1. MR=P MC Review: Market Equilibrium The equilibrium price and quantity are determined by the market demand and market supply curves. First Question: Where does the market supply curve come from? The market supply curve is the horizontal sum of each individual firm’s supply curve. Second Question:Where does an individual firm’s supply curve come from? Profit Maximization Marginal Revenue (MR):Change in the firm’s total revenue resulting from a one unit change in the quantity of output produced. Marginal Cost (MC):Change in the firm’s total cost resulting from a one unit change in the quantity of output produced. MR > MC  More production increases profit MR < MC  Less production increases profit MR = MC  Profit is maximized Marginal Revenue and Perfect Competition: MR = P Marginal Cost Curve: Upward Sloping q q*

2. Individual Firm’s Supply Curve: The individual firm’s supply curve is its marginal cost curve. q MR =.50 MC Second Question: Where does an individual firm’s supply curve come from? That is, how does a firm decide how much output to produce? Firm A’s supply curve: How many cans of beer would firm A produce, if the price of beer were _____, given that everything else relevant to the supply of beer remains the same? If P =.50 MR = 1.00If P = 1.00 MR = 1.50If P = 1.50 Profit Maximization: Produce the quantity of output at which MR = MC..501.001.50 It looks like an individual firm’s supply curve is the firm’s marginal cost curve. P In fact, we must add one caveat. S

3. Review: Short Run versus Long Run Short Run  Firms must meet their short run commitments  Terminology: When a firm goes out of business in the short run, we say that the firm shuts down. Long Run  Firms can escape their short run commitments  Terminology: When a firm goes out of business in the long run we say that the firm exits the industry. Short Run Shutdown “Rule” Price and Average Variable Cost (AVC)  P < AVC  Firm goes out of business in the short run  The firm shuts down. Long Run Exit “Rule” Price and Average Total Cost (ATC)  P < ATC  Firm goes out of business in the long run  The firm exits the industry. Rationale for the Caveat and the Long Run Behavior of an Individual Firm Question: How does the owner of a firm decide to Continue to operate Owner’s income when operating the firm Go out of business Owner’s income if he/she goes out of business and works for someone else Answer: Compare or with q MC P Individual Firm’s Supply Curve: The individual firm’s supply curve is its marginal cost curve until the price is very low and falls below average variable cost. When the price is less than average variable cost, the firm will shut down and produce nothing. S

4. Jeff’s monthly income if he continues to operate his firm = Total Revenue Jeff’s monthly income in the long run if he goes out of business Opportunity Costs  Accounting Costs = Profit of Jeff’s FirmTotal Revenue  Total Costs= Total Revenue  (Accounting Costs + Opportunity Costs)= Total Revenue  Accounting Costs  Opportunity Costs = (Total Revenue  Accounting Costs)  Opportunity Costs =  Jeff’s monthly income if he continues to operate his firm  Jeff’s monthly income in the long run if he goes out of business  =Profit of Jeff’s Firm Total Revenue  Total Cost= PqPq  ATC  q = Total Revenue = P  q ATC = Total Cost Total Cost = ATC  q q = (P  ATC)  q Claim: A firm’s profit depends on price P and average total cost (ATC).

5. Profit of Jeff’s Firm = (P  ATC)  q P<ATC  Jeff’sJeff’s incomeincome when < in the long run operatingif he goes his firmout of business  Jeff earns less income by operating his firm than by working for someone else.  Exit occurs in the long run P>ATC  Jeff’sJeff’s incomeincome when > in the long run operatingif he goes his firmout of business  Jeff earns more income by operating his firm than by working for someone else.  Entry occurs in the long run P=ATC  Jeff’sJeff’s incomeincome when = in the long run operatingif he goes his firmout of business  Jeff earns the same income by operating his firm or by working for someone else.  Long run equilibrium  Profit<0  Profit=0  Profit>0 q MC ATC The ATC curve intersects the MC curve at minimum ATC. MC < ATC ATC falls MC > ATC ATC rises

6. ATC MC qQ P Scenario 1: P* < Min ATC P* q*  Max profit: q = q*  P* < ATC  Profit < 0  Firms exit in the long run  Supply curve shifts left in the long run  Price rises in the long run D S MR = P* S’ Summary P* < Min ATC  Price rises in the long run Intersects the marginal cost curve (MC) at minimum average total cost. Average Total Cost (ATC) Curve

7. ATC MC qQ P Scenario 2: P* > Min ATC P* q*  Max profit: q = q*  P* > ATC  Profit > 0  Firms enter in the long run  Supply curve shifts right in the long run  Price falls in the long run D S MR = P* S’ Intersects the marginal cost curve (MC) at minimum average total cost. Summary: P* > Min ATC  Price falls in the long run Average Total Cost (ATC) Curve

8. ATC MC q D S Q P Scenario 3: P* = Min ATC P* q*  Max profit: q = q*  P* = ATC  Profit = 0  Long run equilibrium  Supply curve will not shift in the long run MR = P* Summary: P* = Min ATC  Long run equilibrium Intersects the marginal cost curve (MC) at minimum average total cost. Average Total Cost (ATC) Curve  Price does not change in the long run

9. President Clinton’s “Level Playing Field” Claim On April 7, 1994, President Clinton (Hilary’s husband) held a town meeting at the KCTV television studios in Kansas City, Missouri. He fielded a variety of questions concerning his health care proposal. One question was posed by Herman Cain, president and chief executive officer of Godfather Pizza, Inc. Mr. Cain feared that Clinton’s proposal would raise his costs, hurt his business, and force him to lay off workers. President Clinton agreed that costs would rise, but argued that since the costs of all pizza firms would increase, Godfather would not suffer: “..., so [for] you [the health proposal] would add about one and one-half percent to the total cost of doing business. Would that really cause you to lay a lot of people off if all your competitors had to do it too? Only if people stop eating out. If all your competitors had to do it, and your cost of doing business went up one and one-half percent, wouldn't that leave you in the same position you are in now? Why wouldn't they all be in the same position, and why wouldn't you all be able to raise the price of pizza two percent? I'm a satisfied customer. I'd keep buying from you.” President Clinton’s “Level Playing Field” Claim: Since the costs of all pizza firms would increase, an individual firm would not be hurt.

10. Where does the market supply curve "come from?" What happens to the equilibrium quantity? What happens to the firm's profit maximizing level of output? Decreases. What happens to the equilibrium price?Increases. ATC MC q D S Q P P* q* MR = P* Q* ATC MC S P** MR = P** q** Q**.10 <.10 What is the goal of each pizza firm?Profit maximization A profit maximizing firm produces the level of output at which In a metropolitan area, there are a large number of small, independent pizza firms; consequently, the pizza market is perfectly competitive: In a perfectly competitive market, MR = MC. MR = Price. Is the industry is in long run equilibrium? When an industry is in long run equilibrium, How is the average total cost curve shaped? Yes the price, P*, equals minimum ATC. ATC curve intersects the MC curve at minimum ATC. What happens to the typical firm's average total cost curve? What happens to the typical firm's marginal cost curve? Horizontal sum of each firms MC curve. Shifts up by $.10. What happens to the market supply curve? Shifts up by $.10. What happens to the equilibrium price? Decreases. Increases by less than $.10. How are the price and average total cost related? Price is less than average total cost Will firms enter or exit?Exit What happens to the market supply curve? Shifts left. What happens to the equilibrium quantity? Decreases. S  P*** Q*** Pizza MarketTypical Pizza Firm