Supply Side--Lectures

1
Supply Side--Lectures

• Rebecca Tuttle Baldwin
• BCC--Micro

2
Reminder for our simple model

• Supply side means firms in final goods/service
  market
• We will use corporate structure
• Supply ( Price Quantity relationship) reflects
  the quantity of the good firm willing able to
  produce at various prices.

3
Perfectly Competitive Market

• Many buyers
• Many sellers
• Ease of entry/exit (no barriers)
• Perfect information
• Homogeneous good

4
Profit

• Defined as the residual after subtracting all
  costs to necessary factors of production from
  gross revenues.
• TR-TC
• All firms are profit maximizers, not revenue or
  sales

5
Result for our individual firm

• No market power--it will be a price TAKER

6
How does Total Revenue (TR) depend on Quantity
(Q)?

• Price times Quantity (PxQ)
• focus on one products production at a time
• relatively straightforward (comes from demand)

7
Costs

• capture opportunity costs of factors
• only true costs are opportunity cost
• needed for calculation of economic profit, to
  distinguish from accounting profit
• can be broken down or sorted into fixed/variable
  or implicit/explicit

8
Time Needs to be brought into our model

• Short-run (production decision)
• Relevant decision is what Q to produce at?
• Long-run (investment decision)
• Whether to enter/exit market
• In the Long-Run ALL COSTS ARE VARIABLE (FC0)

9
Production Function

• Links quantity of input to output levels
• Marginal Product of labor is defined at the
  incremental increase in production from one more
  unit of labor, also called Marginal Physical
  Product (MPP)
• Already know marginal concept

10
MPP

• Expect it to decline as we add more workers
• Why?
• When evaluating, we are holding other factors
  constant

11
Marginal Costs

• Change in Total Costs due to one unit change in
  Quantity produced
• change in TC/change in Q
• can graph MC on /Q

12
Review Example

• Economan has been infected by the free enterprise
  bug and set up a firm on extraterrestrial
  affairs. The rent for the building is 4000,
  cost of two secretaries is 40,000 and the cost
  of electricity and gas comes to 5000. There is
  a great demand for his information and his total
  revenues amount to 100,000. He has turned down
  the 50,000 salary he could have made from the
  Friendly Space Agency and he lost the interest of
  4000 he made last year because now his funds are
  tied up in the business

13
Profit?

• Explicit Costs (400040,0005,000)49K
• Implicit Costs (54K)
• TR100K
• Economic Profit -3K

14
Supply Curve for Ind. Firm

• Firm is a price-taker
• Profit Max Rule then PMC
• so the P represents the minimum amount they would
  be willing to accept to produce that quantity for
  sale (our definition of Supply curve)
• Market curve-aggregate across firms

15
Determinants

• Because the Marginal Cost curve is the supply
  curve, anything that changes MC will shift curve.
• Technology, expectations, factor markets

16
Producer Surplus

• difference between price and the marginal cost.
• below market price and above supply curve for
  market

17
Competitive Market Model

• Demand curve is summation of individual demand
  curves, which are based on the MB of additional
  consumption
• Market supply is aggregated across all firms, and
  their individual supply curve comes from their MC
  curve (in S-R)

18
Model driven to equilibrium

• With enough time to adjust, in the absence of
  shifts, this market will reach an equilibrium,
  regardless of where it started
• Once price and Q established within market, now
  we can use the price to answer output and
  consumption for each individual player.

19
Imperfect Information

• Consumer only has information on his/her own
  tastes, WTP
• Individual firm only knows its own MC structure
• Still works fairly well as a predictor

20
Why do we like competitive markets?

• Leads to an efficient outcome
• responsive
• adaptable
• captures societys relative rankings

21
Efficiency

• Use the least amount of resources to produce a
  given level of output
• For a given level of inputs, yield the most
  output
• With voluntary transactions, no one can be made
  better off without making someone else worse off
  (Pareto efficiency or optimal)

22
Conditions for Efficiency

• MBMC for last
• MC equal for all producers
• MB equal across consumers
• Quantity is not the same

23
Efficient Solution

• Not unique outcome
• Depends on initial income distributions
• PROPERTY RIGHTS
• Income inequality (issue of fairness)

24
Market Equilibrium and the Firms Demand Curve
in Perfect Competition
25
Short-Run Profit Maximization
(a) Total Revenue Minus Total Cost

26
Minimizing Short-Run Losses
27
Summary of Short-Run Output Decisions
Marginal cost
t
i

Average total cost
n
u



r
4
e
p


Average variable cost
s
r


a

l
l
o

D
1
p1

d1





0
Quantity per period
q1
28
Aggregating Individual Supply to Form Market
Supply
29
Relationship Between Short-Run Profit
Maximization and Market Equilibrium
30
Long Run Equilibrium for the Firm and the
Industry
(a) Firm
(b) Industry, or market
MC
S
ATC
LRAC
Dollars per unit
Price per unit
e
p
d
p
D

Q
Quantity per period
Quantity per period
0
0
q
31
Long-Run Adjustment to an Increase in Demand
(b) Industry, or Market
(a) Firm
S
MC

ATC



Dollars per unit
Price per unit





LRAC



a


p
d
p

















D







0
q
Qa
0
Quantity per period

Quantity per period
32
Long-Run Adjustment to a Decrease in Demand
(b) Industry, or Market
(a) Firm
S
MC
ATC
LRAC
Dollars per unit
Price per unit
a
e
d
p
p
D
p"
0
0
Qa
q
Quantity per period
Quantity per period

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Exhibit 12 An Increasing-Cost Industry
(a) Firm
(b) Industry, or Market
S
MC



ATC




Price per unit
Dollars per unit




p

a
d
p
a
a
a
a





D












q
0
0
Qa
Quantity per period
Quantity per period
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Consumer Surplus and Producer Surplus for a
Competitive Market in the Short Run
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General Profit Max Rule

• MRMC
• Marginal Revenue (MR) is change in Total Revenue
  (TR)/ change in Q
• MR adds to incremental profit and MC takes away
  from it

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But in our Perfectly Competitive World

• P MR for an individual firm
• so special case, the rule becomes PMC