Chapter Six The Supply Curve and the Behavior of Firms

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 2 Figure 6.1: A Typical Supply Curve for a Market

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 3 Figure 6.2: Applying the Central Idea of Economics

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 4 Case Study Firm: An organization that produces goods or services. Also called company or business. –Establishments: Separate physical locations Sole proprietorship: One owner Partnership: A few owners Corporation: Owned by shareholders –Often, managers profit share to create incentives Fixed factor: A part of production that cannot be changed (land in the pumpkins example, prepaid) Variable factor: A part of production that can be changed (labor in the pumpkins example)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 5 Case Study A supply curve for a single firm tells us the quantity of a good that that firm will produce at different prices Price-taker: Any firm that takes the market price as given; this firm cannot affect the market price because the market is competitive –A firm can’t charge a price much higher than the prevailing market price Competitive market: A market in which no firm has the power to affect the market price of a good

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 6 Case Study Monopoly: Opposite of a competitive market, there is only ONE firm. –Does not have a supply curve, can dictate the price. Therefore it is called a price-maker

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 7 The Firm’s Profits Profits: Total revenue received from selling the product minus the total costs of producing the product –When profits are negative, the firm runs a LOSS –When profits are zero, the firm is BREAKING EVEN –Always must assume the firm tries to maximize profit Total revenue: The price per unit times the quantity the firm sells TR = P x Q

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 8 Total Revenue from Pumpkin Production at Three Prices Quantity Produced Total Revenue $35 ea $70 ea $100 ea

Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 9 Production and Costs Total costs: What the firm has to incur in order to produce the product –Total cost is the sum of variable costs and fixed costs TC = VC + FC For now, we’ll examine the SHORT-RUN Production function: A relationship that shows the quantity of output for any given amount of input Marginal product of labor: The change in production due to a one-unit increase in labor input –Marginal product of labor DECREASES as labor input increases

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.3: A Production Function Relating Output to Labor Input

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Production and costs Diminishing returns to labor: A situation in which the increase in output due to a unit increase in labor declines with increasing labor input: a decreasing marginal product of labor –The occurs when some inputs to production (such as land or machines) are fixed –The return of adding additional workers declines Marginal cost: The change in total costs due to a one-unit change in quantity produced –Marginal cost increase as production increases because of diminishing marginal product of labor

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Example of Costs Quantity produced Hours of labor input Variable costs at $10 Wage Fixed CostsTotal Costs

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Total Costs: Slope (Marginal cost) is increasing

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.5: Marginal Cost (again, increases)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Profit Maximization and the Individual Firm’s Supply Curve Profit maximization: An assumption that firms try to achieve the highest possible level of profits – total revenue minus total costs – given their production function

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Profit Table if price equals $35 per crate CratesTotal CostsTotal RevenueProfits

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Profit Table if price equals $70 per crate CratesTotal CostsTotal RevenueProfits

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Profit table if price equals $100 per crate CratesTotal CostsTotal RevenueProfits

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.8: A Smooth Individual Supply Curve

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Price equals marginal cost Marginal revenue: The change in total revenue due to a one-unit increase in quantity sold A firm will choose its quantity such that price equals marginal cost (for a competitive firm) –In general, a firm will choose a quantity to produce so that marginal revenue equals marginal cost –If the marginal revenue from producing an additional quantity of output is greater than the marginal cost, then the firm should produce that quantity

Copyright © by Houghton Mifflin Company, Inc. All rights reserved The Market Supply Curve The market supply curve can be obtained by adding up the supply curves of all the individual firms in the market

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.9: Derivation of the Market Supply Curve

Copyright © by Houghton Mifflin Company, Inc. All rights reserved The slope of the supply curve Slope and position of individual firms’ supply curves depend on the marginal cost. If marginal cost rises sharply, the supply curve will be steep If marginal cost rises slowly, the supply curve will be flatter Anything that raises or lowers marginal cost will shift the market supply curve

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Producer Surplus Producer surplus: The difference between the price received by a firm for an additional item sold and the marginal cost of the item’s production; for the market as a whole, it is the sum of all the individual firms’ producer surpluses, or the area above the market supply curve and below the market price

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.6: An Initial Approach to Profit Maximization

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.7: Derivation of the Individual Firm's Supply Curve

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.10: Producer Surplus for an Individual Firm

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 6.11: Producer Surplus for the Market