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More on supply

Learn about supply curves, opportunity cost, perfect competition, and profit maximization in economics. Understand concepts like horizontal addition, surplus, and the MB=MC rule. Explore the idea of perfect competition and the steps to profit maximization.

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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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