Promoting active learning

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

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Introduction to Economics

• 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.

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Introduction to Economics

• Costs and supply. Perfect competition
• The firms 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.

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Costs and supply
Input and output
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Input and output

• 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.

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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

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Costs and supply

• Short-run costs
• Total cost

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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

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

• Marginal cost
• ?TC / ?Q

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Deriving marginal costs
Costs ()
Q
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Deriving marginal costs
Costs ()
TC
Q
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Deriving marginal costs
Costs ()
TC
DTC 12
DQ 1
Q
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Deriving marginal costs
Costs ()
TC
MC
Q
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Deriving marginal costs
Costs ()
MC
Q
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Short-run costs

• Average cost
• TC / Q

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Costs ()
Q
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Costs ()
AFC
Q
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Costs ()
AVC
AFC
Q
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Costs ()
AVC
AFC
Q
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Costs ()
AC
AVC
AFC
Q
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Costs ()
Q
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Costs ()
MC
Q
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Q TC MC AC 0 12 1 22 2 28 3
33 4 40 5 52 6 72 7 103
Costs ()
- 22 14 11 10 10.4 12 14.7
MC
10 6 5 7 12 20 31
Q
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Costs ()
Q TC MC AC 0 12 1 22 2 28 3
33 4 40 5 52 6 72 7 103
- 22 14 11 10 10.4 12 14.7
MC
10 6 5 7 12 20 31
AC
Q
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Average and marginal costs
Costs ()
Output (Q)
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Long-run costs

• Long-run costs
• TC / Q

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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

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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

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Alternative long-run average cost curves
Economies of Scale
Costs
O
Output
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Alternative long-run average cost curves
Diseconomies of Scale
Costs
O
Output
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Alternative long-run average cost curves
Constant costs
Costs
O
Output
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A typical long-run average cost curve
Costs
O
Output
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A typical long-run average cost curve
Economies of scale
Constant costs
Diseconomies of scale
Costs
O
Output
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Long-run average and marginal costs
Economies of Scale
Costs
LRAC
O
Output
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Long-run average and marginal costs
LRAC
Diseconomies of Scale
Costs
O
Output
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Long-run average and marginal costs
Constant costs
Costs
LRAC
LRMC
O
Output
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Long-run average and marginal costs
Initial economies of scale, then diseconomies of
scale
LRAC
Costs
O
Output
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Long-run costs

• Relationship between short-run and long-run AC
  curves

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Deriving long-run average cost curves factories
of fixed size
1 factory
Costs
2 factories
3 factories
O
Output
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Deriving long-run average cost curves factories
of fixed size
SRAC5
SRAC1
SRAC2
SRAC4
SRAC3
LRAC
Costs
O
Output
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Deriving long-run average cost curves choice of
factory size
Costs
Examples of short-run average cost curves
O
Output
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Deriving long-run average cost curves choice of
factory size
LRAC
Costs
O
Output
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Perfect competition
Perfect competition and perfectly competitive firm
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Perfect Competition
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Perfect competition

• Short-run equilibrium of firm and industry
  (profit maximising)

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Short-run equilibrium of industry and firm under
perfect competition

P
O
O
Qe
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
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Perfect competition

• The industry
• supply curve

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Deriving the short-run supply curve
P

S
D1 MR1
D2 MR2
D3 MR3
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
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Perfect competition

• Long-run equilibrium

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Long-run equilibrium under perfect competition
Profits return to normal
Supernormal profits
New firms enter
P

O
O
QL
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
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Long-run equilibrium of the firm under perfect
competition

O
Q
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Perfect competition
Profit Maximisation Loss Minimisation
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Profit Maximisation
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Profit maximisation

• Normal profit versus
• Economic profit
• Economic profit (EP)
• Total revenue minus the total economic cost
• Normal profit (NP)
• The portion of firms cost that is not included
  in
• accounting cost
• EP TR TC
• TR P x Q

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Profit maximisation

• Using total cost and revenue curves
• (a) Price taking firm

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Price-taking firm
Costs and revenue ()
600
500
400
300
200
100
0
10
20
30
40
50
60
0
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Quantity
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Profit maximisation

• Using total cost and revenue curves
• (b) Firm facing downward sloping demand curve

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Finding maximum profit using total curves
TR, TC, TP ()
Quantity
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Finding maximum profit using total curves
TR
TR, TC, TP ()
Quantity
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Finding maximum profit using total curves
TC
TR
TR, TC, TP ()
Quantity
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Finding maximum profit using total curves
TC
TR
TR, TC, TP ()
Quantity
TP
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Finding maximum profit using total curves
TC
b
TR
a
TR, TC, TP ()
c
d
Quantity
TP
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Finding maximum profit using total curves
TC
TR
TR, TC, TP ()
Quantity
TP
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Profit maximisation

• Using average and marginal cost and revenue
  curves
• (a) Price taking firm

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Price-taking firm
Costs and Revenue ()
50
40
38
30
20
10
0
0
10
20
30
40
50
60
Quantity
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Profit maximisation

• Using average and marginal cost and revenue
  curves
• (b) Firm facing downward sloping demand curve

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Finding the profit-maximising output using
marginal curves
Costs and revenue ()
Quantity
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Finding the profit-maximising output using
marginal curves
MC
Costs and revenue ()
Quantity
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Finding the profit-maximising output using
marginal curves
MC
Costs and revenue ()
Quantity
MR
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Measuring the maximum profit using average curves
MC
Costs and revenue ()
Quantity
MR
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Measuring the maximum profit using average curves
MC
Costs and revenue ()
AR
Quantity
MR
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Measuring the maximum profit using average curves
MC
Total profit 1.50 x 3 4.50
AC
Costs and revenue ()
T O T A L P R O F I T
AR
Quantity
MR
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Loss Minimisation
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Loss-minimising output
Costs and revenue ()
LOSS
O
Quantity
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Profit maximisation

• Short-run
• shut-down point

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The short-run shut-down point
Costs and revenue ()
O
Quantity
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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 ?

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Introduction to Economics

• Assignment for week 6
• Essay question Productivity and Technological
  changes ?

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