Deriving Firm s Supply Curve

Transcription

1 Firm Decision A. The firm calculates the marginal cost of each unit of output B. The firm calculates the marginal revenue of selling each unit of output. For the competitive firm this is the price of output. C. The firm finds the point at which marginal revenue equals marginal cost. D. The firm checks to make sure that the maximum profits are not negative. If profits are negative, the firm shuts down (does not pay the fixed costs of production) and produces zero units of output.

2 Deriving Firm s Supply Curve Supply curve gives amount firm will supply at each price Using example from last class

3 Price = 300, Quantity = 6 Profit Maximization -- Price = $ Quantity Marginal Revenue Marginal Cost Average Total Cost

4 Price =400, Quantity =8 Profit Maximization -- Price = $ Quantity Marginal Revenue Marginal Cost Average Total Cost

5 These are two points on firm supply curve P Q

6 If we do this for all prices above $250, we are tracing out the Marginal Cost curve Firm Supply Curve $ Quantity Marginal Cost Average Total Cost

7 Break-even Point : Quantity at which MC=AC Firm Supply Curve BE Point $ Quantity Marginal Cost Average Total Cost

8 When the price is below $250, the firm will shut down if it can Profit Maximization -- Price = $ Quantity Marginal Revenue Marginal Cost Average Total Cost

9 Firm Supply Curve = Marginal Cost Curve above Break-even Point Firm Supply Curve $ Quantity Marginal Cost Average Total Cost

10 Market Dynamics Firm Market SR Capital Fixed Number of Labor Flexible Firms Fixed LR Capital Flexible Number of Labor Flexible Firms Flexible

11 Market with Identical Firms All firms have the same technology and cost functions => All firms have the same supply curve SR = Number of firms is fixed LR = Firms enter if there are profits to be made. Firms leave if there are losses.

12 Market Supply = Horizontal Sum of Firm Supply Curves (100 Firms) Price Firm Supply Curve Price Market Supply Curve $250 $250 Quantity 5 500

13 Market Supply = Horizontal Sum of Firm Supply Curves Price Firm Supply Curve Price Market Supply Curve $250 $250 Quantity 5 500

14 Market Supply = Horizontal Sum of Firm Supply Curves Price Firm Supply Curve Price Market Supply Curve $250 $250 Quantity

15 In Short-run, Quantity Supplied must be offered by these 100 firms Price Market Supply Quantity

16 Equilibrium in the Short-run occurs where the Market Demand curve intersects the Market Supply curve Price Market Supply 250 Market Demand 500 Quantity

17 Equilibrium in the Short-run occurs where the Market Demand curve intersects the Market Supply curve Price Market Supply Market Demand Quantity

18 Equilibrium in the Short-run occurs where the Market Demand curve intersects the Market Supply curve Price Market Supply Market Demand Quantity

19 Say Short-run Equilibrium Price is above Break-even Price Price Market Supply 250 Market Demand 500 Quantity

20 Short-run = Each Firm is making profits Price Firm Supply Curve Price Market Supply Curve MC AC $250 $250 Quantity 5 500

21 Between Short-run and Long-run = Firms can enter and exit the market Firms enter if there are profits to be made Firms exit if there are losses

22 Price As firms enter Market Supply (100 Firms) Market Supply (110 Firms) 250 Market Demand 500 Quantity

23 As long as the equilibrium price is above the break-even price, more firms have an incentive to enter the market Price Market Supply (100 Firms) Market Supply (150 Firms) 250 Market Demand 500 Quantity

24 The Long-run Equilibrium occurs when the equilibrium price is the break-even price Price Market Supply (Short-run) Market Supply (Long-Run) 250 Market Demand 500 Quantity

25 Important Point Zero profits = Fair rate of profit Includes return to entrepreneurial skill, management skill, etc.

26 Long-run Market Supply extends out to Market Demand at the Breakeven price Therefore, quantity bought and sold is determined by the quantity demanded at the break-even price. Each firm offers the break-even quantity at the break-even price Number of firms equals Quantity bought and sold divided by the amount that each firm offers

27 Quick Review = Start in LR Equilibrium Price Firm Supply Curve Price SR Supply Curve MC Demand $300 ATC $250 $250 5 Quantity 500

28 Quick Review = What happens if cemand curve shifts to right? Price Firm Supply Curve Price SR Supply Curve Profits MC ATC Demand 1 Demand 2 $300 $300 $250 $250 Quantity

29 New Long-run Equilibrium (150 Firms) Price Firm Supply Curve Price MC Demand 1 Demand 2 New SR Supply Curve $300 ATC $250 $8 5 Quantity 750

30 Unusual Long-run Supply Curve In the long-run, the price is always the break-even price. Firms enter and exit so that quantity demanded equals quantity supplied. This means that the long-run market supply curve is perfectly elastic at the break-even price

31 Long-run Market Supply Price 250 Long-run Market Supply Market Demand Quantity

32 Short-run = number of firms is fixed 1. Calculate the marginal cost and the average cost of each firm. 2. Use the marginal cost and average cost to determine the supply curve of each firm. The supply curve of each firm is the marginal cost curve above the breakeven point. Note that the price at the break-even point (low point on the average cost curve) is the long-run price in a competitive market. The quantity at the break-even point is the quantity that each firm produces at the long-run price. 3. Determine the short-run market supply curve by multiplying (horizontally) the supply curve of each firm by the number of firms in the short-run. 4. Find the short-run equilibrium by determining the price at which the quantity supplied equals the quantity demanded in the market. This gives the equilibrium price and equilibrium quantity in the market. Each firm produces the equilibrium quantity divided by the number of firms. 5. Determine the profits of each firm in the short-run by the difference between the price and the average cost (at the quantity supplied by each firm in the shortrun) multiplied by the quantity supplied by each firm.

33 Long-run = Firms enter and exit 6. The long-run price is the price at the break-even point. The quantity that each firm supplies at the long-run price is the quantity at the break-even point. 7. The total amount bought and sold in the market is determined by the amount that is demanded at the long-run price. 8. The number of firms that must be in the market to drive the price down to the long-run price is given by the quantity demanded divided by the amount that each firm produces at the long-run price. The number that must enter is the difference between the number in the long-run and the initial number of firms. 9. The profits of each firm in a competitive market in the long-run is zero.

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36 What is short-run equilibrium (with 10 firms)? What is long-run equilibrium (with free entry and exit)?

37 Always Find Firm Supply Curve First

38 Break-even price = 120 Break-even quantity = 3

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40 Short-run = Number of Firms Fixed

41 Short-run equilibrium = Intersection of Market Supply and Market Demand Q = 50, P=180

42 Between Short-run and Long-run Firms enter because there are positive profits Profits are driven down to zero (fair rate of profit) Price in long-run is break-even price (120) and each firm offers 3 units

43 Quantity bought and sold in long-run With identical firms, firms enter (each offering the break-even quantity) until the quantity demanded equals the quantity supplied at the break-even price. Quantity bought and sold is the Quantity Demanded at the break even price

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45 Q = 90, P =120, #firms=90/3=30