1. Chapter Six The Supply Curve and the Behavior of Firms

2. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 2 Figure 6.1: A Typical Supply Curve for a Market

3. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 3 Figure 6.2: Applying the Central Idea of Economics

4. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 4 Case Study Firm: An organization that produces goods or services. Also called company or business. –Establishments: Separate physical locations Sole proprietorship: One owner Partnership: A few owners Corporation: Owned by shareholders –Often, managers profit share to create incentives Fixed factor: A part of production that cannot be changed (land in the pumpkins example, prepaid) Variable factor: A part of production that can be changed (labor in the pumpkins example)

5. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 5 Case Study A supply curve for a single firm tells us the quantity of a good that that firm will produce at different prices Price-taker: Any firm that takes the market price as given; this firm cannot affect the market price because the market is competitive –A firm can’t charge a price much higher than the prevailing market price Competitive market: A market in which no firm has the power to affect the market price of a good

6. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 6 Case Study Monopoly: Opposite of a competitive market, there is only ONE firm. –Does not have a supply curve, can dictate the price. Therefore it is called a price-maker

7. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 7 The Firm’s Profits Profits: Total revenue received from selling the product minus the total costs of producing the product –When profits are negative, the firm runs a LOSS –When profits are zero, the firm is BREAKING EVEN –Always must assume the firm tries to maximize profit Total revenue: The price per unit times the quantity the firm sells TR = P x Q

8. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 8 Total Revenue from Pumpkin Production at Three Prices Quantity Produced Total Revenue $35 ea $70 ea $100 ea 0000 13570100 270140200 3105210300 4140280400 5175350500

9. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 9 Production and Costs Total costs: What the firm has to incur in order to produce the product –Total cost is the sum of variable costs and fixed costs TC = VC + FC For now, we’ll examine the SHORT-RUN Production function: A relationship that shows the quantity of output for any given amount of input Marginal product of labor: The change in production due to a one-unit increase in labor input –Marginal product of labor DECREASES as labor input increases

10. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 10 Figure 6.3: A Production Function Relating Output to Labor Input

11. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 11 Production and costs Diminishing returns to labor: A situation in which the increase in output due to a unit increase in labor declines with increasing labor input: a decreasing marginal product of labor –The occurs when some inputs to production (such as land or machines) are fixed –The return of adding additional workers declines Marginal cost: The change in total costs due to a one-unit change in quantity produced –Marginal cost increase as production increases because of diminishing marginal product of labor

12. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 12 Example of Costs Quantity produced Hours of labor input Variable costs at $10 Wage Fixed CostsTotal Costs 00050 12205070 2550 100 31010050150 41818050230 53030050350

13. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 13 Total Costs: Slope (Marginal cost) is increasing

14. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 14 Figure 6.5: Marginal Cost (again, increases)

15. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 15 Profit Maximization and the Individual Firm’s Supply Curve Profit maximization: An assumption that firms try to achieve the highest possible level of profits – total revenue minus total costs – given their production function

16. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 16 Profit Table if price equals $35 per crate CratesTotal CostsTotal RevenueProfits 0500-50 17035-35 210070-30 3150105-45 4230140-90 5350175-175

17. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 17 Profit Table if price equals $70 per crate CratesTotal CostsTotal RevenueProfits 0500-50 170 0 210014040 315021060 423028050 5350 0

18. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 18 Profit table if price equals $100 per crate CratesTotal CostsTotal RevenueProfits 0500-50 17010030 2100200100 3150300150 4230400170 5350500150

19. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 19 Figure 6.8: A Smooth Individual Supply Curve

20. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 20 Price equals marginal cost Marginal revenue: The change in total revenue due to a one-unit increase in quantity sold A firm will choose its quantity such that price equals marginal cost (for a competitive firm) –In general, a firm will choose a quantity to produce so that marginal revenue equals marginal cost –If the marginal revenue from producing an additional quantity of output is greater than the marginal cost, then the firm should produce that quantity

21. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 21 The Market Supply Curve The market supply curve can be obtained by adding up the supply curves of all the individual firms in the market

22. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 22 Figure 6.9: Derivation of the Market Supply Curve

23. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 23 The slope of the supply curve Slope and position of individual firms’ supply curves depend on the marginal cost. If marginal cost rises sharply, the supply curve will be steep If marginal cost rises slowly, the supply curve will be flatter Anything that raises or lowers marginal cost will shift the market supply curve

24. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 24 Producer Surplus Producer surplus: The difference between the price received by a firm for an additional item sold and the marginal cost of the item’s production; for the market as a whole, it is the sum of all the individual firms’ producer surpluses, or the area above the market supply curve and below the market price

25. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 25 Figure 6.6: An Initial Approach to Profit Maximization

26. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 26 Figure 6.7: Derivation of the Individual Firm's Supply Curve

27. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 27 Figure 6.10: Producer Surplus for an Individual Firm

28. Copyright © by Houghton Mifflin Company, Inc. All rights reserved6 - 28 Figure 6.11: Producer Surplus for the Market