MBMC Perfectly Competitive Supply: The Cost Side of The Market

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 2 Thinking About Supply: The Importance of Opportunity Cost Harry is an unemployed, homeless resident of Burlington How much time should Harry spend recycling beer bottles?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 3 Thinking About Supply: The Importance of Opportunity Cost High unemployment: Harry is choosing between waiting in line for an hour to get a meal worth $1.50 (his best alternative option), and collecting containers at 5 cents each. Opportunity cost of collecting cans is $1.50/hour.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 4 Example Search time (hours/day) Total number of containers found Additional number of containers found

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 5 Example

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 6 Thinking About Supply: The Importance of Opportunity Cost Costs and Benefits 1 hour collecting cans = (60)(.05) = $3 Benefit ($3) > Opportunity Cost ($1.50) 2nd hour benefit ($2) > Opportunity Cost ($1.50) 3rd hour benefit ($1.50) = Opportunity Cost ($1.50)

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 7 Thinking About Supply: The Importance of Opportunity Cost Question What is the lowest redemption price that would induce Harry to spend1 hour/day looking for cans to recycle? Solution 60 containers x 2.5 cents = $1.50 = opportunity cost of waiting in line

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 8 Thinking About Supply: The Importance of Opportunity Cost Reservation Price

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 9 Thinking About Supply: The Importance of Opportunity Cost Reservation Price 1 hour recycling = p(60) = $1.50 = 2.5 cents 2 hours recycling = p(40) = $1.50 = 3.75 cents 3 hours recycling = p(30) = $1.50 = 5 cents 4 hours recycling = p(20) = $1.50 = 7.5 cents 5 hours recycling = p(10) = $1.50 = 15 cents

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 10 An Individual Supply Curve for Recycling Services Recycled cans (10s of cans/day) Deposit (cents/can) Harry’s Supply Curve Deposit was $0.05 in 73, ~$.225 today

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 11 The Market Supply Curve for Recycling Services Recycled cans (10s of cans/day) Recycled cans (10s of cans/day) Deposit (cents/can) Harry’s Supply Curve Barry’s Supply Curve

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 12 Recycled cans (10s of cans/day) Deposit (cents/can) = = The Market Supply Curve for Recycling Services Market Supply Curve

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 13 The Market Supply Curve with 1,000 Identical Sellers Recycled cans (10,000s of cans/day) Deposit (cents/can) Market Supply Curve

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 14 Reality check Is this realistic? What happens to the number of cans Harry can get when he has to start competing with Barry and 998 other people laid off by IBM? Many natural resources also fail to increase in supply as the number of producers increases All economic production requires natural resources

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 15 Profit-Maximizing Firms in Perfectly Competitive Markets Profit Maximization Profit  Total Revenue - All Costs paid by the firm (including opportunity costs) Profit-Maximizing Firms  Goal of the firm is to maximize the difference between total revenues and total firm costs

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 16 Reality check: goal of profit maximizing firms in real life Why do CEO’s earn so much even when the company is doing poorly? Privatize profits and socialize costs Who gets the benefits from risky financial investments that pay off, who pays the costs when they don’t? Costs of mercury contamination, climate change, etc.? Who pays the costs of phosphorous and nitrogen runoff from farms, habitat loss, ozone thinning from methyl bromide, etc.? Welfare for Wal-Mart employees, etc.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 17 Reality check: goal of profit maximizing firms in real life Maximize subsidies Ag subsidies: $307 billion despite record profits Farmers Facing Loss of Subsidy May Get New One the top 10 percent of direct-payment recipients in 2010 received 59 percent of the money under the program…The average household income was… $201,465 for families living on large farms. average household income Tax breaks, quotas, not included in these estimates

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 18 Reality check: goal of profit maximizing firms in real life Energy subsidies, perverse subsidies

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Why do so many corporations donate to Democrats and Republicans at the same time?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved.

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 21 Profit-Maximizing Firms in Perfectly Competitive Markets The Perfectly Competitive Market A market in which no individual supplier has significant influence on the market price of the product Is this true for energy, agriculture, pharmaceuticals, Wal-Mart, etc.? A Price Taker A firm that has no influence over the price at which it sells its product What about patented medicine, Wal-Mart?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 22 The Characteristics of Perfect Competition 1.All firms sell the same standardized product. e.g. agriculture, natural resources, somewhat true for clothes, electronics, etc., not true for patented medicines 2.The market has many buyers and sellers, each of which buys or sells only a small fraction of the total quantity exchanged. e.g. small farmers, small woodlots, etc. What about health care, e.g. Fletcher Allen?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 23 Reality check What has been happening in the banking and finance sector? From too big to fail to way too big to fail What has been happening in general in the food & agriculture, energy, retailing and media sectors?

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 24 The Characteristics of Perfect Competition 1.Productive resources are mobile What resources are not mobile? How mobile is labor? 2.Buyers and sellers are well informed Stiglitz’ Nobel Information flows

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 25 The Demand Curve Facing a Perfectly Competitive Firm P0P0 Q0Q0 S D Market Quantity (units/month) Price ($/unit) Market supply and demand

MBMC Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6: Perfectly Competitive Supply Slide 26 DiDi P0P0 The Demand Curve Facing a Perfectly Competitive Firm Price ($/unit) Individual Firm’s Quantity (units/month) Individual firm demand What happens to quantity demanded when the individual firm raises prices? Lowers prices? What is the elasticity of demand for that firm’s output?