Costs and supply. Perfect competition Lectures/DeianDoykov/International University/Foundation Year/Semester

Perfect competition “The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it” Adam Smith. The Wealth of Nations 2 November 05

Introduction to Economics 3 October 05 Costs and supply. Perfect competition  Input and output.  Costs and the choice of technique.  Long run total, marginal and average costs.  Returns to scale.  Average cost and marginal cost.

Introduction to Economics 4 October 05 Costs and supply. Perfect competition  The firm’s short and long run output decisions.  Short run costs and diminishing marginal returns.  Short run and long run costs.  Perfect competition and perfectly competitive firm.

5 November 05 Costs and supply Input and output

 Factors of production Labor and capital used to produce goods and services  Production function The set of all technically efficient Techniques  Technological progress An increase in output without increasing inputs. 6 November 05

Costs and supply Economic cost versus Accounting cost  Economic cost (EC) Explicit costs plus implicit costs  Accounting cost (AC) Measures the explicit costs of operating a business  Explicit costs (Ex. C) The firm's actual cash payments for its inputs  Implicit costs (IC) The opportunity cost of nonpurchased inputs Economic cost versus Accounting cost  Economic cost (EC) Explicit costs plus implicit costs  Accounting cost (AC) Measures the explicit costs of operating a business  Explicit costs (Ex. C) The firm's actual cash payments for its inputs  Implicit costs (IC) The opportunity cost of nonpurchased inputs 7 November 05

Costs and supply Short-run costs Total cost Short-run costs Total cost 8 November 05

Costs and supply  Short run A period of time over which one or more factors of production is fixed; in most cases, a period of time over which a firm cannot modify an existing facility or build a new one  Short-run average total cost (SATC) Short-run total cost divided by the quantity of output, equal to AFC plus AVC.  Short-run average variable cost (SAVC) Variable cost divided by the quantity produced 9 November 05

Output (Q) TFC (£) 12 Total costs for firm X 10 November 05

TFC Output (Q) TFC (£) 12 Total costs for firm X 11 November 05

TFC Output (Q) TFC (£) 12 TVC (£) Total costs for firm X 12 November 05

TVC Output (Q) TFC (£) 12 TVC (£) TFC Total costs for firm X 13 November 05

TVC TFC Diminishing marginal returns set in here Total costs for firm X 14 November 05

TVC Output (Q) TFC (£) 12 TVC (£) TFC Total costs for firm X 15 November 05

TVC TFC Output (Q) TFC (£) 12 TVC (£) TC (£) Total costs for firm X 16 November 05

TC Output (Q) TFC (£) 12 TVC (£) TC (£) TVC TFC Total costs for firm X 17 November 05

TC TVC TFC Diminishing marginal returns set in here Total costs for firm X 18 November 05

Short-run costs Marginal cost =  TC /  Q Marginal cost =  TC /  Q 19 November 05

Deriving marginal costs Q TC MC Q Costs (£) 20 November 05

TC Deriving marginal costs Q TC MC Q Costs (£) 21 November 05

TC Deriving marginal costs Q TC MC Q Costs (£)  TC = 12  Q = 1 22 November 05

TC MC Diminishing returns set in here Q Costs (£) Deriving marginal costs Q TC MC November 05

MC Q Costs (£) Deriving marginal costs Diminishing marginal returns set in here 24 November 05

Short-run costs Average cost =TC / Q Average cost =TC / Q 25 November 05

Q Costs (£) 26 November 05

Q TVC AVC Q Costs (£) AFC 27 November 05

Q Costs (£) AFC AVC Q TVC AVC November 05

Q TC AC Q Costs (£) AFC AVC 29 November 05

Q Costs (£) AC AFC AVC Q TC AC November 05

Q TC MC Q Costs (£) 31 November 05

MC Q Costs (£) Q TC MC November 05

MC Q TC MC AC Q Costs (£) 33 November 05

MC Q Costs (£) AC Q TC MC AC November 05

Output (Q) Costs (£) AFC AVC MC x AC z y Average and marginal costs 35 November 05

Long-run costs =TC / Q Long-run costs =TC / Q 36 November 05

Long-run costs Long run A period of time long enough that a firm can change all the factors of production, meaning that a firm can modify its existing production facility or build a new one  Long-run average cost (LAC) Long-run total cost divided by the quantity of output produced  Long-run total cost The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size 37 November 05

Returns to scale  Economies of scale A situation in which an increase in the quantity produced decreases the long-run average cost of production  Diseconomies of scale A situation in which an increase in the quantity produced increases the long-run average cost of production  Constant returns to scale The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size  Minimum efficient scale The output at which the long-run average cost curve becomes horizontal 38 November 05

Alternative long-run average cost curves Output O Costs LRAC Economies of Scale 39 November 05

Output O Costs Diseconomies of Scale LRAC Alternative long-run average cost curves 40 November 05

Output O Costs LRAC Constant costs Alternative long-run average cost curves 41 November 05

A typical long-run average cost curve Output O Costs LRAC 42 November 05

Output O Costs LRAC Economies of scale Constant costs Diseconomies of scale A typical long-run average cost curve 43 November 05

Long-run average and marginal costs Output O Costs LRAC LRMC Economies of Scale 44 November 05

Output O Costs LRAC LRMC Diseconomies of Scale Long-run average and marginal costs 45 November 05

Output O Costs LRAC = LRMC Constant costs Long-run average and marginal costs 46 November 05

Output O Costs LRMC LRAC Initial economies of scale, then diseconomies of scale Long-run average and marginal costs 47 November 05

Long-run costs Relationship between short-run and long-run AC curves 48 November 05

Deriving long-run average cost curves: factories of fixed size SRAC 3 Costs Output O SRAC 4 SRAC 5 5 factories 4 factories 3 factories 2 factories 1 factory SRAC 1 SRAC 2 49 November 05

SRAC 1 SRAC 3 SRAC 2 SRAC 4 SRAC 5 LRAC Costs Output O Deriving long-run average cost curves: factories of fixed size 50 November 05

Costs Output O Examples of short-run average cost curves Deriving long-run average cost curves: choice of factory size 51 November 05

LRAC Costs Output O Deriving long-run average cost curves: choice of factory size 52 November 05

53 November 05 Perfect competition Perfect competition and perfectly competitive firm

Perfect Competition 54 November 05

Perfect competition Short-run equilibrium of firm and industry (profit maximising) 55 November 05

O £ (b) Firm Q (thousands) O (a) Industry P Q (millions) S D PePe MC AR D = AR = MR QeQe AC Short-run equilibrium of industry and firm under perfect competition 56

Perfect competition The industry supply curve The industry supply curve 57 November 05

OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 MC P2P2 D 2 = MR 2 D2D2 P3P3 D 3 = MR 3 D3D3 Q (thousands) Deriving the short-run supply curve a b c = S 58

Perfect competition Long-run equilibrium 59 November 05

OO P£ Q (millions) S1S1 D LRAC PLPL P1P1 QLQL SeSe AR 1 D1D1 AR L DLDL Q (thousands) Long-run equilibrium under perfect competition New firms enter Supernormal profits Profits return to normal (a) Industry (b) Firm 60

£ Q O (SR)AC (SR)MC LRAC AR = MR DLDL LRAC = (SR)AC = (SR)MC = MR = AR Long-run equilibrium of the firm under perfect competition 61 November 05

62 November 05 Perfect competition Profit Maximisation & Loss Minimisation

Profit Maximisation 63 November 05

Profit maximisation Normal profit versus Economic profit  Economic profit (EP) Total revenue minus the total economic cost  Normal profit (NP) The portion of firm’s cost that is not included in accounting cost EP = TR – TC TR = P x Q Normal profit versus Economic profit  Economic profit (EP) Total revenue minus the total economic cost  Normal profit (NP) The portion of firm’s cost that is not included in accounting cost EP = TR – TC TR = P x Q 64 November 05

Profit maximisation Using total cost and revenue curves (a) Price taking firm Using total cost and revenue curves (a) Price taking firm 65 November 05

Total profit = £100 × 46 = £4600 TR Costs and revenue (£) Quantity Price-taking firm TC b a 66

Profit maximisation Using total cost and revenue curves (b) Firm facing downward sloping demand curve Using total cost and revenue curves (b) Firm facing downward sloping demand curve 67 November 05

TR, TC, T  (£) Quantity Finding maximum profit using total curves 68 November 05

TR, TC, T  (£) TR Quantity Finding maximum profit using total curves 69 November 05

TR, TC, T  (£) TR TC Quantity Finding maximum profit using total curves 70 November 05

TR, TC, T  (£) TT TR TC Quantity Finding maximum profit using total curves 71 November 05

TR, TC, T  (£) TT TR TC a b c d Quantity Finding maximum profit using total curves 72 November 05

TR, TC, T  (£) TT TR TC d e f Quantity Finding maximum profit using total curves 73 November 05

Profit maximisation Using average and marginal cost and revenue curves (a) Price taking firm Using average and marginal cost and revenue curves (a) Price taking firm 74 November 05

Total profit = £16 x 40 = £640 AR = MR MC Quantity Costs and Revenue (£) 22 a Price-taking firm AC 38 b 75

Profit maximisation Using average and marginal cost and revenue curves (b) Firm facing downward sloping demand curve Using average and marginal cost and revenue curves (b) Firm facing downward sloping demand curve 76 November 05

Quantity Costs and revenue (£) Finding the profit-maximising output using marginal curves 77 November 05

Quantity Costs and revenue (£) MC Finding the profit-maximising output using marginal curves 78 November 05

Quantity Costs and revenue (£) e MR MC Profit-maximising output Finding the profit-maximising output using marginal curves 79 November 05

Quantity Costs and revenue (£) Measuring the maximum profit using average curves MR MC 80 November 05

Quantity Costs and revenue (£) MR MC AR Measuring the maximum profit using average curves 81 November 05

MR Quantity Costs and revenue (£) MC AC AR b a Total profit = £1.50 x 3 = £4.50 Measuring the maximum profit using average curves T O T A L P R O F I T 82 November 05

Loss Minimisation 83 November 05

O Costs and revenue (£) Quantity MC AC AR MR Q AC AR Loss-minimising output LOSS 84

Profit maximisation Short-run shut-down point Short-run shut-down point 85 November 05

The short-run shut-down point O Costs and revenue (£) Quantity AR AVC AC P = AVC Q 86 November 05

Costs and supply. Perfect competition Questions for discussions: 1. Most supply curves are vertical ? 2. So what is a firm ? 3. To maximise profit, maximise sales ? 4. Scale economies and the Internet ? 5. Small is beautiful - big is again beautiful ? 6. Firms making losses should quit at once ? Questions for discussions: 1. Most supply curves are vertical ? 2. So what is a firm ? 3. To maximise profit, maximise sales ? 4. Scale economies and the Internet ? 5. Small is beautiful - big is again beautiful ? 6. Firms making losses should quit at once ? 87 November 05

Assignment for week # 6: Essay question: Productivity and Technological changes ? Assignment for week # 6: Essay question: Productivity and Technological changes ? Introduction to Economics 88 November 05