CDAE Class 23 Nov. 13 Last class: Result of Quiz 6 7. Profit maximization and supply Today: 7. Profit maximization and supply 8. Perfectly competitive markets Next class: 8. Perfectly competitive markets Quiz 7 (take-home) Important date: Problem set 6: due Thursday, Nov. 15 (Problems 6.1., 6.4., 6.6., 6.9., and 6.10 from the textbook)

7. Profit maximization and supply 7.1. Goals of a firm 7.2. Profit maximization 7.3. Marginal revenue and demand 7.4. Marginal revenue curve 7.5. Alternatives to profit maximization 7.6. Short-run supply 7.7. Applications

Class exercise (Tuesday, Nov. 6) Suppose that the demand function for a company’s product is estimated as q = P where q is the quantity and P is the price. (1) Draw the demand curve (2) Derive the MR function and draw the MR curve (3) What is the price elasticity of demand when P=4? (4) If the company wants to increase its market share, should it increase or decrease its price?

7.5. Alternatives to profit maximization (1) TR maximization -- A graphical analysis -- Comparison of profit maximization and TR maximization: Output level: TR: Total profit: (2) Markup pricing: -- P = AC + markup -- Markup and price elasticity of demand (e.g, textbooks vs. general books)

A quiz question: Under which of the following conditions the firm should shut down its production (i.e., q=0) in the short run? (a) When the profit is negative (b) When TR < SFC (short-run fixed cost) (c) When TR < FVC (short-run variable cost) (d) When TR < STC (short-run total cost)

7.6. Short-run supply by a price-taking firm (1) Profit maximizing decision: MC = MR = P (2) The firm’s supply (3) Shutdown decision: STC = SFC + SVC If TR < SVC, the company should shut down SAC = SAFC + SAVC i.e., If the price is less than the short-run average variable cost (SAVC), the firm will shut down the production. (4) The firm’s supply curve: SMC above the SAVC

7.6. Short-run supply by a price-taking firm (5) Practice questions according to the graph on the handout (a) Where is the firm’s supply curve (b) What is the break-even production level (c) What is the shutdown price level? (d) What is the total profit at the shutdown price? (e) What is the total profit when P=38? ( f ) What is the total fixed cost?

8. Perfect competition 8.1. Basic concepts 8.2. Supply in the very short run 8.3. Short-run supply 8.4. Short-run price determination 8.5. Shifts in supply and demand curves 8.6. Long-run supply 8.7. Applications

8.1. Basic concepts (1) An overview of an economy (2) Market structures -- Perfectly competitive market -- Monopoly -- Oligopoly (3) Supply response: The change in quantity of output in response to a change in demand conditions. (4) Very short run, short run, and long run

8.2. Supply in the very short run (1) A graphical analysis (Fig. 8.1) (2) Market equilibrium (3) Impact of a shift in demand (4) Impact of trade, inventories, and government interventions

8.3. Short-run supply (1) Short-run: The number of firm is fixed but the existing firms can change their output levels in response to changes in the market. (2) Supply curve: Relationship between market price and quantity supplied. (3) Short-run supply curve of an individual firm: SMC above the SAVC (Ch. 7). (4) Short-run supply curve in a market (Fig. 8.2) (5) Notations

8.3. Short-run supply (6) Short-run elasticity of supply (a) Recall our general definition of elasticity Elasticity of Y with respect to X = (b) Short-run supply elasticity =

8.3. Short-run supply (6) Short-run elasticity of supply (c) Estimation of supply elasticities: -- From two observations -- From a supply equation

8.4. Short-run price determination (Fig. 8.3) (1) Supply and demand in a market (2) Market equilibrium (3) An example (4) Effect of an increase in market demand

Class Exercise Suppose a market has 100 identical producers and each producer has the following supply function: q = P (a) Graph the supply curve for one firm and then graph the supply curve for the market (b) Calculate the supply elasticity for the market when P=12 If the demand function for the market is Q = 1000 – 30 P, (c) Derive the market equilibrium P* and Q* (d) Calculate the demand and supply elasticities at the market equilibrium price and quantity