1. Perfectly Competitive Supply: The Cost Side of the Market

2. Buyers and Sellers Buyers Sellers “Should I buy another unit?”
Answer: If the marginal benefit exceeds the marginal cost
Sellers
“Should I sell another unit?
Answer: If the marginal revenue exceeds the marginal cost of making it

3. Upward-Sloping Supply Curves
The Low-Hanging Fruit Principle
Suppliers first use the resources easiest-to-find
So, the price of the output must go up in order to compensate for using harder-to-find resources
I.E., costs tend to rise when producers expand production in the short-run (some inputs are fixed in the short-run)

4. Fig. 6.1 An Individual Supply Curve for Recycling Services

5. Fig. 6.2 The Market Supply Curve for Recycling Services

6. Profit Maximization Profit Profit-maximizing firm
The difference between the total revenue it receives from the sale of its product minus all costs, explicit and implicit
Note: this includes opportunity cost, and is therefore different than profit in a traditional accounting sense
Profit-maximizing firm
A firm whose primary goal is to maximize profits

7. Types of Markets One firm = 2-12 firms many firms many, many firms
Monopoly Oligopoly Monopolistic Perfect
Competition Competition

8. Firm Decisions to Max Profit
What to produce (what market)?
How much to produce?
What inputs to use?
What price to charge?

9. Perfect Competition Perfectly Competitive Market
A market in which no individual supplier has significant influence on the market price of the product
Many firms all selling the same product. Product is “standardized”
A Price taker is a firm that
Has no influence over the price at which it sells its product
Sells only a fraction of the market output
Can sell as much output as it wishes

10. Perfectly Competitive Firm
Given that there are many firms all selling the exact same product, what does the demand curve for any one firm’s good look like?

11. Fig. 6.4 The Demand Curve Facing Perfectly Competitive Firm

12. Production in the Short Run
Factors of Production
An input used in the production of a good or service
Short Run
A period of time sufficiently short that at least some of the firm’s factors of production are fixed
Long Run
A period of time of sufficient length that all the firm’s factors of production are variable

13. Law of Diminishing Returns
Fixed factor of production
An input whose quantity cannot be altered in the short run. E.g. square footage of factory space
Variable factor of production
An input whose quantity can be altered in the short run. E.g. labor
Law of Diminishing Returns
If one factor is variable and all others are fixed: the increased production of the good eventually requires ever larger increases in the variable factor

14. Law of Diminishing Marginal ReturnsQ
Point of diminishing marginal returns
Labor
MPL

15. Implications for Marginal Costs
Since productivity (MPL) typically first increases and then decreases (at the point of DMR), what will marginal costs do?
When productivity is rising, marginal costs should be falling.
When productivity is falling, marginal costs should be rising.
Unit costs measures are inversely related to productivity measures

16. Choosing Output How much to produce? Cost-Benefit Principle
The goal is to maximize profit
Profit = TR – TC
A perfectly competitive firm chooses to produce the output level where profit is maximized
Cost-Benefit Principle
A firm should increase output if marginal benefit (revenue) exceeds the marginal cost

17. Choosing Output Cost-Benefit Principle
Increase output if marginal benefit exceeds the marginal cost
For a perfectly competitive firm
Marginal benefit = marginal revenue = price
Cost-Benefit Principle for a Price Taker
Keep expanding as long as the price of the product is greater than marginal cost
Choose the output where P = MC

18. Profit Maximizing Condition
Profit = TR – TC
Max Profit with respect to Q
d Profit / dQ = (dTR/ dQ) – (dTC/dQ) = 0
therefore maximum profit occurs where MR = MC

19. Shut Down?
Perfectly competitive firms should produce where MR (P) = MC, unless price is very low
If total revenue falls below variable cost, the best the firm could do is shut down in the short run

20. Fig. 6.5 The Firm’s Marginal Cost of Production

21. Fig. 6.6 Price = Marginal Cost: The Perfectly Competitive Firm’s Profit-Maximizing Supply Rule

22. Perfectly Competitive Firm’s Supply Curve
The perfectly competitive firm’s supply curve is its
Marginal cost curve
At every point along a market supply curve
Price measures what it would cost producers to expand production by one unit

23. Profit Maximization P ATC = Total Cost / Q so, TC = ATC x Q
P > ATC means profit > 0 MC
ATC
10 = P*
D = MR 8
Q* Quantity
100

24. Suppose Price Falls to Min ATC
P = ATC means profit = 0 MC
ATC
7 = P*
D = MR
Q* Quantity

25. Suppose Price Falls below Min ATC
P < ATC means profit < 0 MC
ATC
7 = P*
D = MR
Q* Quantity

26. Producer Surplus
Producer Surplus (PS) is the difference between the firm’s minimum willingness to accept (MC) and what they actually accept (P), summed over all units produced.

27. Producer Surplus and Supply
Graphically then, PS is the area below the price line and above the supply curve, up to Q*
Quantity P 30 10 PS S D
Here, PS = $100
=½(base)(height)
= ½(20)(10)

28. exercises A profit maximizing perfectly competitive firm must decide:
A. only on what price to charge, taking output as fixed. B. both what price to charge and how much to produce. C. only on how much to produce, taking price as fixed. D. only on which industry to join, taking price and output as fixed. E. only on how much revenue it wishes to collect.

29. exercises
To produce 150 units of output, the firm must use 3 employee-hours. To produce 300 units of output the firm must use 8 employee-hours. Apparently, the firm is:
A. more profitable. B. experiencing diminishing marginal returns. C. in the long run. D. not using any fixed factors of production. E. failing to profit maximize.

30. exercises
Which of the following factors of production is likely to be fixed in the short run?
A. The location of the firm. B. The number of employee-hours. C. The amount of electricity consumed. D. The amount of paper used. E. The amount of RAM installed in the network server.
When the marginal return to the variable factor of production is diminishing, the marginal cost curve is
A. upward sloping. B. convex. C. parallel to the vertical axis. D. downward sloping. E. concave.