Warm Up: Two Questions! 1. Which of the following is true of the marginal cost curve? It intersects the average variable cost curve and the average fixed.

Warm Up: Two Questions! 1. Which of the following is true of the marginal cost curve? It intersects the average variable cost curve and the average fixed cost curve at each curve’s minimum point. It lies between the total cost curve and the total variable cost curve. It increases initially, for a time, but begins to decline when the point of diminishing returns is reached. It decreases, because average variable cost is less than marginal cost. It intersects the average variable cost curve and the average total cost curve at each curve’s minimum point 2. If a firm's average total cost decreases as the firm increases its output, the firm's marginal cost must be greater than the average variable cost less than the average fixed cost less than the average total cost decreasing negative

Four Market Structures

FOUR MARKET STRUCTURES
Perfect Competition Monopolistic Competition Pure Monopoly Oligopoly Every product falls somewhere on this spectrum Examples: Agricultural Commodities Mexican Restaurants Oil Diamonds – de Beers Monopolistic Competition (differentiated products) Oligopoly Monopoly Perfect Competition Oligopoly (3 main producers)

Perfect Competition

Imperfect Competition The seller has NO control over price.
FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Pure Monopoly Oligopoly Imperfect Competition Characteristics of Perfect Competition: Many small firms Identical products (perfect substitutes) Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Example of Perfect Competition: Candy bar salesmen on the streets of Chile

Law of One Price In an efficient market, all identical goods must have only one price. Result: Each firm is a price taker. Firms have no control of the price Traffic Analogy When there is heavy traffic, why do all lanes seem to go the same speed? Cars leave slower lanes and enter faster lanes. Similarly, what do you think happens in perfectly competitive markets if firms earn excessive profit? 12

Perfectly Competitive Firms
Example: Say you go out to buy a candy bar on the streets of Viña del Mar, Chile. You quickly find that the price every vendor is charging is 500 pesos. This is the market price (where demand and supply meet) Is it likely that any vendor can sell one for 600 pesos? Is it likely that any shop would sell one for 400? Do you think that vendors make a large profit off of candy bars? Why? These vendors are “price takers” because they sell their products at a price set by the market.

Perfectly Competitive Firms (A Horizontal straight line)
Why are they Price Takers? If a firm charges above the market price, NO ONE will buy. Customers will go to other firms If one firm charges less, all firms will quickly lower their prices to match that firm Therefore, firms are already charging as little as they possibly can Since the price is the same at all quantities demanded, the demand curve for each firm is… Perfectly Elastic (A Horizontal straight line)

The Competitive Firm is a Price Taker Price is set by the Industry
Demand $15 $15 D Q 5000 Q Firm (price taker) Industry

The Competitive Firm is a Price Taker Price is set by the Industry
What is the additional revenue for selling an additional unit? 1st unit earns $15 2nd unit earns $15 Marginal revenue is constant at $15 Notice: Total revenue increases at a constant rate MR equal Average Revenue P Demand $15 MR=D=AR=P Q Firm (price taker) 16 16

For Perfect Competition: Demand = MR (Marginal Revenue)
The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an additional unit? 1st unit earns $15 2nd unit earns $15 Marginal revenue is constant at $15 Notice: Total revenue increases at a constant rate MR equal Average Revenue P Demand $15 MR=D=AR=P Q Firm (price taker) 17 17

Which of the following is true about the marginal revenue of a firm in a perfectly competitive industry? It is constant It increases as output sold increases. It decreases as output sold increases. It increases at first, then decreases. It decreases at first, then increases.

Maximizing PROFIT! 20

Short-Run Profit Maximization
What is the goal of every business? To Maximize Profit! To maximize profit firms must make the right output Firms should continue to produce until the additional revenue from each new output equals the additional cost. Example (Assume the price is $10) Should you produce… …if the additional cost of another unit is $5? …if the additional cost of another unit is $9? …if the additional cost of another unit is $11?

Profit Maximizing Rule Short-Run Profit Maximization
MR=MC Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! To maximum profit firms must make the right output Firms should continue to produce until the additional revenue from each new output equals the additional cost. Example (Assume the price is $10) Should you produce… …if the additional cost of another unit is $5 …if the additional cost of another unit is $9 …if the additional cost of another unit is $11 22

Don’t forget that averages show PER UNIT COSTS
How much output should be produced? How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? P $9 8 7 6 5 4 3 2 1 MC MR=D=AR=P Profit = $18 ATC AVC Don’t forget that averages show PER UNIT COSTS Total Cost=$45 Total Revenue =$63 Q

The profit maximizing rule is also the loss minimizing rule!!!
Suppose the market demand falls. What would happen if the price is lowered from $7 to $5? The MR=MC rule still applies but now the firm will make an economic loss. The profit maximizing rule is also the loss minimizing rule!!!

MC ATC AVC MR=D=AR=P Q How much output should be produced?
How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue AVC Loss =$7 MR=D=AR=P Total Cost = $42 Total Revenue=$35 Q

If a perfectly competitive firm is producing where
marginal cost is rising and greater than marginal revenue, to maximize profits it should (A) increase the level of production (B) decrease the level of production (C) maintain current level of production (D) increase price (E) decrease price

Warm Up: Two Questions! 1. All of the following are essential characteristics of a perfectly competitive industry EXCEPT: (A) All products produced by the firms in the industry are homogeneous. (B) All firms in the industry are price takers. (C) All consumers and firms are completely aware of the prices at which transactions take place in the industry. (D) There are barriers to entry into and exit from the industry. (E) Price is equal to marginal revenue for every firm in the industry. 2. If a firm is experiencing economies of scale, which of the following will decrease as output increases? (A) Fixed cost (B) Long-run total cost (C) Long-run average total cost (D) Marginal cost (E) Short-run average total cost

Assume the market demand falls even further
Assume the market demand falls even further. If the price is lowered from $5 to $4 the firm should stop producing. Shut Down Rule: A firm should continue to produce as long as the price is above the AVC When the price falls below AVC then the firm should minimize its losses by shutting down Why? If the price is below AVC the firm is losing more money by producing than they would if they shut down altogether

Minimum AVC is shut down point
SHUT DOWN! Produce Zero MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue AVC Minimum AVC is shut down point Q

P<AVC. They should shut down
Producing nothing is cheaper than staying open. MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue Fixed Costs=$10 AVC TC=$35 MR=D=AR=P TR=$20 Q

In the short run, the firm will realize an economic loss but will continue to produce if the price is below P1 between P1 and P2 (C) below P2 (D) between P2 and P3 (E) between P3 and P4

Profit Maximizing Rule
MR = MC Three Characteristics of MR=MC Rule: Rule applies to ALL market structures (PC, Monopolies, etc.) The rule applies only if price is above AVC Rule can be restated P = MC for perfectly competitive firms (because MR = P)

Practice 37

#1 MC MR=D=AR= P ATC AVC Q $10 8 5 4 7 2 3 Should the firm produce?
What output should the firm produce? What is TR at that output? What is TC? How much profit or loss? Yes 10 TR=$140 TC=$100 Profit=$40 $10 8 5 4 2 MC MR=D=AR= P 7 ATC Cost and Revenue AVC 3 Q 4

#2 MC ATC AVC MR=D=AR=P Q $20 15 10 5 11 9
What output should the firm produce? What is TR where MR=MC? What is TC where MR=MC? How much profit or loss? Zero $45 $55 Loss= $10 $20 15 10 5 MC ATC AVC 11 Cost and Revenue 9 MR=D=AR=P Q 5 7

#3 MC ATC AVC MR=D=AR=P Q $40 30 20 10 19 15
What output should the firm produce? What is TR at that output? What is TC? How much profit or loss? 6 $90 $120 Loss= $30 $40 30 20 10 MC ATC Cost and Revenue AVC 19 15 MR=D=AR=P Q 6 8

Side-by-side graph for a perfectly competitive industry and firm.
Is the firm making a profit or a loss? Why? P S P MC ATC MR=D $15 $15 AVC D Q 5000 8 Q Firm (price taker) Industry 41

Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC? How much is the profit or loss? Where is the Shutdown Point? $25 20 15 10 MC MR=P Profit ATC Cost and Revenue AVC Total Revenue Total Cost

Supply Revisited 43

Marginal Cost and Supply As price increases, quantity increases
$50 45 40 35 30 25 20 15 10 5 MC ATC MR5 Cost and Revenue AVC MR4 MR3 MR2 MR1 Q 44

Marginal Cost and Supply
When price increases, quantity increases When price decreases, quantity decreases $50 45 40 35 30 25 20 15 10 5 MC = Supply MC above AVC is the (short run) supply curve (short run) ATC Cost and Revenue AVC Q 45

What if variable costs increase (e.g. a tax)? MC2=Supply2 $50 45 40 35 30 25 20 15 10 5 MC1=Supply1 AVC Cost and Revenue AVC When MC increases, SUPPLY decreases Q 46

What if variable costs decrease (e.g. a subsidy)? MC1=Supply1 $50 45 40 35 30 25 20 15 10 5 MC2=Supply2 AVC Cost and Revenue AVC When MC decreases, SUPPLY increases Q 47

Take a minute to review for the quiz!
Warm Up Take a minute to review for the quiz!

Question! Assume that, for a perfectly competitive firm, marginal cost equals average variable cost at $10, marginal cost equals average total cost at $15, and marginal revenue equals marginal cost at $12. On the basis of this information, the firm should (A) close down in the short run (B) operate in the short run, even though it will sustain a loss (C) operate in the short run, because it will make an economic profit of $3 per unit (D) operate in the long run, because it will make an economic profit of $3 per unit (E) operate in the short run, but decrease output to decrease its cost

Question! Which of the following segments of the marginal cost curve lies entirely on the firm’s short-run supply curve? (A) STU (B) RSTU (C) RSTUV (D) RS (E) TUV

Question! Do Now: Take out your Cost Curves and Utility FRQs Homework
Try this Question! The short-run supply curve for a firm in a perfectly competitive industry is its entire marginal cost curve its average variable cost curve above its marginal cost curve its average total cost curve above its marginal cost curve its marginal cost curve above the minimum point of its average total cost curve its marginal cost curve above the minimum point of its average variable cost curve

Costs FRQ 7 points

Assume that a firm uses capital as a fixed factor of production and uses labor as a variable factor. The marginal product of labor at first increases and then decreases with the amount of labor. (a) Using a correctly labeled graph, draw and identify the firm's average total cost curve (ATC), average variable cost curve (AVC), and marginal cost curve (MC).

•One point is earned for a U-shaped ATC curve.
•One point is earned for a U-shaped AVC curve that lies below the ATC curve. •One point is earned for an MC curve that is drawn correctly given the average costs curve.

(b) Given your graph in part (a), answer each of the following.
(i) Why is the MC curve shaped as it is? One point is earned for stating that the MC curve is U-shaped because there are increasing returns to labor followed by decreasing returns to labor OR because of the law of diminishing marginal returns.

One point is earned for stating the average fixed cost
(b) Given your graph in part (a), answer each of the following. (i) Why is the MC curve shaped as it is? (ii) What does the difference between the AVC and the ATC represent? One point is earned for stating the average fixed cost

(c) Define economies of scale.
One point is earned for stating that the long-run average cost curve decreases as the firm increases output.

(d) Draw a long-run average total cost curve that has a region of economies of scale followed by a region of diseconomies of scale, as output increases.

One point is earned for drawing a U-shaped long-run average total cost curve.

Marginal Utility from Bagels Marginal Utility from Toy Cars
Number of Bagels Marginal Utility from Bagels Number of Toy Cars Marginal Utility from Toy Cars 1 8 10 2 7 3 6 4 5 (a) The table above shows Theresa’s marginal utility from bagels and toy cars.

Number of Bagels Marginal Utility from Bagels Number of Toy Cars Marginal Utility from Toy Cars 1 8 10 2 7 3 6 4 5 (i) What is her total utility from purchasing three toy cars? One point: 24 (10+8+6)

Number of Bagels Marginal Utility from Bagels Number of Toy Cars Marginal Utility from Toy Cars 1 8 10 2 7 3 6 4 5 (ii) Theresa’s weekly income is $11, the price of a bagel is $2, and the price of a toy car is $1. What quantity of bagels and toy cars will maximize Theresa’s utility if she spends her entire weekly income on bagels and toy cars? Explain your answer using marginal analysis. One point: 5 toy cars, 3 bagels

One point is earned for explaining that with this combination of bagels and toys, the marginal utility per dollar spent on bagels equals the marginal utility per dollar spent on toy cars.

Number of Bagels Marginal Utility from Bagels Marginal Utility Per Dollar Number of Toy Cars Marginal Utility from Toy Cars 1 8 4 10 2 7 3.50 3 6 5 2.50 1.50 (b) Assume that the price of wheat, an input for the production of bagels, increases. Will Theresa’s demand for bagels increase, decrease, or not change? Explain. One point: Not change; this affects supply, not demand

Number of Bagels Marginal Utility from Bagels Marginal Utility Per Dollar Number of Toy Cars Marginal Utility from Toy Cars 1 8 4 10 2 7 3.50 3 6 5 2.50 1.50 (c) Suppose that Theresa’s income elasticity for bagels is –0.2. Does the value of Theresa’s income elasticity indicate that bagels are normal goods, inferior goods, substitutes, or complements?. One point: inferior goods

Number of Bagels Marginal Utility from Bagels Marginal Utility Per Dollar Number of Toy Cars Marginal Utility from Toy Cars 1 8 4 10 2 7 3.50 3 6 5 2.50 1.50 (d) Suppose that when the price of toy cars increases by 10 percent, Theresa buys 5 percent fewer toy cars and 4 percent less of a different toy, blocks. Calculate the cross-price elasticity for toy cars and blocks and indicate if it is positive or negative. One point: ( -4% / 10% )

Perfect Competition in the Long-Run
You are a Chilean candy bar street vendor. You learn that there is a lot more profit in selling completos. What do you do in the long run?

The Chilean Completo = A Recipe for Profit

(No Economic Profit = “Normal Profit”)
In the Long Run… Firms will enter if there is profit Firms will leave if there is loss So, ALL firms break even, they make NO economic profit (No Economic Profit = “Normal Profit”) In long run equilibrium, a perfectly competitive firm is EXTREMELY efficient.

Is the firm making a profit or a loss? Why?
Side-by-side graph for perfectly competitive industry and firm in the LONG RUN Is the firm making a profit or a loss? Why? P S P MC ATC MR=D $15 $15 D Q 5000 8 Q Firm (price taker) Industry 73

Firm in Long-Run Equilibrium
Price = MC = Minimum ATC Firm making a normal profit P MC ATC $15 MR=D There is no incentive to enter or leave the industry TC = TR 8 Q 74

Going from Short-Run to Long-Run
75

Is this the short or the long run? Why?
What will firms do in the long run? What happens to P and Q in the industry? What happens to P and Q in the firm? P S P MC ATC $15 $15 MR=D D Q 5000 6000 8 Q Industry Firm 76

Firms enter to earn profit so supply increases in the industry
Price decreases and quantity increases P S P MC S1 ATC $15 $15 MR=D $10 D Q 5000 6000 8 Q Industry Firm 77

Price falls for the firm because they are price takers.
Price decreases and quantity decreases P S P MC S1 ATC $15 $15 MR=D $10 $10 MR1=D1 D Q 5000 6000 5 8 Q Industry Firm 78

New Long Run Equilibrium at $10 Price
Zero Economic Profit P P MC S1 ATC $10 $10 MR1=D1 D Q 5000 6000 5 Q Industry Firm 79

Is this the short or the long run? Why?
What will firms do in the long run? What happens to P and Q in the industry? What happens to P and Q in the firm? P S P MC ATC $15 $15 MR=D D Q 4000 5000 8 Q Industry Firm 80

Firms leave to avoid losses so supply decreases in the industry
Price increases and quantity decreases S1 P S P MC ATC $20 $15 $15 MR=D D Q 4000 5000 8 Q Industry Firm 81

Price increase for the firm because they are price takers.
Price increases and quantity increases S1 P S P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D Q 4000 5000 8 9 Q Industry Firm 82

New Long Run Equilibrium at $20 Price
Zero Economic Profit S1 P P MC ATC $20 $20 MR1=D1 D Q 9 4000 Q Industry Firm 83

Question! Short Run Long Run
Assume that a firm that produces a good in a perfectly competitive industry is in long-run equilibrium. If the demand for the good increases, the profit-maximizing output by the firm will change in which of the following ways in the short run and long run? Short Run Long Run (A) Return to original level Return to original level (B) Increase Increase (C) Increase Return to original level (D) Decrease Decrease (E) Decrease Return to original level

Question! Which of the following indicates that a perfectly competitive firm is in long-run equilibrium? (A) Price equals marginal cost. (B) Price equals average revenue. (C) Price equals marginal cost, which equals average total cost. (D) Price equals average revenue, which equals marginal revenue. (E) Price equals average fixed cost.

Going from Long-Run to Long-Run
88

Currently in Long-Run Equilibrium
If demand increases, what happens in the short run and how does it return to the long run? P S P MC ATC MR1=D1 $15 $15 MR=D D Q 5000 8 Q Industry Firm 89

Demand Increases The price increases and quantity increases
Profit is made in the short-run P S P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D1 D Q 5000 8 9 Q Industry Firm 90

Firms enter to earn profit so supply increases in the industry
Price Returns to $15 P S S1 P MC ATC $20 $20 MR1=D1 $15 $15 MR=D D1 D Q 5000 7000 8 9 Q Industry Firm 91

Back to Long-Run Equilibrium
The only thing that changed from long-run to long-run is quantity in the industry P S1 P MC ATC $15 $15 MR=D D1 D Q 7000 8 Q Industry Firm 92

Constant Cost vs. Increasing Cost Industries
Constant Cost Industry In the long run, an increase in demand for the product won’t change the market price Resources used to make the product are assumed to be unlimited and won’t get depleted by new firms entering the industry Long run industry supply curve is horizontal Increasing Cost Industry In the long run, an increase in demand for the product will increase the market price Resources used to make the product are limited More firms entering the industry drive up resource prices – every firm’s long run average cost curve shifts upward Long run industry supply curve is upward sloping

Question! For a perfectly competitive, increasing-cost industry, an increase in the industry’s demand will lead to which of the following in the long run? (A) An increase in each firm’s profit (B) A decrease in the price of an input and a decrease in total industry profits (C) A decrease in total industry sales (D) A decrease in total producer surplus and an increase in total consumer surplus (E) An upward shift in each firm’s long-run average cost curve

Question! Which of the following statements about a constant-cost perfectly competitive industry in long-run equilibrium must be true? The long run supply curve is upward sloping The long run supply is curve is perfectly inelastic The total cost of production remains the same as output increases An increase in demand will cause no change in the long run equilibrium price An increase in demand will cause no change in the long run equilibrium quantity

Efficiency

Efficiency refers to the optimal use of society’s scarce resources
PERFECT COMPETITION AND EFFICIENCY Efficiency refers to the optimal use of society’s scarce resources Perfect Competition forces producers to use limited resources to their fullest. Inefficient firms have higher costs and are the first to leave the industry. Perfectly competitive industries are extremely efficient There are two kinds of efficiency: 1. Productive Efficiency 2. Allocative Efficiency

Efficiency Revisited Productive Efficient combinations are A through D
Which points are productively efficient? Which are allocatively efficient? 14 12 10 8 6 4 2 Productive Efficient combinations are A through D (they are produced at the lowest cost) A B G Bikes C Allocative Efficient combinations depend on the wants of society E F D Computers 100

Productive Efficiency
The production of a good in the least costly way. (Minimum amount of resources are being used) Graphically, it is where… Price = Minimum ATC

Short-Run MC ATC D=MR Price
Profit Price P Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity

Short-Run MC ATC Price D=MR Quantity P Q
Loss D=MR Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity

Long-Run Equilibrium MC ATC Price D=MR Quantity P Q
Notice that the product is being made at the lowest possible cost (Minimum ATC) Q Quantity

Why? Price represents the benefit people get from a product.
Allocative Efficiency Producers are allocating resources to make the products most wanted by society. Graphically it is where… Price = MC Why? Price represents the benefit people get from a product.

Optimal amount being produced
Long-Run Equilibrium MC MR P Price Optimal amount being produced The marginal benefit to society (as measured by the price) equals the marginal cost. Q Quantity

What if the firm makes 15 units?
MC MR $5 Price The marginal benefit to society is greater the marginal cost. Not enough produced. Society wants more $3 15 20 Underallocation of resources Quantity

What if the firm makes 22 units?
MC $7 MR $5 Price The marginal benefit to society is less than the marginal cost. Too much Produced. Society wants less 20 22 Overallocation of resources Quantity

Long-Run Equilibrium P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! MC
Price D=MR P P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! Q Quantity 109

Warm Up: Two Questions! 1. Which of the following is true of the marginal cost curve? It intersects the average variable cost curve and the average fixed.

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Warm Up: Two Questions! 1. Which of the following is true of the marginal cost curve? It intersects the average variable cost curve and the average fixed.

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Presentation on theme: "Warm Up: Two Questions! 1. Which of the following is true of the marginal cost curve? It intersects the average variable cost curve and the average fixed."— Presentation transcript:

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