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More on supply

More on supply. Today: Supply curves, opportunity cost, perfect competition, and profit maximization. In previous lectures…. …we have studied demand Today, we start supply Some concepts from demand carry over to supply Horizontal addition Surplus. Other supply concepts.

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More on supply

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  1. More on supply Today: Supply curves, opportunity cost, perfect competition, and profit maximization

  2. In previous lectures… • …we have studied demand • Today, we start supply • Some concepts from demand carry over to supply • Horizontal addition • Surplus

  3. Other supply concepts • It is important to think like an economist when looking at supply • Opportunity cost is important in decision making • Economic profit includes not only explicit costs, but also implicit costs • Costs can be fixed or variable • Some firms may operate at a loss in the short run • MB = MC rule (except under shutdown condition)

  4. Today • Idea of perfect competition • Very little or no market power by any firm • Individual supply to market supply • Opportunity costs • The first steps to profit maximization

  5. Perfect competition • For all discussion until Ch. 10 (monopoly), assume that all markets are perfectly competitive, unless mentioned otherwise • In perfect competition, there are many firms, each of which produces a very small percentage of the good in question

  6. Perfect competition • Each firm has no significant control over price charged under perfect competition • Perfectly competitive markets do not necessarily occur when product differentiation occurs • This will also be addressed in Ch. 10

  7. Perfect competition • Since each firm has no control over price, each firm is called a price taker • In this example, market equilibrium is $5 • Each firm can sell as much of the good it wants at $5/lb.

  8. Perfect competition • How much will each firm sell? • Theory: Each firm will sell the output that maximizes profits

  9. The steps to profit maximization • Profit = Total revenue – Total cost = Total revenue – Variable Cost – Fixed Cost • Opportunity costs are included in the total cost when calculating economic profit

  10. Opportunity cost • Always think “what is the best use of my time?” • Assume that you have 10 hours per week for jobs • Building widgets, which sell for $1 each • Working at an I.V. coffee shop for $10/hr. • Assume that material costs for widgets and walking costs to I.V. are negligible

  11. Opportunity cost • Should I only build widgets, since I am making positive profits for each widget produced? • Maybe • For each widget I build, I must work less at the coffee shop • Similar logic applies to working at the coffee shop

  12. Supply of widgets and coffee shop work • How much should I work at each job? • To make the most money, of course • Remember that marginal analysis is important in making the most money

  13. Widget production function

  14. Why diminishing marginal productivity? • Assume that widget production is labor-intensive • You will pick your most productive work hour each week to be the first hour of work on widgets • You use the best opportunities to be the most productive

  15. How many widgets should I build? • Again, we use marginal analysis in maximizing your earnings for your 10 hours available for work each week • I should build widgets as long as: MB ≥ MC (in dollars)

  16. How many widgets should I build? • MB of 1st hour of work: $15 • MB of 2nd hour of work: $13 • MB of 3rd hour of work: $11 • MB of 4th hour of work: $9 • MC of each hour of widget building is the $10 lost in wages from working at the coffee shop

  17. How many widgets should I build? • Is MB ≥ MC? • 1st hour?  Yes, since $15 > $10 • 2nd hour?  Yes, since $13 > $10 • 3rd hour?  Yes, since $11 > $10 • 4th hour?  No, since $9 < $10

  18. How many widgets should I build? • You should build widgets for 3 hours/week, earning $39 from widgets • You should work 7 hours/week, earning $70 from work • Total earnings: $109/week • Marginal analysis  Maximize earnings

  19. Deriving individual supply • From previous example: • If price of widgets goes up, I would want to spend more time building widgets • If price of widgets goes down, I would want to spend less time building widgets • As price goes up, quantity supplied increases • We have justified an upward-sloping supply curve

  20. Market supply • Horizontal addition from individual supply to market supply • We did this already with demand

  21. Moving on… • Today, we will not start analyzing the costs necessary to analyze profit maximization • We will look at this on Friday

  22. Long run • By definition, the long run is such that all costs are variable • Analysis in the long run is easier than in the short run • In the long run, profits are maximized to be either positive or at zero

  23. Fixed costs in the short run • The short run is defined such that some costs must be spent, whether or not a firm operates • Short run cost examples could include: • Rent • Capital (e.g. manufacturing equipment) • Contract laborers

  24. Simplified analysis • Although there may be many fixed costs and many variable costs, we will study a simple case • One fixed cost: Building rent • One variable cost: Labor costs

  25. Graphical approach? • A graphical approach is best used with continuous cost functions • We will start with a discrete example on Friday

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