Firm Short Run Profit Maximization & Perfectly Competitive Supply Lecture 18 Dr. Jennifer P. Wissink ©2016 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 6, 2016

Announcements(micro)-Spring 2016 u Prelim 2 is Thursday April 14, 7:30pm-9:00pm. –Please go to Blackboard and register for Option 1 or Option 2 if you have a Cornell created evening prelim conflict. See our syllabus for your options. –For all other prelim conflicts/issues you must come and see Prof. Wissink in person ASAP. –Coverage: Starts with the elasticity stuff we didn’t test on prelim 1 and goes through when I say “stop” on Tuesday April 12 in lecture 19. –Locations: All testing locations will be announced via Bb by Friday – please bolo u Upcoming MEL Quizzes –Quiz#09 due April 8 –Quiz#10 due April 11 – a gift! (you can review right after you submit, so everyone should get all of them right if they do the quiz twice!) –Quiz#11 due April 12 – a review quiz that everyone can do u Optional Handwritten Exercise for MEL Points –Posted on: Friday, April 1, :30:09 PM EDT –Here's a good question to try in preparation for Prelim 2. It is worth 50 MEL points if turned in on time (points will be added in May to my master Excel grade sheet, if you need them - note you will never see them on the MEL site itself.) –Due: In class on Wednesday April 13 –Absolutely NO extensions or makeups or late submissions! –Please make a copy of your work to keep for yourself to study from if you hand it in, since you will not get it back. –The link to the Excel file with the problem: –Ok to do this via Excel – then print out your work and turn that in. Remember to put YOUR name on the print out.

Example: The Bang/Buck Rule u Suppose q=100 tons of apples. u Suppose: L s =10 hours & the MP s at 10 th hour is 48 tons. u Suppose: L u =25 hours & the MP u at 25 th hour is 36 tons. u Suppose P s =$12/hour u Suppose P u =$6/hour u Jonathan’s Variable Cost = $ $625 = $270 u Bang/buck in skilled = MP s /P s = 48/12 = 4 tons u Bang/buck in unskilled = MP u /P u = 36/6 = 6 tons u i>clicker Question Given this information, to make q=100 tons of apples more cost efficiently, Jonathan should A. do nothing – he’s doing great! B. use more Skilled and the same Unskilled. C. use only Skilled. D. use more Skilled and less Unskilled. E. use more Unskilled and less Skilled. Hours Skilled Labor Hours Unskilled Labor mp skilled mp unskilled tons

Example: The Bang/Buck Rule u RECALL: –Bang/buck in skilled = MP s /P s = 48/12 = 4 –Bang/buck in unskilled = MP u /P u = 36/6 = 6 u So… hire 1 less skilled worker, and with the money saved, hired as many unskilled workers as you can. What happens? –Variable costs will stay the same. –You’ll hire 1 less skilled worker and 2 more unskilled workers (based on the two wages). –You will produce 48 fewer tons using 1 less skilled worker, but… –You will produce 72 more tons using 2 more unskilled workers, so…. –For the same costs, you now have produced 24 more tons of apples! –NOW WHAT WILL THE “Bang/buck” ratios look like? Hours Skilled Labor Hours Unskilled Labor mp skilled mp unskilled tons

So What? u The 7 short run cost curves will still look and feel and hang together the same way. u We just now know that if there is more than one variable input behind the scenes, the plant manager has successfully carried out the cost minimization exercise correctly and has equated the bang/buck across all his variable inputs. u In this way we derive the “best” or “minimum” cost functions. 0 THE COST GRAPH

Now What?

Short Run Profit Maximization, Finally… u Profit (  ) = total revenue (tr) – short run total cost (srtc). –(minimum or best) short run total cost u Profit depends on the firm’s output level (q). –That is:  (q) = tr(q) - srtc(q). u Firm’s problem: –choose q* to maximize  where  (q) = tr(q) - srtc(q). u Note: –Marginal revenue (mr) =  tr/  q –Marginal cost (srmc) =  tc/  q

Rules For Profit(  ) Maximization in the Short Run u If q* maximizes  (q) = tr(q) – srtc(q), then –(1) mr(q*) = srmc(q*) »the first order condition, or f.o.c. –(2)  (q*) is a maximum and not a minimum »the second order condition, or s.o.c –(3) at q* it is worth operating:  (q*>0)   (q=0) u NOTE: This procedure is good, no matter what type of firm considered.

Intuition: Why mr=mc at the Profit Maximizing q* u Why? Because.... –If mr > mc at q, then… –If mr < mc at q, then… –If mr = mc at q, then…

“To Be (open) OR Not To Be (open)” - The Short Run Shut Down Decision

Sunk & Avoidable Fixed Costs u When q > 0, fixed costs are just that. Fixed. u When q = 0, need to rethink fixed costs –some are sunk fixed costs –some are avoidable fixed costs u How would shut down rule be changed? u i>clicker question: If half of your fixed costs are avoidable fixed costs, then would you tend to shut down at a higher market price or lower? A. higher B. lower

Short Run Profit Maximization in a Perfectly Competitive Output Market u Consider: –Structure, then –Conduct, then –Performance. u Recall Structure: For Perfectly Competitive Markets –(1) Many firms, and –(2) Homogeneous output, and –(3) Free entry and exit, and –(4) Full and symmetric information. u Our Example: –The Apple market, Cortland variety, of which Jonathan’s apple orchard is one of many u Recall: –Structure implies Jonathan is a PRICE TAKER! u Interesting Piece: –Big Seed: Consolidation Is Shrinking The Industry Even Further – shrinking-the-industry-even-further

Conduct: Short Run Profit Maximization in a Perfectly Competitive Output Market u Notation Reminder –Let q = Jonathan’s output –Let Q = The aggregate output of the entire apple market –Let P = The market price for apples u Jonathan is a “price taker”. –So, Jonathan’s perceived demand for HIS apples (δ) will be the prevailing market price P. –So, for Jonathan tr = P∙q –which implies that for Jonathan mr = P = δ

Jonathan’s Profit Maximizing Move When Market Price P=$528 u Recall: If q* maximizes , then: –(1) mr(q*) = srmc(q*) –(2)  (q*) is a maximum and not a minimum. –(3) at q* it is worth operating:  (q*>0)   (q=0) Jonathan's Apple Farm Costs (detail) Apples (tons/year) $Land $Hired Labor $Proprietor's time $Total Cost $Average Cost $Marginal Cost larger delta method 20012,40054,40013,20080, ,40058,56013,20084, ,40063,20013,20088, ,40068,24013,20093, ,40073,76013,20099, ,40080,00013,200105, ,40086,40013,200112,000431

If you’re looking at a table of $mc values, and none of them exactly match your $mr value... A.you should guess an answer. B.you should cry frantically and loudly. C.you should use $mc relative to $mr to narrow down your decision to one of two quantities. D.you should try to approximate something between the two quantity values in the table. E.then there is no profit maximizing equilibrium quantity. i>clicker question Jonathan's Apple Farm Costs (finer detail) Apples (tons/year)Total Cost Marginal Cost (smaller delta) 20080, , , , , , ,000

i>clicker question Consider Purity Ice Cream and Footies Freeze in the month of January. Which statement below is the most correct. A.Graph A represents both B.Graph B represents both C.Graph A represents Purity and B Footies D.Graph A represents Footies and B Purity $π$π $π$π A B

THE COST GRAPH for Jonathan

The Cost Graph u Does The Cost Graph always look exactly like this? u Yes and No. u Suppose –Joe’s fc=$100 –Joe’s vc=q 2 0