Supply Side--LecturesSupply Side--Lectures
Rebecca Tuttle BaldwinRebecca Tuttle Baldwin
BCC--MicroBCC--Micro
Reminder for our simple model 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.
Perfectly Competitive MarketPerfectly Competitive Market
• Many buyers
• Many sellers
• Ease of entry/exit (no barriers)
• Perfect information
• Homogeneous good
ProfitProfit
• 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
Result for our individual firmResult for our individual firm
• No market power--it will be a price TAKER
How does Total Revenue (TR) depend on How does Total Revenue (TR) depend on
Quantity (Q)?Quantity (Q)? • = Price times Quantity (PxQ)
• focus on one product’s production at a time
• relatively straightforward (comes from demand)
CostsCosts
• 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
Time Needs to be brought into our Time Needs to be brought into our modelmodel
• 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)
Production FunctionProduction 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
MPPMPP
• Expect it to decline as we add more workers
• Why?
• When evaluating, we are holding other factors constant
Marginal CostsMarginal Costs
• Change in Total Costs due to one unit change in Quantity produced
• =change in TC/change in Q
• can graph MC on $/Q
Review ExampleReview 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
Profit?Profit?
– Explicit Costs ($4000+$40,000+5,000)=49K– Implicit Costs ($54K)– TR=$100K– Economic Profit -3K
Supply Curve for Ind. FirmSupply 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
DeterminantsDeterminants
• Because the Marginal Cost curve is the supply curve, anything that changes MC will shift curve.
• Technology, expectations, factor markets
Producer SurplusProducer Surplus
• difference between price and the marginal cost.
• below market price and above supply curve for market
Competitive Market ModelCompetitive 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)
Model driven to equilibriumModel 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.
Imperfect InformationImperfect 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
Why do we like competitive markets?Why do we like competitive markets?
• Leads to an efficient outcome
• responsive
• adaptable
• captures society’s relative rankings
EfficiencyEfficiency
• 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)
Conditions for EfficiencyConditions for Efficiency
• MB=MC for last
• MC equal for all producers
• MB equal across consumers
• Quantity is not the same
Efficient SolutionEfficient Solution
• Not unique outcome
• Depends on initial income distributions
• PROPERTY RIGHTS
• Income inequality (issue of fairness)
Market Equilibrium and the Market Equilibrium and the
Firm’s Demand Curve in Perfect CompetitionFirm’s Demand Curve in Perfect Competition
Market Equilibrium and the Market Equilibrium and the
Firm’s Demand Curve in Perfect CompetitionFirm’s Demand Curve in Perfect Competition
Bushels ofwheat per day
$5
0 1,200,000
S
D
Pri
ce p
er b
ush
el
(a) Market Equilibrium
Pri
ce p
er b
ush
el
$5
0 Bushels ofwheat per day
d
5 10 15
(b) Firm’s Demand
Short-Run Short-Run Profit Profit
MaximizationMaximization
Short-Run Short-Run Profit Profit
MaximizationMaximization
$60
48
15
0
Total cost Total revenue ( $5 × q )
Maximum economicprofit $12
Bushels of wheat per day 5 7 10 12 15
To
tal
do
lla
rs
(a) Total Revenue Minus Total Cost
$5
4
0 15
Marginal cost
Average total cost
d Marginal revenue average revenue
e
a
Profit
Bushels of wheat per day 12 10 5
Do
lla
rs p
er
un
it
(b) Marginal Cost Equals Marginal Revenue
Minimizing Minimizing Short-Run Short-Run
Losses Losses
Minimizing Minimizing Short-Run Short-Run
Losses Losses
$4.00
3.00 2.50
0 5 10 15
Marginal cost
Average total cost
d Marginal revenue average revenue
Average variable cost
eLoss
Bushels of wheat per day
Do
lla
rs p
er
bu
sh
el
(b) Marginal Cost Equals Marginal Revenue
$40
30
15
0 5 10 15
Total cost
Total revenue( $3 × q )
Minimum economicloss = $10
Bushels of wheat per day
(a) Total Cost and Total Revenue
To
tal
do
lla
rs
Summary of Short-Run Summary of Short-Run Output Decisions Output Decisions
Summary of Short-Run Summary of Short-Run Output Decisions Output Decisions
Do
lla
rs p
er
un
it
0
q1 Quantity per period
d1
Average total cost
Average variable cost
4
1
Marginal cost
p1
Shutdownpoint
2
q2
p2 d
2
q3
3p
3 d
3
Break-evenpoint
q4
p4 d
4
q5
p5
5d
5
Aggregating Individual Aggregating Individual Supply to Form Market Supply Supply to Form Market Supply
Aggregating Individual Aggregating Individual Supply to Form Market Supply Supply to Form Market Supply
Pri
ce p
er
un
it
p'
p
0 10 20
(a) Firm A
SA
Quantity per period
p'
p
0 30 60
(d) Industry, or market, supply
Quantity per period
(b) Firm B (c) Firm C
p'
p
0 10 20
p'
p
0 10 20
SCSB
Quantity per period
Quantity per period
SAS
BS
C S
Relationship Between Relationship Between Short-Run Profit Maximization and Short-Run Profit Maximization and
Market Equilibrium Market Equilibrium
Relationship Between Relationship Between Short-Run Profit Maximization and Short-Run Profit Maximization and
Market Equilibrium Market Equilibrium
Do
llars
per
un
it
$5 4
0 5 10 12 Bushels of wheatper day
Bushels of wheatper day
(a) Firm
d
Pri
ce p
er u
nit
$5
0 1,200,000
(b) Industry, or market
D
ATCAVC
Profit
MC = SMC = s
Long Run Equilibrium Long Run Equilibrium for the Firm and the Industryfor the Firm and the Industry
Long Run Equilibrium Long Run Equilibrium for the Firm and the Industryfor the Firm and the Industry
p
0
d
Quantity per period
MC
ATC
e
LRAC
q
Do
llars
per
un
it
p
0
Q Quantity per period
Pri
ce p
er u
nit
S
D
(a) Firm (b) Industry, or market
Long-Run Adjustment Long-Run Adjustment to an Increase in Demandto an Increase in Demand
Long-Run Adjustment Long-Run Adjustment to an Increase in Demandto an Increase in Demand
0
ATC
MC
LRAC
Quantityper period
(a) Firm
0
D
a
Qa Quantity
per period
(b) Industry, or Market
p
S
S*
Do
lla
rs p
er
un
it
Pri
ce
pe
r u
nit
p
d
q
d'
D'
Profitp'
q'
p' b
Qb
S'
c
Qc
Long-Run Adjustment Long-Run Adjustment to a Decrease in Demandto a Decrease in Demand
Long-Run Adjustment Long-Run Adjustment to a Decrease in Demandto a Decrease in Demand
p
p"
0
d
MC
ATC
e
LRAC
Quantityper period
(a) Firm
0
S
Quantityper period
Qa
(b) Industry, or Market
D
ap
g
S"
Qg
q"
d"
Lossp"
D"
f
Qf
S*
Do
llars
per
un
it
Pri
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nit
q
Exhibit 12: An Increasing-Cost IndustryExhibit 12: An Increasing-Cost IndustryExhibit 12: An Increasing-Cost IndustryExhibit 12: An Increasing-Cost Industry
p a
0
d a
ATC
MC
a
Quantityper period
(a) Firm
pa
0
S
S*
D
a
QaQuantity
per period
(b) Industry, or Market
Do
lla
rs p
er
un
it
Pri
ce
pe
r u
nit
b bp b d
qb
b p
D'
b
Qbq
cc
ccp d
ATC'
MC'
p
S'
c
Qc
Consumer Surplus and Consumer Surplus and Producer Surplus for a Competitive Producer Surplus for a Competitive
Market in the Short RunMarket in the Short Run
Consumer Surplus and Consumer Surplus and Producer Surplus for a Competitive Producer Surplus for a Competitive
Market in the Short RunMarket in the Short RunD
olla
rs p
er u
nit
$10
6 5
0 100,000 120,000 200,000
Producer surplus
Consumer surplus
D
S
m
e
Quantity per period
General Profit Max RuleGeneral 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
But in our Perfectly Competitive WorldBut in our Perfectly Competitive World
• P= MR for an individual firm
• so special case, the rule becomes P=MC