph MC curve Supply Curve Compe11ve firm chooses Q by maximizing profit: max p Q - C(Q) Q Q This occurs when MR = MC: If MR < MC, then lose money if make addi1onal Q , should move to lower Q If MR > MC, then make money if make addi1onal Q , should move to higher Q For compe11ve firm, MR=PQ So, if the output price is PQ, firm will choose Q where PQ=MC 5 Caveats Supply curve is only the upward-sloping part of the MC curve If MC is downward sloping, can produce more at lower cost per unit Supply curve is only the part of the MC above the AVC curve A firm would not produce if AVC > PQ they would be beOer off shunng down Graph 6 Graphing Profits = TR - TC TR TC = - Q Q Q = P - ATC Q = (P - ATC)Q Short-run vs. Long-run supply Just as with demand curves, the long-run supply curve will be more elas1c than the short-run because firms can make more changes to adjust to price 7 Market Supply Short-run market/industry supply curve is just sum of supplies of individual firms in the market Long-run market supply LR market supply curve in compe11ve industry is very flat In an industry with free entry, profits will be driven to zero by new entrants; when profits are posi1ve, new firms come in and compete In the short-run there can be profits 8 ...
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- Spring '11
- Economics, AFC, AVC, compe11ve