1 Econ 1000 Lecture 6: Perfect Competition C.L. Mattoli (C) Red Hill Capital Corp., Delaware, USA 2008

*Econ 1000 Lecture 6:Perfect CompetitionC.L. Mattoli(C) Red Hill Capital Corp., Delaware, USA 2008

(C) Red Hill Capital Corp., Delaware, USA 2008

PrologueBusinesses are stuck in the short run, although the length of the short run can vary depending on the business.The point is that, in most businesses it is not possible to change everything quickly.For example, if you own a store, it will not be easy to move the location. To move will require fitting out the new place, changing business cards, advertising the new location, etc.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueOther changes for other businesses might be even longer.Thus, businesses will have some inputs that are fixed and others that can be more easily varied, like man (woman) hours.When we begin production and go from 0 units to the first, that will require adding some variable input, for example, labor, to the fixed.Given that, we can calculate the output per unit of the variable input, e.g., labor.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueThere is efficiency gained when you add, for example, a second unit of labor.Suppose that the company consists of 2 machines, fixed inputs. The first machine does the roughing out of the products and the second machine is a finishing machine.With one laborer she has to do the roughing out, then, move over to the other machine to finish the product. It is very inefficient.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueThere is an efficiency gain, and the two can produce more than 2 times the output of one laborer. The marginal product is the change in output that occurs by adding one more unit of variable input. So it is a unit cost, specifically, for the next unit.As more units of input are added, there will continue to be efficiency gains, up to a point, then, efficiency begins to be lost.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueAs a result, the extra (marginal) output (product) increases, peaks, then, decreases.There is also an average output per unit of input.Using the average-marginal rule, the average output per unit of input will increase, as marginal product increases.Average variable cost per unit of output is inversely related to average output per unit variable input, i.e., 1/[output/variable input] = variable input/output.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueFor example, 2 employees/2.2 tons of grapes = 0.91 employees/ton of grapes. So, it costs 0.91 employees per unit of grapes.Thus, as MP increases, average cost decreases, and vice versa. As output increases, the fixed input is also spread over more units, so total cost per unit decreases, then increases.*(C) Red Hill Capital Corp., Delaware, USA 2008


PrologueMC will be inverse to MP, as the change in output per input increasing means the cost per new unit is decreasing.Then, we can use the average-marginal rule to look at cost curves.We give a diagrammatic summary of the basic concepts in the next few slides.*(C) Red Hill Capital Corp., Delaware, USA 2008


*Marginal Product(C) Red Hill Capital Corp., Delaware, USA 2008

Marginal ProductEmployeesMarginal Product00.011.021.231.140.950.660.2


Chart3

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0.9

0.6

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Marginal Product

Sheet1

EmployeeProduce

000

111

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31.13.3

40.94.2

50.64.8

60.25

me

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Tons

Employees

Total Output

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Marginal Product

Marginal Product

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*MP vs. MC(C) Red Hill Capital Corp., Delaware, USA 2008

LaborMPOutputTVCMC/unit00.00011.01100100.0021.22.220083.3331.13.330090.9140.94.2400111.1150.64.8500166.6760.25600500.00


Chart6

00

1100

1.283.3333333333

1.190.9090909091

0.9111.1111111111

0.6166.6666666667

0.2500

Output

Cost ($)

MP

MP vs. MC

Sheet1

EmployeeMarginal ProductProduceTCMC/unit

00.000

11.01100100

21.22.220083.3333333333

31.13.330090.9090909091

40.94.2400111.1111111111

50.64.8500166.6666666667

60.25600500

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

Sheet1

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Average and Marginal Costs vs. Output

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Cost ($)

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MP vs. MC

*AC & MC AVCAFCATCMC(C) Red Hill Capital Corp., Delaware, USA 2008

QTCMCAFCAVCAC0100------------115050100.0050.00150.0021843450.0042.0092.0032082433.3336.0069.3342271925.0031.7556.7552502320.0030.0050.0062803016.6730.0046.6773183814.2931.1445.4383664812.5033.2545.7594255911.1136.1147.22105007510.0040.0050.0011595959.0945.0054.09127121178.3351.0059.33


Chart5

1005050150

50423492

33.3333333333362469.3333333333

2531.751956.75

20302350

16.6666666667303046.6666666667

14.285714285731.14285714293845.4285714286

12.533.254845.75

11.111111111136.11111111115947.2222222222

10407550

9.0909090909459554.0909090909

8.33333333335111759.3333333333

Quantity

Unit Cost($)


Sheet1

EmployeeMarginal ProductProduce

00.00

11.01

21.22.2

31.13.3

40.94.2

50.64.8

60.25

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

Sheet1

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5

Tons

Employees

Total Output

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Employees

Marginal Product

Marginal Product

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Quantity

Cost ($)

Cost vs. Quantity

Quantity

Unit Cost($)


*This weekChapter 7Perfect Competition(C) Red Hill Capital Corp., Delaware, USA 2008


*ObjectivesWe will describe market structure.We will finally get to a bottom line: profits.We will look at what it means for a market to be perfectly competitive.We will see why governments around the world promote market competition.We will examine how the internet is changing the structure of world markets(C) Red Hill Capital Corp., Delaware, USA 2008


*Where we are coming fromWe have studied the ideas of supply and demand, on their own, and examined the underlying motivations that lead to the general shapes of supply and demand curves.Then, we looked at general interactions between supply and demand to get market equilibrium, and think about how changes in equilibrium might occur.(C) Red Hill Capital Corp., Delaware, USA 2008


*Where we are coming fromPeople are motivated by self-interest, but that self-interest leads to competition on both sides, supply and demand, and, in the end, self-interest serves society and results in positive benefits.On the demand side, self-interest is manifest in wants, desires, and needs, but it also tempers the price that they will pay for things.That puts limits on the supply side: they cannot simply charge whatever they want. (C) Red Hill Capital Corp., Delaware, USA 2008


*Where we are coming fromWhat suppliers charge will affect not only how much they sell but also the total revenue that they will be able to take in.Last week we examined output, its motivations, and its limitations.Suppliers want to make profits but they have to face certain constraints.We saw that there is a short-run, in which only certain changes can be made to change the ability to supply, and a longer-run, in which more can be done to change supply.



*Where we are coming fromWe examined the cost side and found that suppliers face diminishing returns to inputs.Diminishing returns means that suppliers will face changing unit costs, which will affect their eventual profitability.We also saw that they might face changing costs structures depending on their size, which are manifest in concepts of economies of scale: bigger, itself, might result in a longer-run way to reduce unit cost.(C) Red Hill Capital Corp., Delaware, USA 2008


*Where we are coming fromSuppliers, eventually, might also face diseconomies of scale because of the organizational structure of business, in general.In the end, that means that suppliers will, in most cases, always face a cost structure that will limit their ability to make profits.This week, we examine profitability in the case of perfectly competitive markets.(C) Red Hill Capital Corp., Delaware, USA 2008


*Market Structures(C) Red Hill Capital Corp., Delaware, USA 2008


*Market StructureFirms sell things under a number of different sets of market conditions, which economists refer to as market structures.Economists then go on to identify several basic forms of market structure characterized by certain key features.The basic characteristics that shape market structure, include the number of firms in the industry, the differentiability of products, ease of entry and exit in the market, and availability and dissemination of information.(C) Red Hill Capital Corp., Delaware, USA 2008


*Market StructureThose characteristics are indicative of the degree of competition firms face in a market.If there are more firms, there are more places to buy something.If the products of those firms are more or less interchangeable, there is no reason to go to one firm than to another, except, perhaps for other reasons of convenience. If entry into the industry is easy, firms already in the industry will face the threat of more competition. If it is difficult, they will face less of a threat.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Basic Market Structures Based on these simple parameters, there will be a range of competitiveness by firms in markets, ranging from none to a lot.In a monopoly, there is one seller who dominates the market.Then, there might be only a few large firms that dominate a market in an oligopoly.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Basic Market Structures After that, there might be monopolistic competition, in which products are differentiable, and there are many sellers, but monopolists compete to get people to like their product instead of the others.Finally, there is perfect competition, which is the focus of this lecture.We summarize features of the various market structures, in the next slide.(C) Red Hill Capital Corp., Delaware, USA 2008


*Comparative Market Structures(C) Red Hill Capital Corp., Delaware, USA 2008

Structure# of sellersProduct EntryExamplesPerfect CompetitionLargeHomogeneousVery easySmall crops, commodities marketsMonopolistic competitionLargeDifferentiableEasyRestaurants, motels, clothing or other types of boutiquesOligopolyFewUsually differentiable; can be homoDifficultAirlines, Automobile manufacturing, oil productionMonopolyOneUniqueExtremely difficultPublic utilities


*The Elements of Perfect Competition(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionPerfect competition means, basically, that no single firm can gain a competitive advantage over the others. That will be the case under a few rudimentary conditions.If there are many small firms, none of which has a large enough share of total output (total supply) that it can affect market price.(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionIn addition, it must be assumed that the suppliers do not collude but act independently.Example would be egg farmers. There are thousands of egg farmers. If one decides to raise his price, it will have no affect on the going market price for eggs.(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionNext, we assume the product is fungible (homogeneous, indistinguishable, standardized, all the same).That way, no single supplier is able to gain a competitive advantage through advertising, quality distinction, or even convenience of location. (C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionBuyers are indifferent about which supplier they go to. There are no famous brand names. No one knows Coke and Pepsi. They just know cola.For example, fishmonger Hos lobster (long xia) is no better than fishmonger Chens lobster. They all come from the same sea.(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionEase of both entry and exit are part of the basis for perfect competition.That means, first, that there are no barriers to entry, like, startup cost (financial), technical, licensing, patent, permit, or government-imposed barriers. In that regard, anyone will be able to enter the market, on the one hand, and will not be discouraged by penalties, like investment, contractual, or legal reasons, to exit the business, on the other hand.(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect CompetitionResources are completely mobile to freely enter and exit the market. That is especially important in an industry in decline, in order for prices to adjust quickly. Easy entry assures that excess profits will not persist. Others seeing juicy profits will quickly enter the industry, and prices will be competitive.



*Perfect CompetitionFor example, you go into the bicycle rental business. You buy a bicycle and a cell phone to start your business, and you can easily close the business any time.A further assumption is that market participants are well-informed and well-educated about the product, including knowledge of the product, its production costs, and prices. (C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect World (No ones Perfect)The idea of perfect competition is a perfect world ideal. Models are not reality but only try to approximate it under simplified ideal conditions.The world is not perfect and rational. There is no perfect information. There is convenience of going to a store one block from you instead of one mile. Self-interest can lead to bad behavior.(C) Red Hill Capital Corp., Delaware, USA 2008


*Perfect World (No ones Perfect)However, we expect markets, like farm products, inter-city trucking, or housecleaning services, to be close to the competitive model. There are many sellers, and products are very similar.Moreover, the model can provide a benchmark against which real-world market structure and performance can be judged.(C) Red Hill Capital Corp., Delaware, USA 2008


*Competition and PolicyIn chapter 4, we saw that lack of competition can lead to market failures that result in inefficient outcomes.On the other hand, perfectly competitive markets will lead to maximum efficiency.In that regard, governments around the world have devoted much regulation and legislation to promote efficiency by encouraging competition and to discourage anti-competitive behavior through legal and financial penalties.(C) Red Hill Capital Corp., Delaware, USA 2008


*ACCC: Australias Competition WatchdogIn Australia, for example, The Australian Competition and Consumer Commission (ACCC) is the statutory authority charged with oversight and enforcement of the relevant Trade Practices Act that deal with competition.The objective of The Act is to enhance the welfare of Australians by promoting competition and fair trading and providing for consumer protection. The ACCC also administers the Price Surveillance Act.(C) Red Hill Capital Corp., Delaware, USA 2008


*ACCC ObjectivesImprove competition and efficiency in marketsFoster fair trade practices in well-informed markets. Promote competitive pricing when possible and restrain prices in markets where competition is less than effectiveInform and educate the community about the Trade Practices ActUse resources efficiently and effectively(C) Red Hill Capital Corp., Delaware, USA 2008


*New Zealand Commerce Commission (NZCC) GoalsDynamic markets and all goods and services produced at competitive pricesConsumers confident of information they receive when making choicesRegulated industries constrained from making excess profits, face incentives to invest, and share efficiency gains with consumers.(C) Red Hill Capital Corp., Delaware, USA 2008


*Policy Goals, SummarizedEven if not all industries are naturally competitive, government policies encourage efficiency by encouraging them to act as if they are competitive.Even though not all people practice enlightened self-interest, policy seeks to ban unethical behavior.Bad behaviors that governments seek to eliminate are: colluding to raise price/ profitability, exercising monopoly power at the expense of consumers, and misleading advertising.(C) Red Hill Capital Corp., Delaware, USA 2008


*Policy Goals, SummarizedThe authorities can order breakups of companies that have gained too much market power. They can disallow mergers that would result in too much market power residing in one company.They can disallow false advertising.They can impose price controls, like many countries do with public utility companies.They can impose fines and compensatory damages for bad behaviors, (C) Red Hill Capital Corp., Delaware, USA 2008


InformationInformation is one of the most important things in business.Businesses need to keep some information secret, otherwise their competitors will gain advantage.The importance of information is highlighted by the large role that disclosure of information and its accuracy play in competition and securities laws around the world.(C) Red Hill Capital Corp., Delaware, USA 2008*


*Consequences of Perfect Competition for Suppliers(C) Red Hill Capital Corp., Delaware, USA 2008


*Price Taker, not Price MakerIn a perfectly competitive market, market price is determined by aggregate supply and demand.Moreover, consumers have perfect information about the actual market price.The product is fungible, and the firm faces competition from inside the industry and the threat of others entering the industry.(C) Red Hill Capital Corp., Delaware, USA 2008


*Price Taker, not Price MakerAn individual firm is small and has no control to affect price (no market power), and if it tried to charge a higher-than-market price, informed consumers would not purchase from that firm because they can switch to another supplier with no effort, at all (he is right next door with the proper price).Thus, a firm is a price taker: it will necessarily have to sell at the going market price or sell nothing, at all.(C) Red Hill Capital Corp., Delaware, USA 2008


*Price Taker, not Price MakerIn that regard, we can think of the individual firm as facing a completely horizontal, perfectly elastic demand curve.The firm must supply any amount that it can and wants to supply at the going market price or consumers will simply turn to another of the many other suppliers.Quantity of output(1000s units/hour)0 20 40 60 80 1000 5 10Market AggregatesIndividual Firms120

100

807060

40

20Price per unit(dollars)Quantity of output(units/hour)The International Market for Electronic Components(C) Red Hill Capital Corp., Delaware, USA 2008


*Each Firm Faces Perfect Elastic DemandIn the above, graphical example, the individual firms output is several units per hour, while the industry output is an aggregate of 60,000 units/hr. at equilibrium with total demand.Equilibrium occurs at a price of $70/unit.Therefore, a firm must take that price, no matter what its output. (C) Red Hill Capital Corp., Delaware, USA 2008


*Each Firm Faces Perfect Elastic DemandIt, effectively, faces horizontal demand, on its part, because no matter how much output it supplies, that is the price that people will be willing to pay for its product.As we learned, when demand is horizontal, perfect elastic, a firm charging a higher price than that where supply intersects the demand curve will sell nothing.(C) Red Hill Capital Corp., Delaware, USA 2008


*Each Firm Faces Perfect Elastic DemandOn the other hand, selling at a price, below the one price in demand, would be stupid because he can sell the same amount at a higher price.Moreover, a downward change in price would, in that case, also lead to a decrease in revenues because the firm will not be able to increase sales by decreasing price ([Q/Q]/[P/P] = ED = 0).(C) Red Hill Capital Corp., Delaware, USA 2008


*Short-run Profit Maximization: Perfect Competition(C) Red Hill Capital Corp., Delaware, USA 2008


*The FrameworkAt the beginning of module 3, we discussed how elasticity of demand puts a constraint on the supplier because changing price can have different affects on total revenues.In perfect competition, the constraint becomes one fixed price against which the supplier must judge his costs and ability to make a profit.(C) Red Hill Capital Corp., Delaware, USA 2008


*The FrameworkIn the last lecture, we analyzed the elements of increasing and diminishing returns and cost constraints, which suppliers face.Now, we can put it all together and analyze profit.We saw how the unit cost curves were U-shaped with minimums due to a maximum in marginal product, which comes at the point of diminishing returns.(C) Red Hill Capital Corp., Delaware, USA 2008


*The FrameworkProfits = revenues costs. On supply and demand curves we show price per units, and the average cost figures show cost per unit.We shall look at two methods to determine maximum profits: the total revenue-total cost approach and the marginal revenue equals marginal cost method.We are in the short-run. (C) Red Hill Capital Corp., Delaware, USA 2008


*Industry: Output, Revenue, Cost & ProfitWe show possible output, revenue, cost, and profits for a mythical company in our mythical electronic component industry, in tabular form, here.The data, in graphical form, is shown on the next page.It continues MAT ATMs from the previous lecture.(C) Red Hill Capital Corp., Delaware, USA 2008

unitsTRTCProfitsMCMR00100-100170150-8050702140184-443470321020822470428022753197053502501002370642028014030707490318172387085603661944870963042520559701070050020075701177059517595701284071212811770


*Industry: Output, Revenue, Cost & ProfitAs you can see from the table and the figures, maximum profit occurs at 9 unit.It is also between 8 and 10 units that marginal cost equals marginal revenues.LossBreak-evenProfit(C) Red Hill Capital Corp., Delaware, USA 2008


Chart1

0100

70150

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490318

560366

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770595

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Total Revenue & Cost

Sheet1

unitsTRTCProfitsMCMR

00100-100

170150-805070

2140184-443470

321020822470

4280227531970

53502501002370

64202801403070

74903181723870

85603661944870

96304252055970

107005002007570

117705951759570

1284071212811770

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00100-100

170150-805070

2140184-443470

321020822470

4280227531970

53502501002370

64202801403070

74903181723870

85603661944870

96304252055970

107005002007570

117705951759570

1284071212811770

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*Analysis of the data and discussionGiven a market equilibrium price of $70, we calculate TR = $70 x unit output.Profits = TR TC.Marginal revenues are always equal to $70 because unit price never changes: MR = P.Marginal cost is changing unit cost: TC/Q = MC.(C) Red Hill Capital Corp., Delaware, USA 2008


*Analysis of the data and discussionThe firm has fixed costs, so there are losses until output reaches 3 units, which is an approximate break-even point (profit = $2 = almost zero).After that, profitability comes, but maximum profits are at around 9 units/hour.Maximum profit will be $205 per hour.Above 9 units/hour profit declines. (C) Red Hill Capital Corp., Delaware, USA 2008


*Marginal Revenue = Marginal costMarginal revenue is equal to the extra revenue from one more unit of output MR = TR/Q.In a perfectly competitive industry, the MR will always equal market price per unit, and the TR will be on a straight line with constant slope = MR.Max profits will occur at MC = MR, Profit = TR TC.Profit/Q = TR/Q TC/Q = MR MC.(C) Red Hill Capital Corp., Delaware, USA 2008


*Marginal Revenue = Marginal costThat equation tells us that profit will increase (Profit/Q > 0; positive change in profit) if MR > MC.That simply says that the extra revenue you get from selling that one extra unit, MR, is greater than the extra cost that you take on to produce that extra unit, MC.Therefore, there will be an addition to profits.(C) Red Hill Capital Corp., Delaware, USA 2008


*Marginal Revenue = Marginal costProfit will stop increasing (Profit/Q = 0) when MR=MC. And profit will begin to decrease (Profit/Q < 0; negative change in profit) after that point when MC > MR.It is only logical that total profits should decline at that point since the extra revenue that you take in, MR, is less than the extra cost that you incur, MC. (C) Red Hill Capital Corp., Delaware, USA 2008


*Marginal Revenue = Marginal costSo you will actually be subtracting the difference, MC MR, from profits that have already been booked.Then, we have the MR=MC Rule which says that maximum profits or minimum loss will occur at the point where MR=MC.(C) Red Hill Capital Corp., Delaware, USA 2008


*MR = MCWe can take the cost curves from last weeks lecture and spreadsheet files and combine it with MR, this week.Max profit/min loss occurs at MR=MCThen, profit is equal to the area contained in the yellow square.AVCAFCATCMCMRProfit(C) Red Hill Capital Corp., Delaware, USA 2008


Chart5

1005050150

50423492

33.3333333333362469.3333333333

2531.751956.75

20302350

16.6666666667303046.6666666667

14.285714285731.14285714293845.4285714286

12.533.254845.75

11.111111111136.11111111115947.2222222222

10407550

9.0909090909459554.0909090909

8.33333333335111759.3333333333

Quantity

Unit Cost($)


Sheet1

EmployeeMarginal ProductProduce

00.00

11.01

21.22.2

31.13.3

40.94.2

50.64.8

60.25

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

Sheet1

0

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2.2

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Employees

Total Output

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*Loss MinimizationSimilarly, when a firm faces a MR less than its unit cost at any output, again it should choose output when MC=MR.Then, it will minimize its short-run losses.At that point the spread (loss) between ATC and MR will be a minimum. ATCMCMR(C) Red Hill Capital Corp., Delaware, USA 2008


Chart4

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-114

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-75

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Loss

Losing Firm

Sheet1 (2)

EmployeeMarginal ProductProduceTVCMC/unit

00.000

11.01100100.00

21.22.220083.33

31.13.330090.91

40.94.2400111.11

50.64.8500166.67

60.25600500.00

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

3 Factory Sizes

QUnit cost sunit cost munit cost l

350

437

53250

63040

73230

83722

9502050

102237

113032

124030

135032

1437

1550

16


350

437

532

630

73230

822

920

102230

11303229

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133227

143726

155025

1624

1822

2020

3020

4020

6020

8020

8520

9020

10030

200

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1

1.2

1.1

0.9

0.6

0.2

Employees

Marginal Product

Marginal Product

Sheet2

1000100

10050150

10084184

100108208

100127227

100150250

100180280

100218318

100266366

100325425

100400500

100495595

100612712

Quantity

Cost ($)

Cost vs. Quantity

Sheet3

100505015035

5042349235

33.3333333333362469.333333333335

2531.751956.7535

2030235035

16.6666666667303046.666666666735

14.285714285731.14285714293845.428571428635

12.533.254845.7535

11.111111111136.11111111115947.222222222235

1040755035

9.0909090909459554.090909090935

8.33333333335111759.333333333335

Quantity

Unit Cost($)


00

1100

1.283.3333333333

1.190.9090909091

0.9111.1111111111

0.6166.6666666667

0.2500

Output

Cost ($)

MP

MP vs. MC

5033

3744

32505

30406

32307

37228

502050

102237

113032

124030

135032

141437

151550

Quantity of output

Unit costs

Cost curves for 3 factories

5033

3744

3255

3066

32307

8228

9209

102210

113032

121230

131332

141437

151550

Quantity of output

Unit costs


3

4

5

6

7

8

9

30

29

28

27

26

25

24

22

20

20

20

20

20

20

20

30

unitsTRTCProfitsMCMRMRLLoss

00100-10035-100

170150-80507035-115

2140184-44347035-114

32102082247035-103

428022753197035-87

5350250100237035-75

6420280140307035-70

7490318172387035-73

8560366194487035-86

9630425205597035-110

10700500200757035-150

11770595175957035-210

128407121281177035-292

00

00

00

00

00

00

00

00

00

00

00

00

00

Units

$


0

0

0

0

0

0

0

0

0

0

0

0

0

Profits

0

0

0

0

0

0

0

0

0

0

0

0

Units

Loss

Losing Firm

Chart5

100505015035

5042349235

33.3333333333362469.333333333335

2531.751956.7535

2030235035

16.6666666667303046.666666666735

14.285714285731.14285714293845.428571428635

12.533.254845.7535

11.111111111136.11111111115947.222222222235

1040755035

9.0909090909459554.090909090935

8.33333333335111759.333333333335

Quantity

Unit Cost($)


Sheet1 (2)


00.000

11.01100100.00

21.22.220083.33

31.13.330090.91

40.94.2400111.11

50.64.8500166.67

60.25600500.00

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

3 Factory Sizes


350

437

53250

63040

73230

83722

9502050

102237

113032

124030

135032

1437

1550

16


350

437

532

630

73230

822

920

102230

11303229

123028

133227

143726

155025

1624

1822

2020

3020

4020

6020

8020

8520

9020

10030

200

Sheet1 (2)

0

1

2.2

3.3

4.2

4.8

5

Tons

Employees

Total Output

Sheet1

0

1

1.2

1.1

0.9

0.6

0.2

Employees

Marginal Product

Marginal Product

Sheet2

Quantity

Cost ($)

Cost vs. Quantity

Sheet3

35

35

35

35

35

35

35

35

35

35

35

35

Quantity

Unit Cost($)


00

1100

1.283.3333333333

1.190.9090909091

0.9111.1111111111

0.6166.6666666667

0.2500

Output

Cost ($)

MP

MP vs. MC

5033

3744

32505

30406

32307

37228

502050

102237

113032

124030

135032

141437

151550

Quantity of output

Unit costs


5033

3744

3255

3066

32307

8228

9209

102210

113032

121230

131332

141437

151550

Quantity of output

Unit costs


3

4

5

6

7

8

9

30

29

28

27

26

25

24

22

20

20

20

20

20

20

20

30


00100-10035-100

170150-80507035-115

2140184-44347035-114

32102082247035-103

428022753197035-87

5350250100237035-75

6420280140307035-70

7490318172387035-73

8560366194487035-86

9630425205597035-110

10700500200757035-150

11770595175957035-210

128407121281177035-292

Units

$


Profits

Units

Loss

Losing Firm

*(C) Red Hill Capital Corp., Delaware, USA 2008


Chart5

100505015035

5042349235

33.3333333333362469.333333333335

2531.751956.7535

2030235035

16.6666666667303046.666666666735

14.285714285731.14285714293845.428571428635

12.533.254845.7535

11.111111111136.11111111115947.222222222235

1040755035

9.0909090909459554.090909090935

8.33333333335111759.333333333335

Quantity

Unit Cost($)


Sheet1 (2)


00.000

11.01100100.00

21.22.220083.33

31.13.330090.91

40.94.2400111.11

50.64.8500166.67

60.25600500.00

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

3 Factory Sizes


350

437

53250

63040

73230

83722

9502050

102237

113032

124030

135032

1437

1550

16


350

437

532

630

73230

822

920

102230

11303229

123028

133227

143726

155025

1624

1822

2020

3020

4020

6020

8020

8520

9020

10030

200

Sheet1 (2)

0

1

2.2

3.3

4.2

4.8

5

Tons

Employees

Total Output

Sheet1

0

1

1.2

1.1

0.9

0.6

0.2

Employees

Marginal Product

Marginal Product

Sheet2

Quantity

Cost ($)

Cost vs. Quantity

Sheet3

35

35

35

35

35

35

35

35

35

35

35

35

Quantity

Unit Cost($)


00

1100

1.283.3333333333

1.190.9090909091

0.9111.1111111111

0.6166.6666666667

0.2500

Output

Cost ($)

MP

MP vs. MC

5033

3744

32505

30406

32307

37228

502050

102237

113032

124030

135032

141437

151550

Quantity of output

Unit costs


5033

3744

3255

3066

32307

8228

9209

102210

113032

121230

131332

141437

151550

Quantity of output

Unit costs


3

4

5

6

7

8

9

30

29

28

27

26

25

24

22

20

20

20

20

20

20

20

30


00100-10035-100

170150-80507035-115

2140184-44347035-114

32102082247035-103

428022753197035-87

5350250100237035-75

6420280140307035-70

7490318172387035-73

8560366194487035-86

9630425205597035-110

10700500200757035-150

11770595175957035-210

128407121281177035-292

Units

$


Profits

Units

Loss

Losing Firm

*Shutting Down: MR < AVCWhen MR finally falls below AVC, then, MR = MC < AVC at all possible outputs.That means that revenues cannot even cover part of fixed cost per unit, which can happen when MR < AVC.Thus, the firm should exit the business.MCAVCMRShut downpoint(C) Red Hill Capital Corp., Delaware, USA 2008


Chart6

10050501502525

504234922525

33.3333333333362469.33333333332525

2531.751956.752525

203023502525

16.6666666667303046.66666666672525

14.285714285731.14285714293845.42857142862525

12.533.254845.752525

11.111111111136.11111111115947.22222222222525

104075502525

9.0909090909459554.09090909092525

8.33333333335111759.33333333332525

2525

Quantity

Unit Cost($)


Sheet1 (2)


00.000

11.01100100.00

21.22.220083.33

31.13.330090.91

40.94.2400111.11

50.64.8500166.67

60.25600500.00

MAT ATM's

QTFCTVCTCMCAFCAVCAC

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.67

71002183183814.2931.1445.43

81002663664812.5033.2545.75

91003254255911.1136.1147.22

101004005007510.0040.0050.00

11100495595959.0945.0054.09

121006127121178.3351.0059.33

3 Factory Sizes


350

437

53250

63040

73230

83722

9502050

102237

113032

124030

135032

1437

1550

16


350

437

532

630

73230

822

920

102230

11303229

123028

133227

143726

155025

1624

1822

2020

3020

4020

6020

8020

8520

9020

10030

200

Sheet1 (2)

0

1

2.2

3.3

4.2

4.8

5

Tons

Employees

Total Output

Sheet1

0

1

1.2

1.1

0.9

0.6

0.2

Employees

Marginal Product

Marginal Product

Sheet2

1000100

10050150

10084184

100108208

100127227

100150250

100180280

100218318

100266366

100325425

100400500

100495595

100612712

Quantity

Cost ($)

Cost vs. Quantity

Sheet3

100505015035

5042349235

33.3333333333362469.333333333335

2531.751956.7535

2030235035

16.6666666667303046.666666666735

14.285714285731.14285714293845.428571428635

12.533.254845.7535

11.111111111136.11111111115947.222222222235

1040755035

9.0909090909459554.090909090935

8.33333333335111759.333333333335

Quantity

Unit Cost($)


00

1100

1.283.3333333333

1.190.9090909091

0.9111.1111111111

0.6166.6666666667

0.2500

Output

Cost ($)

MP

MP vs. MC

5033

3744

32505

30406

32307

37228

502050

102237

113032

124030

135032

141437

151550

Quantity of output

Unit costs


5033

3744

3255

3066

32307

8228

9209

102210

113032

121230

131332

141437

151550

Quantity of output

Unit costs


3

4

5

6

7

8

9

30

29

28

27

26

25

24

22

20

20

20

20

20

20

20

30

unitsTRTCProfitsMCMRMRLLossMRSD

00100-10035-10025

170150-80507035-11525

2140184-44347035-11425

32102082247035-10325

428022753197035-8725

5350250100237035-7525

6420280140307035-7025

7490318172387035-7325

8560366194487035-8625

9630425205597035-11025

10700500200757035-15025

11770595175957035-21025

128407121281177035-29225

0100

70150

140184

210208

280227

350250

420280

490318

560366

630425

700500

770595

840712

Units

$


-100

-80

-44

2

53

100

140

172

194

205

200

175

128

Profits

0

0

0

0

0

0

0

0

0

0

0

0

Units

Loss

Losing Firm

100505015000

5042349200

33.3333333333362469.333333333300

2531.751956.7500

2030235000

16.6666666667303046.666666666700

14.285714285731.14285714293845.428571428600

12.533.254845.7500

11.111111111136.11111111115947.222222222200

1040755000

9.0909090909459554.090909090900

8.33333333335111759.333333333300

00

Quantity

Unit Cost($)


*Example: Motel at the beachDuring the summer season, Moms Motel offers rooms for $100 per night.Fixed cost/room, including insurance, depreciation, and taxes is $50/room (AFC).AVC, including electricity, water, and room cleaning is $25/room.In the off-season, would it be ok to charge $40/night for a room, or would it be better to just close the motel and let mom take a vacation?(C) Red Hill Capital Corp., Delaware, USA 2008


*Example AnalysisSince AVC = $25, if the motel charges $40/night for a room, it will have $15 left over after pay for AFC/room.That leftover $15 of revenues, while not enough to actually recover all AFC per room, will at least go towards paying some of it.Since the AFC has to be paid whether or not the motel is open, it is better business sense to at least pay for some by charging only $40/night than to close down and not recover any at all.(C) Red Hill Capital Corp., Delaware, USA 2008


*Break TimePlease take a 10 minute break(C) Red Hill Capital Corp., Delaware, USA 2008


*Short-run Supply Curves:Perfect Competition(C) Red Hill Capital Corp., Delaware, USA 2008


*Individual Firms Possible SupplyWe looked at costs interacting with revenues and discovered some general rules for a firm to remain in business.For it to make sense for a firm to remain in business, MR must be equal to or above the minimum variable cost, the point at which MC = AVC.Otherwise the firm cannot cover any FC, and it will go deeper and deeper into debt.(C) Red Hill Capital Corp., Delaware, USA 2008


*Individual Firms Possible SupplyAfter that condition is met, the firm should supply the quantity that corresponds to MR = MC. Then, it will maximize its profits.Thus, the supply curve for a firm is represented by its MC curve above the AVC curve, as shown in the next slide.The MC curve represents the best possibilities for profit that the firm can face, in terms of what it should supply. (C) Red Hill Capital Corp., Delaware, USA 2008


*Firm Supply Curve MC AVCAs long as MC equal to or greater than AVC, it is beneficial for a firm to offer supplyDemandPossibilities = MRSupplyPossibilities = MC AVC(C) Red Hill Capital Corp., Delaware, USA 2008


Chart8

10050150352570

504292352570

33.33333333333669.3333333333352570

2531.7556.75352570

203050352570

16.6666666667303046.6666666667352570

14.285714285731.14285714293845.4285714286352570

12.533.254845.75352570

11.111111111136.11111111115947.2222222222352570

10407550352570

9.0909090909459554.0909090909352570

8.33333333335111759.3333333333352570

Quantity

Sheet1 (2)


00.000

11.01100100.00

21.22.220083.33

31.13.330090.91

40.94.2400111.11

50.64.8500166.67

60.25600500.00

MAT ATM's

QTFCTVCTCMCAFCAVCACMCM

010001000

11005015050100.0050.00150.00

2100841843450.0042.0092.00

31001082082433.3336.0069.33

41001272271925.0031.7556.75

51001502502320.0030.0050.00

61001802803016.6730.0046.6730

71002183183814.2931.1445.4338

81002663664812.5033.2545.7548

91003254255911.1136.1147.2259

101004005007510.0040.0050.0075

11100495595959.0945.0054.0995

121006127121178.3351.0059.33117

3 Factory Sizes


350

437

53250

63040

73230

83722

9502050

102237

113032

124030

135032

1437

1550

16


350

437

532

630

73230

822

920

102230

11303229

123028

133227

143726

155025

1624

1822

2020

3020

4020

6020

8020

8520

9020

10030

200

Sheet1 (2)

0

1

2.2

3.3

4.2

4.8

5

Tons

Employees

Total Output

Sheet1

0

1

1.2

1.1

0.9

0.6

0.2

Employees

Marginal Product

Marginal Product

Sheet2

000

000

000

000

000

000

000

000

000

000

000

000

000

Quantity

Cost ($)

Cost vs. Quantity

Sheet3

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

0000352570

Quantity

00

00

00

00

00

00

00

Output

Cost ($)

MP

MP vs. MC

000

000

000

000

000

000

000

000

000

000

000

000

000

Quantity of output

Unit costs


5033

3744

3255

3066

32307

8228

9209

102210

113032

121230

131332

141437

151550

Quantity of output

Unit costs


3

4

5

6

7

8

9

30

29

28

27

26

25

24

22

20

20

20

20

20

20

20

30

unitsTRTCProfitsMCMRMRLLossMRSD

00100-10035-10025

170150-80507035-11525

2140184-44347035-11425

32102082247035-10325

428022753197035-8725

5350250100237035-7525

6420280140307035-7025

7490318172387035-7325

8560366194487035-8625

9630425205597035-11025

10700500200757035-15025

11770595175957035-21025

128407121281177035-29225

00

00

00

00

00

00

00

00

00

00

00

00

00

Units

$


0

0

0

0

0

0

0

0

0

0

0

0

0

Profits

0

0

0

0

0

0

0

0

0

0

0

0

Units

Loss

Losing Firm

100505015000

5042349200

33.3333333333362469.333333333300

2531.751956.7500

2030235000

16.6666666667303046.666666666700

14.285714285731.14285714293845.428571428600

12.533.254845.7500

11.111111111136.11111111115947.222222222200

1040755000

9.0909090909459554.090909090900

8.33333333335111759.333333333300

00

Quantity

Unit Cost($)


100505015000

5042349200

33.3333333333362469.333333333300

2531.751956.7500

2030235000

16.6666666667303046.666666666700

14.285714285731.14285714293845.428571428600

12.533.254845.7500

11.111111111136.11111111115947.222222222200

1040755000

9.0909090909459554.090909090900

8.33333333335111759.333333333300

00

Quantity

Unit Cost($)


*Industry Short-run supplyThen, we do the same for each individual firm in the industry: their supply curves will be their MC curves above the minimum AVC curves.If their minimum AVC curves are above MR, the only price in the market, they should be or will be out of business.Short-run industry supply curve is, then, the sum of all of the individual supply curves constructed as above and in the last slide.We illustrate the construction in the next slide.(C) Red Hill Capital Corp., Delaware, USA 2008


*Industry Short-run supplyThe short-run supply curve is the sum of all individual MC supply curves.For 2 firms, for example, we have the situation depicted, below.We have put in two possible horizontal demand curves, also, to expand description and detail.We assume that input prices remain the same as output expands.71011151825$90$45Firm AFirm BIndustryMCAMCB MCB + MCA+==+(C) Red Hill Capital Corp., Delaware, USA 2008


*Short-run EquilibriumAdding in the an aggregate demand schedule gives an interaction to find market price and quantity in equilibrium.Firms will earn a profit, as long as the MR = an equilibrium price is above, not only the AVC, but also the ATC.Profit = QP(=MR) Q[AFC + AVC](C) Red Hill Capital Corp., Delaware, USA 2008


*Short-run EquilibriumThey will minimize loss by supplying on MC=MR, below ATC but above AVC.Short-run equilibrium will retain until something happens that changes it. We show the situation for an individual firm and the industry in the next slide.(C) Red Hill Capital Corp., Delaware, USA 2008


*Short-run EquilibriumFor a firm and the industry. Equilibrium is at $90/unit with quantity demanded and supplied = 10,000 units.At that price the hypothetical firm produces 10 units. Profit = [Price/unit ATC] x Q PAggregate MarketHypothetical Individual Firm10MCATCMRS = MCD10,00090Q = units7550250Profits(C) Red Hill Capital Corp., Delaware, USA 2008


*Long-run Supply Curves:Perfect Competition(C) Red Hill Capital Corp., Delaware, USA 2008


*The long-runIn the long-run, all inputs become variable.Existing firms can react to opportunities for profits by expanding or down-sizing, buying or selling PP&E or other inputs that remain fixed in the short-run. Opportunities for profit will attract new firms, while losses will cause firms to exit the business.Free entry and exit are a crucial part of perfectly competitive markets.(C) Red Hill Capital Corp., Delaware, USA 2008


*Long-run EquilibriumVariability of all inputs means that a firm can decide to completely shut down, if it is earning less than normal profits (negative economic profits).New firms will enter, if they see that existing firms are earning above normal profits. Entry/exit of firms is the key factor in long-run market equilibrium.(C) Red Hill Capital Corp., Delaware, USA 2008


*Long-run EquilibriumIf new firms enter, supply is increased, price decreases for the interaction of the old demand curve with the new supply curve.The process will continue until there are no more above normal profits to be had.If firms exit, supply will shift left, price will increase, and a new equilibrium will come when economic profits get up to the zero level, above loss levels.In the next slide, we show a firm in long-run equilibrium. (C) Red Hill Capital Corp., Delaware, USA 2008


*A Typical Firm in Long-run EquilibriumP = MR = SRMC = SRATC = LRAC.In LR equilibrium, firms will operate at the minimum of LRAC. SRMCSRATCLRACMREntry/ExitOf FirmsZero LREconomic ProfitsLong-RunEquilibriumCausal Chain(C) Red Hill Capital Corp., Delaware, USA 2008


*Typical Firm in LR EquilibriumRelating it back to the LR graph from last lecture:(C) Red Hill Capital Corp., Delaware, USA 2008SRMCSRATCLRACMR


*P = MR = SRMC = SRATC = LRACWe have established the P = MR =SRMC concept, already.Also, SRMC = SRATC is the short run minimum level for profits to cover all costs.In the long-run, a firm will also want to be at the minimum in the LRAC curve, also, because larger or smaller operations will be on either side of that minimum will have higher average total costs.(C) Red Hill Capital Corp., Delaware, USA 2008


*P = MR = SRMC = SRATC = LRACThus, LR equilibrium can occur only after all firms have adjusted to that perfect minimal cost point.As long as no variables change, there is no reason for a firm to produce a new level of output. Everything is the best that it can be.There is no reason to change size of plant or anything else. (C) Red Hill Capital Corp., Delaware, USA 2008


*P = MR = SRMC = SRATC = LRACSince all firms are happy where they are, the industry will be in equilibrium.There is no extra profit to cause new entries and enough profit to keep all existing producers.The price in the LR equilibrium is the best price that can be achieved.(C) Red Hill Capital Corp., Delaware, USA 2008


*P = MR = SRMC = SRATC = LRACThe market is acting perfectly efficiently and consumer welfare is maximized.Since things are constantly changing (even world population, for example), LR equilibrium will not often be achieved, and Most of the time markets will just be moving in the direction of an apparent LR equilibrium state.(C) Red Hill Capital Corp., Delaware, USA 2008


*3 Types of Long-run Supply Curves(C) Red Hill Capital Corp., Delaware, USA 2008


*LR supplyA perfect competitive industrys LR supply curve shows the quantities that the industry will supply at various equilibrium prices after all entry and exit has been completed.The shape of the LR supply curve depends on the response of prices of inputs as new firms enter an industry.There are three possibilities, increasing, flat and decreasing costs.We look at each, in turn.(C) Red Hill Capital Corp., Delaware, USA 2008


*Constant Cost IndustryA constant cost industry is one in which the expansion of output by entry of new firms into the industry has no affect on the firms cost curves.Consider an upward shift in demand (see next slide).In response to the demand shift, in the short run, price will rise along the supply curve to a new short-run equilibrium.(C) Red Hill Capital Corp., Delaware, USA 2008


*Constant Cost IndustryAt that new equilibrium, existing firms will adjust output along their supply curves, and they will increase profits to above normal.As a result of excess profits, new firms will be induced to enter the industry.Then, supply will increase until there are no abnormal profits. (C) Red Hill Capital Corp., Delaware, USA 2008


*Constant Cost IndustryOld firms will adjust down their SRMC supply curves to the point that they were at before the change with the new equilibrium price of new demand met by new supply at an expanded quantity. Since we have no increases in costs at the expanded output, the new equilibrium price should be the same as the original equilibrium price before demand increased.In that regard, the change in equilibrium price traces out a straight line (see figure in next slide), and that is the long-term supply curve.(C) Red Hill Capital Corp., Delaware, USA 2008


*Constant Cost IndustryCausal ChainSRMCSRATCLRACMR1S1S2D2LRSupplyCurveD1MR2IncreaseIn demand sets higher equilibriumEntry of New firmsIncreasessupplyInitialEquilibrium Price isrestoredPerfectlyElastic Long-runSupply curveFirmIndustry(C) Red Hill Capital Corp., Delaware, USA 2008


*Constant Cost IndustryIf you imagine that the reverse situation happens and demand decreases:New SR equilibrium will be at a lower price.That means that firms are making less than normal profits.Thus, firms will exit the business, supply will decrease, and price will eventually be restored at the original equilibrium price with a lower quantity supplied.(C) Red Hill Capital Corp., Delaware, USA 2008


*Decreasing Cost IndustryAs new firms enter a decreasing cost industry, input prices fall as total output expands.A decreasing-cost industry is one in which expansion of industry output by the entry of new firms decreases firms costs.Consider, for example, the computer market. (C) Red Hill Capital Corp., Delaware, USA 2008


*Decreasing Cost IndustryAs output of computers increase, suppliers of computer chips might experience economies-of-scale cost decreases, themselves, and be able to supply a larger computer industry with cheaper chips. Thus, computer makers will be able to decrease their costs as a direct result of their industry expansion.Then (see slide below), an increase in demand will cause a temporary increase in price, resulting in expanded profits. (C) Red Hill Capital Corp., Delaware, USA 2008


*Decreasing Cost IndustryAs new entrants into the market a new supply curve will develop at which all suppliers have a new cost curve, below the original one.Tracing out the straight line between equilibrium prices is a downward sloping curve.Thus, the LR supply curve, in this case, is downward sloping. See the next slide for a graphical illustration for this case.(C) Red Hill Capital Corp., Delaware, USA 2008


*Decreasing Cost IndustryCausal ChainSRATC1SRATC2MR3S1S2D2LRSupplyCurveD1MR1MR2IncreaseIn demand sets higher Equilibrium priceEntry of newFirms IncreasessupplyEquilibriumPrice and ATCdecreaseDownwardSloping LR supplycurveFirmIndustry(C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryAs an increasing cost industry expands its output with the entry of new firms, prices of inputs rise.As the industry uses more labor, land, machinery, and raw materials, the demand for greater quantities drives up some or all of their prices.(C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryFor example, suppose that the home electronics industry uses a significant percentage of electrical engineers, in the country, and it decides to expand. Then, salaries of electrical engineers, who are in limited supply, will increase, and the cost of home electronics might increase.(C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryIt is believed that most industries, in practice, are increasing-cost industries.As a result, the long-run supply curve of such industries is the usual upward-sloping supply curve that we are familiar with.We show what happens in such an increasing cost industry in the slide, below.Demand increases, causing a temporary increase in equilibrium price, up the old supply curve, and a chance to earn abnormal profits.(C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryIn response to this excess profit potential, new firms enter the industry, and supply expands.As a result, price begins to decrease. However, because of increasing costs for everyone in the industry, there is a new ATC cost structure curve which is shifted upward from the initial one. (C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryThen, the equilibrium price declines to a level, which is above the initial equilibrium price.Thus, the LR supply curve traced out by the overall movement between initial and final market equilibriums is upward sloping.See the figures for details..(C) Red Hill Capital Corp., Delaware, USA 2008


*Increasing Cost IndustryCausal ChainSRATC2SRATC1MR1S1S2D2LRSupplyCurveD1MR3MR2IncreaseIn demand sets higher Equilibrium priceEntry of newFirms IncreasessupplyEquilibriumPrice and ATCincreaseUpwardSloping LR supplycurve(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet & Global Markets(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceThe development of the internet has increased competition on a global basis.With the existence of the internet, information is more readily available, and it is as easy to order a book or a new coat, on-line, as it is to make a phone call to your local book or clothing boutique.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceNow, a girl with a bedroom full of books can market her books to people as easily as someone who has a book store. Both offer their own convenience. The store has books on display that you can page through, the girl has excerpts of books on her website and you dont even need to take a walk to the store.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceIt also has done away with the monopolies that people have locally or geographically. Previously, one would have to invest in opening a local store. Now, a bookseller from a small town in Guangdong province can offer books to a person in New York City.In that regard, barriers to entry to many markets have been lowered by the internet and the ability to do browsing, buying and selling, on-line.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceIt has also allowed communication among buyers and sellers in fragmented markets, like collectibles and art. Now a local dealer in 19th century pottery can find current prices, on-line, at auction markets, like E-bay, and can adjust her prices according to a larger market with more information.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceSecurities markets and commodities futures markets have also become more efficient because of the internet. Previously, a person could call his broker on the phone and place an order. Now, with the internet, a person can open his computer and enter orders to trade securities on-line or be directly connected to major exchanges, like the New York Stock Exchange or the Sydney Futures Exchange, even if they live in a small village in western China. (C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceSmaller businesses, even with no actual storefront in their house but only a dinghy storeroom in the back, can now compete directly with larger players who have large beautiful stores in elegant cites around the world and they can increase their reach in markets, from a local market that they would be stuck in, selling dresses in a small town, to selling their dresses around the world, competing with other sellers in a globalized marketplace.(C) Red Hill Capital Corp., Delaware, USA 2008


*The Internet and the Global MarketplaceConsumers, too, can look around the whole world for competitive price, quality, and information.Thus, the internet revolution has the potential to close the gap between idealized economic models of perfect competition and the reality that exists because of previous barriers to entry that have been battered down by electronic commerce.(C) Red Hill Capital Corp., Delaware, USA 2008


Ask YourselfA horizontal demand curve is perfectly elastic. Can you explain what it means, in terms of perfect elasticity, its definition and consequences, when we say that a firm in a perfectly competitive industry faces a horizontal demand curve?You are a seller of a good in a perfectly competitive industry. You decide to make a famous brand name for your product and hire a marketing firm to develop the brand name and engage in an extensive advertising campaign. What will be the result in terms of your sales, costs, and profits?(C) Red Hill Capital Corp., Delaware, USA 2008*


Ask YourselfWhy is it important to assume that there are no entry or exit costs in building a model of perfect competition?At the point P=MR=SRATC=SRMC, what are profits? Why can a firm operate at zero profit: does it mean that the owners of the business are benefactors, not entrepreneurs, and earn no money for themselves but just run the business for the benefit of others?Can you explain, in words and pictures, why MC will have a minimum when MP has its peak?(C) Red Hill Capital Corp., Delaware, USA 2008*


Ask YourselfCan you explain why we allow monopolies in businesses, like electricity and water suppliers? After we do allow that, what else do we do to such industries?As it turns out, many people do not have enlightened self-interest but, instead, are greedy? How do modern societies deal with that?Can you explain in words why maximum profits will happen when P=MC=MR?(C) Red Hill Capital Corp., Delaware, USA 2008*


Ask YourselfCan you explain why we refer to businesses, like expensive exclusive restaurants or small expensive clothing boutiques, as monopolistic competition?In the past, we have argued that supply curves are upward sloping. What does the LR supply curve look like for a decreasing cost industry? Can you give some examples of industries that might be decreasing-cost industries, and can you explain why they are, when prices of most things go up, not down?(C) Red Hill Capital Corp., Delaware, USA 2008*


*Fill in the tableFill in the table.Graph the TR, MR, MC, and TC curves, and discuss the intersection points of the various curves.(C) Red Hill Capital Corp., Delaware, USA 2008

unitsTRTCMRMCProfits00501509021001203150130420014052501606300190735023084002809450335105003951155047012600550


*HomeworkChapter 7:Questions/Problems 1-13Multiple Choice 1-17(C) Red Hill Capital Corp., Delaware, USA 2008


*Next WeekWe begin a new module:We leave microeconomic studies and move on to macroeconomics.Covers chapters 11 and 12 (part) introducing some macroeconomic concepts and the business cycle. Also, dont forget, your on-line exam is coming up.(C) Red Hill Capital Corp., Delaware, USA 2008


*END(C) Red Hill Capital Corp., Delaware, USA 2008


Documents

1 Econ 1000 Lecture 6: Perfect Competition C.L. Mattoli (C) Red Hill Capital Corp., Delaware, USA 2008