1. Wrapping up supply Today: More on profit maximization, determinants of supply, and surplus

2. Previously… Fixed costs Marginal productivity Variable costs

3. Today… We make this graph make intuitive sense We will see that: Profits are positive at price P 1 Profits are negative at prices P 2 and P 3 Firms will shut down when price is P 3

4. Profit maximization Remember that this is our goal For the most part, we will implement MB/MC analysis again Exception: Shutdown condition If a firm can lose less by closing than opening, it will close

5. Costs Cost to hire an employee is $100/day Assume $1000 in fixed costs for a phone manufacturer per day Note average fixed cost (AFC) decreases as the number of phones increases

6. Our output example for today # of employees hired per dayNumber of phones produced 0 0 1 20 2 45 3 55 4 63 5 67

7. Increasing returns? Notice that the marginal productivity for the 1 st worker is 20; 2 nd worker, 25 Why? Specialization Assembly line can help increase marginal productivity up to a certain point Marginal productivity eventually decreases

8. Cost table # of empl./day Phones per day Fixed cost ($/day) Var. cost ($/day) Total cost ($/day) MC ($/phone) 0010000 12010001001100 24510002001200 35510003001300 46310004001400 56710005001500

9. How to calculate MC Marginal cost (MC) is how much additional cost is necessary to produce an additional phone For example, each additional phone from the 1 st worker is cost to hire worker / # of phones produced ($100/day) / (20 phones/day) = $5/phone

10. Cost table # of empl./day Phones per day Fixed cost ($/day) Var. cost ($/day) Total cost ($/day) MC ($/phone) 0010000 5.00 12010001001100 4.00 24510002001200 10.00 35510003001300 12.50 46310004001400 25.00 56710005001500

11. Suppose that phones sell for $18 each How many people should be hired? Hire the next worker if the MB of the next phone produced is at least as much as the MC This is the same as finding the number of workers that maximizes profits

12. Marginal analysis: Hire 4 employees/day # of empl./dayPhones per day MB ($/phone)MC ($/phone) 00 18.005.00 120 18.004.00 245 18.0010.00 355 18.0012.50 463 18.0025.00 567

13. How much profit? –$266 # of empl./day Phones per day Total rev. ($/day) Total cost ($/day) Profit ($/day) 0001000–1000 1203601100–740 2458101200–390 3559901300–310 46311341400–266 56712061500–294

14. Shutdown condition Finally, we must check to see if the firm is better off shutting down when profits are negative If total revenue is less than total variable cost for all levels of output (Q), then the firm should shut down This is equivalent to the firm making worse profits for all Q > 0 than for Q = 0

15. Shutdown condition check Profits are better when 4 employees are hired (–$266) than when the firm shuts down (–$1000) This firm stays in business # of empl./day Total cost ($/day) Profit ($/day) 01000–1000 11100–740 21200–390 31300–310 41400–266 51500–294

16. Back to our graph We have finished a discrete example Now, we will see how we get the marginal cost (MC), average total cost (ATC), and average variable cost (AVC) curves

17. Marginal cost MC starts by decreasing, then increases sharply # of empl./dayMC ($/phone) 0 5.00 1 4.00 2 10.00 3 12.50 4 25.00 5

18. Average total cost ATC falls initially, then eventually increases # of empl./day Phones per day Total cost ($/day) ATC ($/phone) 001000N/A 120110055 245120026.67 355130023.64 463140022.22 567150022.39

19. Average variable cost AVC falls initially, then eventually increases # of empl./day Phones per day VC ($/day)AVC ($/phone) 000N/A 1201005.00 2452004.44 3553005.45 4634006.35 5675007.46

20. ATC and AVC costs converge Note ATC = AVC + AFC Since AFC is decreasing as Q increases, the difference between ATC and AVC gets smaller as Q increases Thus, ATC and AVC curves get closer as Q increases

21. MC curve Remember: Marginal means for an additional unit produced If marginal is below average, this brings the average down If marginal is above average, this brings the average up

22. MC curve Marginal cost curve tells us how average cost curves (ATC and AVC) move MC curve is below average cost curve when average cost curve is decreasing MC curve is above average cost curve when average cost curve is increasing

23. Back to the graph All curves decrease initially, but eventually increase MC curve tells us which direction ATC and AVC curves are going

24. Back to the graph At P 1  positive profits, since TR > TC (P  Q > ATC  Q) At P 2  negative profits At P 3  firm shuts down (TR is less than VC for all Q)

25. Warning! Look at red circle This is a point where P 3 and MC curves intersect Ignore these points on the MC curve that are downward- sloping, since profit is minimized here

26. Before we wrap up… A few minutes to talk about Determinants of supply Producer surplus

27. Determinants of supply Changes in the following can shift supply curves Technology Input prices The number of suppliers Expectations of future prices Changes in the price of other relevant products

28. Some examples If technology improves or input prices decrease, production becomes less costly If the number of suppliers increases, we can horizontally add the additional supply to the market If the price of calculators increases, some phone suppliers may devote more of its capital to producing calculators

29. Producer surplus Producer surplus is similar conceptually to consumer surplus For a unit or service sold, producer surplus is the difference between the price paid and the minimum payment the seller is willing to accept for it

30. Example of producer surplus When P = 25 per unit, shaded area is approximate producer surplus Area is a triangle, one-half times length times height: 0.5  10  25 = 125

31. Why are CS and PS important? Consumer surplus (CS) and producer surplus (PS) are important since these measures give us a crude measure of the total benefits to society Recall the human supply/demand curve activity Next week, we will see situations in which total surplus can be reduced

32. This concludes supply (End of Unit 1) Important things to remember with supply Individual and market supply Steps to profit maximization Useful to know individual firm supply, production function, FC, VC, TC, MC, AFC, AVC, ATC, shutdown condition Determinants of supply Producer surplus