Supply Side--Lectures

1. Supply Side--Lectures Rebecca Tuttle Baldwin BCC--Micro

2. Reminder for our simple model • Supply side means firms in final goods/service market • We will use corporate structure • Supply ( Price & Quantity relationship) reflects the quantity of the good firm willing & able to produce at various prices.

3. Perfectly Competitive Market • Many buyers • Many sellers • Ease of entry/exit (no barriers) • Perfect information • Homogeneous good

4. Profit • Defined as the residual after subtracting all costs to necessary factors of production from gross revenues. • TR-TC • All firms are profit maximizers, not revenue or sales

5. Result for our individual firm • No market power--it will be a price TAKER

6. How does Total Revenue (TR) depend on Quantity (Q)? • = Price times Quantity (PxQ) • focus on one product’s production at a time • relatively straightforward (comes from demand)

7. Costs • capture opportunity costs of factors • only true costs are opportunity cost • needed for calculation of “economic” profit, to distinguish from “accounting profit” • can be broken down or sorted into fixed/variable or implicit/explicit

8. Time Needs to be brought into our model • Short-run (production decision) • Relevant decision is what Q to produce at? • Long-run (investment decision) • Whether to enter/exit market • In the Long-Run ALL COSTS ARE VARIABLE (FC=0)

9. Production Function • Links quantity of input to output levels • Marginal Product of labor is defined at the incremental increase in production from one more unit of labor, also called Marginal Physical Product (MPP) • Already know marginal concept

10. MPP • Expect it to decline as we add more workers • Why? • When evaluating, we are holding other factors constant

11. Marginal Costs • Change in Total Costs due to one unit change in Quantity produced • =change in TC/change in Q • can graph MC on $/Q

12. Review Example • Economan has been infected by the free enterprise bug and set up a firm on extraterrestrial affairs. The rent for the building is $4000, cost of two secretaries is $40,000 and the cost of electricity and gas comes to $5000. There is a great demand for his information and his total revenues amount to $100,000. He has turned down the $50,000 salary he could have made from the Friendly Space Agency and he lost the interest of $4000 he made last year because now his funds are tied up in the business

13. Profit? • Explicit Costs ($4000+$40,000+5,000)=49K • Implicit Costs ($54K) • TR=$100K • Economic Profit -3K

14. Supply Curve for Ind. Firm • Firm is a price-taker • Profit Max Rule then P=MC • so the P represents the minimum amount they would be willing to accept to produce that quantity for sale (our definition of Supply curve) • Market curve-aggregate across firms

15. Determinants • Because the Marginal Cost curve is the supply curve, anything that changes MC will shift curve. • Technology, expectations, factor markets

16. Producer Surplus • difference between price and the marginal cost. • below market price and above supply curve for market

17. Competitive Market Model • Demand curve is summation of individual demand curves, which are based on the MB of additional consumption • Market supply is aggregated across all firms, and their individual supply curve comes from their MC curve (in S-R)

18. Model driven to equilibrium • With enough time to adjust, in the absence of shifts, this market will reach an equilibrium, regardless of where it started • Once price and Q established within market, now we can use the price to answer output and consumption for each individual player.

19. Imperfect Information • Consumer only has information on his/her own tastes, WTP • Individual firm only knows its own MC structure • Still works fairly well as a predictor

20. Why do we like competitive markets? • Leads to an efficient outcome • responsive • adaptable • captures society’s relative rankings

21. Efficiency • Use the least amount of resources to produce a given level of output • For a given level of inputs, yield the most output • With voluntary transactions, no one can be made better off without making someone else worse off (Pareto efficiency or optimal)

22. Conditions for Efficiency • MB=MC for last • MC equal for all producers • MB equal across consumers • Quantity is not the same

23. Efficient Solution • Not unique outcome • Depends on initial income distributions • PROPERTY RIGHTS • Income inequality (issue of fairness)

24. (a) Market Equilibrium (b) Firm’s Demand S l l e e h h s s u u b b r r e e p p d $5 $5 e e c c i i r r P P D 0 0 1,200,000 5 10 15 Bushels of wheat per day Bushels of wheat per day Market Equilibrium and the Firm’s Demand Curve in Perfect Competition

25. Total cost Total revenue (= $5 × q ) $60 Maximum economic profit = $12 48 Total dollars 15 0 5 15 7 10 12 Bushels of wheat per day (b) Marginal Cost Equals Marginal Revenue Marginal cost Average total cost e d = Marginal revenue $5 Profit = average revenue 4 a Dollars per unit 0 5 10 12 15 Bushels of wheat per day (a) Total Revenue Minus Total Cost Short-Run Profit Maximization

26. (a) Total Cost and Total Revenue Total cost Total revenue (= $3 ×q ) Total dollars $40 30 Minimum economic loss = $10 15 0 5 10 15 Bushels of wheat per day (b) Marginal Cost Equals Marginal Revenue Marginal cost Average total cost Average variable cost $4.00 Dollars per bushel Loss e d = Marginal revenue 3.00 = average revenue 2.50 Bushels of wheat per day 0 5 10 15 Minimizing Short-Run Losses

27. Break-even point 5 p5 d5 p4 d4 3 d3 p3 2 p2 d2 Shutdown point q2 q3 q5 q4 Summary of Short-Run Output Decisions Marginal cost t i Average total cost n u r 4 e p Average variable cost s r a l l o D 1 p1 d1 0 Quantity per period q1

28. (d) Industry, or market, supply (a) Firm A (b) Firm B (c) Firm C SA+ SB+ SC= S S S S A t C B i n u r e p' p' p' p' p e c p p p p i r P 0 30 60 0 10 20 0 10 20 0 10 20 Quantity Quantity Quantity Quantity per period per period per period per period Aggregating Individual Supply to Form Market Supply

29. (a) Firm (b) Industry, or market t t i i n n u u r r SMC = S e e MC = s p p s e r c a i r l l P o ATC D AVC d $5 $5 Profit 4 D 0 5 10 12 Bushels of wheat 0 1,200,000 Bushels of wheat per day per day Relationship Between Short-Run Profit Maximization and Market Equilibrium

30. Long Run Equilibrium for the Firm and the Industry (a) Firm (b) Industry, or market MC S ATC LRAC Dollars per unit Price per unit e p d p D Q Quantity per period 0 Quantity per period 0 q

31. S' p' b p' d' Profit c S* D' q' Qc Qb Long-Run Adjustment to an Increase in Demand (b) Industry, or Market (a) Firm S MC ATC Dollars per unit Price per unit LRAC a p d p D 0 q Qa 0 Quantity per period Quantity per period

32. S" g S* Loss f p" d" D" q" Qg Qf Long-Run Adjustment to a Decrease in Demand (b) Industry, or Market (a) Firm S MC ATC LRAC Dollars per unit Price per unit a e d p p D p" 0 q 0 Qa Quantity per period Quantity per period

33. MC' S' b p b p d b b b ATC' S* c p p d c c c c D' qb Qb Qc Exhibit 12: An Increasing-Cost Industry (a) Firm (b) Industry, or Market S MC ATC Price per unit Dollars per unit p a d p a a a a D q 0 0 Qa Quantity per period Quantity per period

34. Consumer t S i n surplus u r e p e s $10 r a l l o Producer D surplus D 6 5 m 0 100,000 120,000 200,000 Quantity per period Consumer Surplus and Producer Surplus for a Competitive Market in the Short Run

35. General Profit Max Rule • MR=MC • Marginal Revenue (MR) is change in Total Revenue (TR)/ change in Q • MR adds to incremental profit and MC takes away from it

36. But in our Perfectly Competitive World • P= MR for an individual firm • so special case, the rule becomes P=MC