1. Chapter 6: Perfectly Competitive Supply
Derive a supply curve
Opportunity cost
The principle of increasing opportunity cost
Seller’s reservation price
Cost-Benefit principle
Marginal benefit vs. marginal cost

2. Individual’s Supply Curve
An example
Opportunity cost of Harry's time
Wash dishes for $6 per hour is his baseline
Recycling aluminum cans is the alternative
Harry earns 2¢ per can
How much labor should Harry supply to each activity?
Harry should work at recycling as long as he is earning at least $6 per hour

3. Additional Number of Cans Found Total Number of Containers Found
Harry’s Supply Curve
Recycling Services
Additional Number of Cans Found
600
400
300
200
100
Hours per Day
Total Number of Containers Found 1
600 2
1,000 3
1,300 4
1,500 5
1,600

4. Additional Number of Cans Found Revenue from Additional Cans
Harry’s Supply Curve
Recycling Services
Hours per Day
Additional Number of Cans Found
Revenue from Additional Cans 1
600
$12.00 2
400
$8.00 3
300
$6.00 4
200
$4.00 5
100
$2.00
Harry's rule is to collect cans if the return in an hour is the same as washing dishes;
The opportunity cost of collecting cans in an hour is the revenue given up from washing dishes - $6;
Therefore, Harry should spend 3 hours in recycling cans.

5. Additional Number of Cans Found
Harry’s Supply Curve
Reservation Price Per Can
What is the lowest deposit per can that would get Harry to recycle for an hour?
What price makes his wage at recycling equal to his opportunity cost?
1st hour price is 1¢
2nd hour is 1.5¢
3rd hour is 2¢
4th hour is 3¢
5th hour is 6¢
Hours per Day
Additional Number of Cans Found 1
600 2
400 3
300 4
200 5
100

6. Harry’s Supply Curve Reservation Price (¢) Number of Cans (00s) 1 6
Recycled cans
(100s of cans/day)
Deposit (cents/can) 6 10 13 16 3 2 1
Reservation Price (¢)
Number of Cans (00s) 1 6
1.5 10 2 13 3 15 16

7. Individual and Market Supply Curves
Harry’s Supply Curve
Barry’s Supply Curve
Market Supply Curve 16 6 32 13 3 2 15 26 30 6 1 12
Recycled cans
(00s of cans/day)
Recycled cans
(00s of cans/day)
Recycled cans
(00s of cans/day)

8. Profit Maximization Economists assume firms seek to maximize profits
Corresponds to buyers' maximizing utility
Profit is total revenue minus total cost
Both explicit and implicit costs are included in total cost

9. Perfectly Competitive Firm

10. Perfectly Competitive Firm's Demand
Market supply and market demand set the price
Buyers and sellers takes price (P) as given
Perfectly competitive firm can sell all it wants to sell at the market price
Since the supplier is small, its output decision will not change market price
Each firm must decide how much to supply (Q)

11. Perfectly Competitive Firm's Demand

12. Profit Maximization – An Example
In the example, the model has a single product and two inputs, labor and capital
Capital is fixed, labor is variable
Determine the profit maximizing level of output for a perfectly competitive bottle manufacturer
Capacity of the bottle-making machine is fixed

13. Law of Diminishing Return
The Law of Diminishing Returns With all inputs except one fixed, additional units of the variable input yield ever smaller amounts of additional output

14. Law of Diminishing Return
At low levels of production, the law of diminishing returns may not hold
Similar to the increase in a buyer's marginal utility from a second unit
As with marginal utility, marginal product eventually diminishes
Lower marginal products are often caused by congestion
Workers per machine
Information flows

15. Cost Concepts
A fixed factor of production is an input whose quantity cannot be changed in the short run
Fixed cost (FC) is the sum of all payments for fixed inputs
A variable factor of production is an input whose quantity can be changed in the short run
Variable cost (VC) is the sum of all payments for variable inputs
Total cost (TC) is the sum of all payments for inputs
Marginal cost (MC) is the change in total cost divided by the change in output

16. Profit Maximization - Data
Workers
Bottles per Day 1 80 2
200 3
260 4
300 5
330 6
350 7
362
Fixed Costs ($/day)
$40 40
Variable Cost ($/day) $0 12 24 36 48 60 72 84
Total Cost ($/day)
$40 52 64 76 88
100
112
124
Marginal Cost ($/bottle)
$0.15
0.10
0.20
0.30
0.40
0.60
1.00

17. Profit Maximization Profit = Total revenue – Total cost
Since Total cost = Fixed cost + Variable cost
Profit = Total revenue – Variable cost – Fixed cost
The firm must know about both revenues and costs in order to maximize profits
Increase output if marginal benefit is at least as great as marginal cost
Decrease output if marginal benefit is less than marginal cost

18. Profit Maximization
Firms maximize their profit when marginal benefit equals marginal cost;
In a perfectly competitive market, marginal benefit is simply the market price, which is a constant;
Fixed costs do not affect the marginal cost, since the change in fixed costs is zero.

19. ATC, AVC, and MC Marginal cost (MC)
Average values are the total divided by quantity
Average variable cost (AVC) is
AVC = VC / Q
Average total cost (ATC) is
ATC = TC / Q
Marginal cost (MC)
MC = ΔTC/ΔQ

20. Marginal Cost ($/unit)
Cost Structure
Workers per day
Bottles per day
Variable Cost ($/day)
AVC ($ per unit)
Total Cost
ATC ($ per unit) 40 1 80 12
0.15 52
0.65 2
200 24
0.12 64
0.32 3
260 36
0.135 76
0.292
Marginal Cost ($/unit)
0.15
0.10
0.20

21. Cost Structure – A graph

22. Profit Maximization – A graph
Market price is $0.20 per bottle
Produce where the marginal benefit of selling a bottle (price) equals the marginal cost
260 bottles per day

23. Profit Maximization – A graph

24. Production Loss – A graph

25. Shut Down Decision Firms can make losses in the short run
Some firms continue to operate
Some firms shut down
If the firm shuts down in the short run, it loses all of its fixed costs;
The firm should shut down if revenue is less than variable cost: P x Q < VC for all levels of Q;
The firm should continue its business if revenue is at least larger than variable cost.

26. Shut Down – A graph MC ATC AVC Cost ($/bottle) Price
Output (bottles/day)

27. "Law" of Supply Short-run marginal cost curves have a positive slope
Higher prices generally increase quantity supplied
In the long run, all inputs are variable
Long-run supply curves can be flat, upward sloping, or downward sloping
The perfectly competitive firm's supply curve is its marginal cost curve
At every quantity on the market supply curve, price is equal to the seller's marginal cost of production
Applies in both the short run and the long run

28. Increases in Supply

29. Producer Surplus
Producer surplus is the difference between the market price and the seller's reservation price
Reservation price is on the supply curve
Producer surplus is the area above the supply curve and below the market price