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Chapter 6 Perfectly Competitive Supply: The cost side of the market

Chapter 6 Perfectly Competitive Supply: The cost side of the market. Odd-numbered Qs. Q.3, 9 Please refer to “tutorial materials”. Problem #1, Chapter 6 (1).

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Chapter 6 Perfectly Competitive Supply: The cost side of the market

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  1. Chapter 6 Perfectly Competitive Supply:The cost side of the market Odd-numbered Qs. Q.3, 9 Please refer to “tutorial materials”

  2. Problem #1, Chapter 6 (1) • Zoe is trying to decide how to divide her time between her job as a wedding photography, which pays $27 per hours for as many hours as she chooses to work, and as a fossil collector, in which her pay depends both on the price of fossils and the number of them she finds. Earnings aside, Zoe is indifferent between the two tasks, and the number of fossils she can find depends on the number of hours a day she researches, as shown in the table below.

  3. Problem #1, Chapter 6 (2)

  4. Solution to Problem #1 (1) • Derive a table with a price in dollar increments from $0 to $30 in the first column and the quantity of fossils Zoe is willing to supply per day at that price in the second column

  5. Solution to Problem #1 (2) • In the first hour, Zoe can collect 5 fossils • If the price of a fossil is $5, Zoe can make a total $25 in an hour if she devotes all her time to collecting fossils, which is less than the money she can earn from photography • Thus, she won’t collect fossil if the price of a fossil is less than $5 • If the price of a fossil is $6 Zoe should devote all her time to photography, as she can make $30 an hour from photography

  6. Solution to Problem #1 (3) • An additional hour would yield only 4 additional fossils or $24 additional revenue, so she should not spend any further time looking for fossils • If the price of fossils rises to $7, however, the additional hour gathering fossils would yield an additional $28, so gathering fossils during that hour would then be the best choice, and Zoe would therefore supply 9 fossils per day

  7. Solution to Problem #1 (4)

  8. Solution to Problem #1 (5) • Plot these points in a graph with price on the vertical axis and quantity per day on the horizontal. What is this curve called? • The curve will depict a price-quantity supplied relationship for fossils as follows • In other words, it is SUPPLY CURVE for fossils

  9. Solution to Problem #1 (6)

  10. Problem #5, Chapter 6 • The supply curve for the only two firms in a competitive industry are given by P=2Q1 and P= 2+Q2, where Q1 is the output of firm 1 and Q2 is the output of firm 2. What is the market supply curve for this industry? (Hint: graph the two curves side by side, then add their respective quantities at a sample of different prices.)

  11. Solution to Problem #5 (1) • Horizontal summation means holding price fixed and adding the corresponding quantities Market supply curve Firm 1 Firm 2 P P P P =2+Q2 P =2Q1 S 6 6 6 P= (4/3) + (2/3)Q for P>2 4 4 4 2 2 2 P= 2Q for P<2 Q1 Q2 Q 2 1 2 3 4 1 4 7

  12. Problem #7, Chapter 6 • For the pizza seller whose marginal, average variable, and average total cost curves are shown in the accompanying diagram, what is the profit-maximizing level of output and how much profit will this producer earn if the price of pizza is $2.50 per slice?

  13. Solution to Problem #7 (1) MC Price ($/slice) 2.50 ATC AVC 1.40 0 0 0 570 Quantity (slices/day)

  14. Solution to Problem #7 (2) MC ATC Price ($/slice) 2.50 AVC 1.40 0 0 0 570 Quantity (slices/day) Wrong! MC cuts ATC at its minimum.

  15. Solution to Problem #7 (3) MC ATC Price ($/slice) 2.50 AVC 1.40 0 0 0 570 Quantity (slices/day) Wrong! MC cuts AVC at its minimum.

  16. Solution to Problem #7 (4) MC ATC Price ($/slice) 2.50 AVC 1.40 0 0 0 570 Quantity (slices/day) Wrong! AVC and ATC approaches each other as quantity increases.

  17. Solution to Problem #7 (5) • Assume it is a perfectly competitive market • Firms are earning a zero economic profit • Firms should always charge at a price that is equal to their marginal cost

  18. Solution to Problem #7 (6) • If P > ATC > AVC, the firm operates with a profit • If ATC > P > AVC, the firm still operates but with a loss- the operation can cover part of its fixed cost • If ATC > AVC > P, the firm should shut down as it cannot even cover part of its fixed cost

  19. Solution to Problem #7 (7) • To maximize profit, the firm will produce 570 slices of pizza a day • Why? • At 570 slices of pizza per day, the difference between the marginal cost (MC) and the average total cost (ATC) is maximized • The associated profit is (P or MC – ATC)*Q • ($2.5 / slice - $1.4 / slice) * 570 slices / day • $627 / day

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