1. Supply Side--Lectures Rebecca Tuttle Baldwin BCC--Micro

2. Reminder for our simple model Supply side means firms in final goods/service market We will use corporate structure Supply ( Price & Quantity relationship) reflects the quantity of the good firm willing & able to produce at various prices.

3. Perfectly Competitive Market Many buyers Many sellers Ease of entry/exit (no barriers) Perfect information Homogeneous good

4. Profit Defined as the residual after subtracting all costs to necessary factors of production from gross revenues. TR-TC All firms are profit maximizers, not revenue or sales

5. Result for our individual firm No market power--it will be a price TAKER

6. How does Total Revenue (TR) depend on Quantity (Q)? = Price times Quantity (PxQ) focus on one product’s production at a time relatively straightforward (comes from demand)

7. Costs capture opportunity costs of factors only true costs are opportunity cost needed for calculation of “economic” profit, to distinguish from “accounting profit” can be broken down or sorted into fixed/variable or implicit/explicit

8. Time Needs to be brought into our model Short-run (production decision) –Relevant decision is what Q to produce at? Long-run (investment decision) –Whether to enter/exit market –In the Long-Run ALL COSTS ARE VARIABLE (FC=0)

9. Production Function Links quantity of input to output levels Marginal Product of labor is defined at the incremental increase in production from one more unit of labor, also called Marginal Physical Product (MPP) Already know marginal concept

10. MPP Expect it to decline as we add more workers Why? When evaluating, we are holding other factors constant

11. Marginal Costs Change in Total Costs due to one unit change in Quantity produced =change in TC/change in Q can graph MC on $/Q

12. Review Example –Economan has been infected by the free enterprise bug and set up a firm on extraterrestrial affairs. The rent for the building is $4000, cost of two secretaries is $40,000 and the cost of electricity and gas comes to $5000. There is a great demand for his information and his total revenues amount to $100,000. He has turned down the $50,000 salary he could have made from the Friendly Space Agency and he lost the interest of $4000 he made last year because now his funds are tied up in the business

13. Profit? –Explicit Costs ($4000+$40,000+5,000)=49K –Implicit Costs ($54K) –TR=$100K –Economic Profit -3K

14. Supply Curve for Ind. Firm –Firm is a price-taker –Profit Max Rule then P=MC –so the P represents the minimum amount they would be willing to accept to produce that quantity for sale (our definition of Supply curve) –Market curve-aggregate across firms

15. Determinants Because the Marginal Cost curve is the supply curve, anything that changes MC will shift curve. Technology, expectations, factor markets

16. Producer Surplus difference between price and the marginal cost. below market price and above supply curve for market

17. Competitive Market Model Demand curve is summation of individual demand curves, which are based on the MB of additional consumption Market supply is aggregated across all firms, and their individual supply curve comes from their MC curve (in S-R)

18. Model driven to equilibrium With enough time to adjust, in the absence of shifts, this market will reach an equilibrium, regardless of where it started Once price and Q established within market, now we can use the price to answer output and consumption for each individual player.

19. Imperfect Information Consumer only has information on his/her own tastes, WTP Individual firm only knows its own MC structure Still works fairly well as a predictor

20. Why do we like competitive markets? Leads to an efficient outcome responsive adaptable captures society’s relative rankings

21. Efficiency Use the least amount of resources to produce a given level of output For a given level of inputs, yield the most output With voluntary transactions, no one can be made better off without making someone else worse off (Pareto efficiency or optimal)

22. Conditions for Efficiency MB=MC for last MC equal for all producers MB equal across consumers Quantity is not the same

23. Efficient Solution Not unique outcome Depends on initial income distributions PROPERTY RIGHTS Income inequality (issue of fairness)

24. Market Equilibrium and the Firm’s Demand Curve in Perfect Competition Bushels of wheat per day $5 0 1,200,000 S D P r i c e p e r b u s h e l (a) Market Equilibrium P r i c e p e r b u s h e l $5 0 Bushels of wheat per day d 5 1015 (b) Firm’s Demand

25. Short-Run Profit Maximization $60 48 15 0 Total costTotal revenue (= $5 × q ) Maximum economic profit = $12 Bushels of wheat per day 5 71012 15 Total dollars (a) Total Revenue Minus Total Cost $5 4 0 15 Marginal cost Average total cost d = Marginal revenue = average revenue e a Profit Bushels of wheat per day 12 10 5 Dollars per unit (b) Marginal Cost Equals Marginal Revenue

26. Minimizing Short-Run Losses $4.00 3.00 2.50 0 5 10 15 Marginal cost Average total cost d = Marginal revenue = average revenue Average variable cost e Loss Bushels of wheat per day Dollars per bushel (b) Marginal Cost Equals Marginal Revenue $40 30 15 0 5 10 15 Total cost Total revenue (= $3 × q ) Minimum economic loss = $10 Bushels of wheat per day (a) Total Cost and Total Revenue Total dollars

27. Summary of Short-Run Output Decisions D o l l a r s p e r u n i t 0 q1q1 Quantity per period d1d1 Average total cost Average variable cost 4 1 Marginal cost p1p1 Shutdown point 2 q2q2 p2p2 d2d2 q3q3 3 p3p3 d3d3 Break-even point q4q4 p4p4 d4d4 q5q5 p5p5 5 d5d5

28. Aggregating Individual Supply to Form Market Supply P r i c e p e r u n i t p' p 0 10 20 (a) Firm A S A Quantity per period p' p 0 30 60 (d) Industry, or market, supply Quantity per period (b) Firm B(c) Firm C p' p 0 10 20 p' p 0 10 20 S C S B Quantity per period Quantity per period S A + S B + S C = S

29. Relationship Between Short-Run Profit Maximization and Market Equilibrium D o l l a r s p e r u n i t $5 4 0 5 10 12Bushels of wheat per day Bushels of wheat per day (a) Firm d P r i c e p e r u n i t $5 0 1,200,000 (b) Industry, or market D ATC AVC Profit SMC = S MC = s

30. Long Run Equilibrium for the Firm and the Industry p 0 d Quantity per period MC ATC e LRAC q Dollars per unit p 0 Q Quantity per period Price per unit S D (a) Firm(b) Industry, or market

31. Long-Run Adjustment to an Increase in Demand 0 ATC MC LRAC Quantity per period (a) Firm 0 D a QaQa Quantity per period (b) Industry, or Market p S S* Dollars per unit Price per unit p d q d' D' Profit p' q' p' b QbQb S' c QcQc

32. Long-Run Adjustment to a Decrease in Demand p p" 0 d MC ATC e LRAC Quantity per period (a) Firm 0 S Quantity per period QaQa (b) Industry, or Market D a p g S" QgQg q" d" Loss p" D" f QfQf S* Dollars per unit Price per unit q

33. Exhibit 12: An Increasing-Cost Industry p a 0 d a ATC MC a Quantity per period (a) Firm p a 0 S S* D a QaQa Quantity per period (b) Industry, or Market Dollars per unit Price per unit b b p b d qbqb b p D' b QbQb q c c c c p d ATC' MC' p S' c QcQc

34. Consumer Surplus and Producer Surplus for a Competitive Market in the Short Run D o l l a r s p e r u n i t $10 6 5 0 100,000 120,000 200,000 Producer surplus Consumer surplus D S m e Quantity per period

35. General Profit Max Rule MR=MC Marginal Revenue (MR) is change in Total Revenue (TR)/ change in Q MR adds to incremental profit and MC takes away from it

36. But in our Perfectly Competitive World P= MR for an individual firm so special case, the rule becomes P=MC