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Costs and supply. Perfect competition Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005.

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Presentation on theme: "Costs and supply. Perfect competition Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005."— Presentation transcript:

1 Costs and supply. Perfect competition Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005

2 Perfect competition “The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it” Adam Smith. The Wealth of Nations 2 November 05

3 Introduction to Economics 3 October 05 Costs and supply. Perfect competition  Input and output.  Costs and the choice of technique.  Long run total, marginal and average costs.  Returns to scale.  Average cost and marginal cost.

4 Introduction to Economics 4 October 05 Costs and supply. Perfect competition  The firm’s short and long run output decisions.  Short run costs and diminishing marginal returns.  Short run and long run costs.  Perfect competition and perfectly competitive firm.

5 5 November 05 Costs and supply Input and output

6  Factors of production Labor and capital used to produce goods and services  Production function The set of all technically efficient Techniques  Technological progress An increase in output without increasing inputs. 6 November 05

7 Costs and supply Economic cost versus Accounting cost  Economic cost (EC) Explicit costs plus implicit costs  Accounting cost (AC) Measures the explicit costs of operating a business  Explicit costs (Ex. C) The firm's actual cash payments for its inputs  Implicit costs (IC) The opportunity cost of nonpurchased inputs Economic cost versus Accounting cost  Economic cost (EC) Explicit costs plus implicit costs  Accounting cost (AC) Measures the explicit costs of operating a business  Explicit costs (Ex. C) The firm's actual cash payments for its inputs  Implicit costs (IC) The opportunity cost of nonpurchased inputs 7 November 05

8 Costs and supply Short-run costs Total cost Short-run costs Total cost 8 November 05

9 Costs and supply  Short run A period of time over which one or more factors of production is fixed; in most cases, a period of time over which a firm cannot modify an existing facility or build a new one  Short-run average total cost (SATC) Short-run total cost divided by the quantity of output, equal to AFC plus AVC.  Short-run average variable cost (SAVC) Variable cost divided by the quantity produced 9 November 05

10 Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 Total costs for firm X 10 November 05

11 TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 Total costs for firm X 11 November 05

12 TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 Total costs for firm X 12 November 05

13 TVC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 TFC Total costs for firm X 13 November 05

14 TVC TFC Diminishing marginal returns set in here Total costs for firm X 14 November 05

15 TVC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 TFC Total costs for firm X 15 November 05

16 TVC TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 Total costs for firm X 16 November 05

17 TC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TVC TFC Total costs for firm X 17 November 05

18 TC TVC TFC Diminishing marginal returns set in here Total costs for firm X 18 November 05

19 Short-run costs Marginal cost =  TC /  Q Marginal cost =  TC /  Q 19 November 05

20 Deriving marginal costs Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 Q Costs (£) 20 November 05

21 TC Deriving marginal costs Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 Q Costs (£) 21 November 05

22 TC Deriving marginal costs Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 Q Costs (£)  TC = 12  Q = 1 22 November 05

23 TC MC Diminishing returns set in here Q Costs (£) Deriving marginal costs Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 23 November 05

24 MC Q Costs (£) Deriving marginal costs Diminishing marginal returns set in here 24 November 05

25 Short-run costs Average cost =TC / Q Average cost =TC / Q 25 November 05

26 Q Costs (£) 26 November 05

27 Q TVC AVC 0 0 - 1 10 10 2 16 8 3 21 7 4 28 7 5 40 8 6 60 10 7 91 13 Q Costs (£) AFC 27 November 05

28 Q Costs (£) AFC AVC Q TVC AVC 0 0 - 1 10 10 2 16 8 3 21 7 4 28 7 5 40 8 6 60 10 7 91 13 28 November 05

29 Q TC AC 0 12 1 22 22 2 28 14 3 33 11 4 40 10 5 52 10.4 6 72 12 7 103 14.7 Q Costs (£) AFC AVC 29 November 05

30 Q Costs (£) AC AFC AVC Q TC AC 0 12 1 22 22 2 28 14 3 33 11 4 40 10 5 52 10.4 6 72 12 7 103 14.7 30 November 05

31 Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 Q Costs (£) 31 November 05

32 MC Q Costs (£) Q TC MC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 32 November 05

33 MC Q TC MC AC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 - 22 14 11 10 10.4 12 14.7 Q Costs (£) 33 November 05

34 MC Q Costs (£) AC Q TC MC AC 0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103 10 6 5 7 12 20 31 - 22 14 11 10 10.4 12 14.7 34 November 05

35 Output (Q) Costs (£) AFC AVC MC x AC z y Average and marginal costs 35 November 05

36 Long-run costs =TC / Q Long-run costs =TC / Q 36 November 05

37 Long-run costs Long run A period of time long enough that a firm can change all the factors of production, meaning that a firm can modify its existing production facility or build a new one  Long-run average cost (LAC) Long-run total cost divided by the quantity of output produced  Long-run total cost The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size 37 November 05

38 Returns to scale  Economies of scale A situation in which an increase in the quantity produced decreases the long-run average cost of production  Diseconomies of scale A situation in which an increase in the quantity produced increases the long-run average cost of production  Constant returns to scale The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size  Minimum efficient scale The output at which the long-run average cost curve becomes horizontal 38 November 05

39 Alternative long-run average cost curves Output O Costs LRAC Economies of Scale 39 November 05

40 Output O Costs Diseconomies of Scale LRAC Alternative long-run average cost curves 40 November 05

41 Output O Costs LRAC Constant costs Alternative long-run average cost curves 41 November 05

42 A typical long-run average cost curve Output O Costs LRAC 42 November 05

43 Output O Costs LRAC Economies of scale Constant costs Diseconomies of scale A typical long-run average cost curve 43 November 05

44 Long-run average and marginal costs Output O Costs LRAC LRMC Economies of Scale 44 November 05

45 Output O Costs LRAC LRMC Diseconomies of Scale Long-run average and marginal costs 45 November 05

46 Output O Costs LRAC = LRMC Constant costs Long-run average and marginal costs 46 November 05

47 Output O Costs LRMC LRAC Initial economies of scale, then diseconomies of scale Long-run average and marginal costs 47 November 05

48 Long-run costs Relationship between short-run and long-run AC curves 48 November 05

49 Deriving long-run average cost curves: factories of fixed size SRAC 3 Costs Output O SRAC 4 SRAC 5 5 factories 4 factories 3 factories 2 factories 1 factory SRAC 1 SRAC 2 49 November 05

50 SRAC 1 SRAC 3 SRAC 2 SRAC 4 SRAC 5 LRAC Costs Output O Deriving long-run average cost curves: factories of fixed size 50 November 05

51 Costs Output O Examples of short-run average cost curves Deriving long-run average cost curves: choice of factory size 51 November 05

52 LRAC Costs Output O Deriving long-run average cost curves: choice of factory size 52 November 05

53 53 November 05 Perfect competition Perfect competition and perfectly competitive firm

54 Perfect Competition 54 November 05

55 Perfect competition Short-run equilibrium of firm and industry (profit maximising) 55 November 05

56 O £ (b) Firm Q (thousands) O (a) Industry P Q (millions) S D PePe MC AR D = AR = MR QeQe AC Short-run equilibrium of industry and firm under perfect competition 56

57 Perfect competition The industry supply curve The industry supply curve 57 November 05

58 OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 MC P2P2 D 2 = MR 2 D2D2 P3P3 D 3 = MR 3 D3D3 Q (thousands) Deriving the short-run supply curve a b c = S 58

59 Perfect competition Long-run equilibrium 59 November 05

60 OO P£ Q (millions) S1S1 D LRAC PLPL P1P1 QLQL SeSe AR 1 D1D1 AR L DLDL Q (thousands) Long-run equilibrium under perfect competition New firms enter Supernormal profits Profits return to normal (a) Industry (b) Firm 60

61 £ Q O (SR)AC (SR)MC LRAC AR = MR DLDL LRAC = (SR)AC = (SR)MC = MR = AR Long-run equilibrium of the firm under perfect competition 61 November 05

62 62 November 05 Perfect competition Profit Maximisation & Loss Minimisation

63 Profit Maximisation 63 November 05

64 Profit maximisation Normal profit versus Economic profit  Economic profit (EP) Total revenue minus the total economic cost  Normal profit (NP) The portion of firm’s cost that is not included in accounting cost EP = TR – TC TR = P x Q Normal profit versus Economic profit  Economic profit (EP) Total revenue minus the total economic cost  Normal profit (NP) The portion of firm’s cost that is not included in accounting cost EP = TR – TC TR = P x Q 64 November 05

65 Profit maximisation Using total cost and revenue curves (a) Price taking firm Using total cost and revenue curves (a) Price taking firm 65 November 05

66 Total profit = £100 × 46 = £4600 TR Costs and revenue (£) Quantity 600 500 400 300 200 100 0 0 102030405060 Price-taking firm TC 100 46 b a 66

67 Profit maximisation Using total cost and revenue curves (b) Firm facing downward sloping demand curve Using total cost and revenue curves (b) Firm facing downward sloping demand curve 67 November 05

68 TR, TC, T  (£) Quantity Finding maximum profit using total curves 68 November 05

69 TR, TC, T  (£) TR Quantity Finding maximum profit using total curves 69 November 05

70 TR, TC, T  (£) TR TC Quantity Finding maximum profit using total curves 70 November 05

71 TR, TC, T  (£) TT TR TC Quantity Finding maximum profit using total curves 71 November 05

72 TR, TC, T  (£) TT TR TC a b c d Quantity Finding maximum profit using total curves 72 November 05

73 TR, TC, T  (£) TT TR TC d e f Quantity Finding maximum profit using total curves 73 November 05

74 Profit maximisation Using average and marginal cost and revenue curves (a) Price taking firm Using average and marginal cost and revenue curves (a) Price taking firm 74 November 05

75 Total profit = £16 x 40 = £640 AR = MR MC 50 40 30 20 10 0 0 2030405060 Quantity Costs and Revenue (£) 22 a Price-taking firm AC 38 b 75

76 Profit maximisation Using average and marginal cost and revenue curves (b) Firm facing downward sloping demand curve Using average and marginal cost and revenue curves (b) Firm facing downward sloping demand curve 76 November 05

77 Quantity Costs and revenue (£) Finding the profit-maximising output using marginal curves 77 November 05

78 Quantity Costs and revenue (£) MC Finding the profit-maximising output using marginal curves 78 November 05

79 Quantity Costs and revenue (£) e MR MC Profit-maximising output Finding the profit-maximising output using marginal curves 79 November 05

80 Quantity Costs and revenue (£) Measuring the maximum profit using average curves MR MC 80 November 05

81 Quantity Costs and revenue (£) MR MC AR Measuring the maximum profit using average curves 81 November 05

82 6.00 4.50 MR Quantity Costs and revenue (£) MC AC AR b a Total profit = £1.50 x 3 = £4.50 Measuring the maximum profit using average curves T O T A L P R O F I T 82 November 05

83 Loss Minimisation 83 November 05

84 O Costs and revenue (£) Quantity MC AC AR MR Q AC AR Loss-minimising output LOSS 84

85 Profit maximisation Short-run shut-down point Short-run shut-down point 85 November 05

86 The short-run shut-down point O Costs and revenue (£) Quantity AR AVC AC P = AVC Q 86 November 05

87 Costs and supply. Perfect competition Questions for discussions: 1. Most supply curves are vertical ? 2. So what is a firm ? 3. To maximise profit, maximise sales ? 4. Scale economies and the Internet ? 5. Small is beautiful - big is again beautiful ? 6. Firms making losses should quit at once ? Questions for discussions: 1. Most supply curves are vertical ? 2. So what is a firm ? 3. To maximise profit, maximise sales ? 4. Scale economies and the Internet ? 5. Small is beautiful - big is again beautiful ? 6. Firms making losses should quit at once ? 87 November 05

88 Assignment for week # 6: Essay question: Productivity and Technological changes ? Assignment for week # 6: Essay question: Productivity and Technological changes ? Introduction to Economics 88 November 05

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