II. Thinking About Supply
A. Examples of recycling production decisions B. Individual and market supply curves
1. plotting supply curves for individuals 2. aggregating to market supply curves 3. why supply curves slope upward
a. Increasing Opportunity Cost Principle b. Low-Hanging-Fruit Principle for individuals c. different opportunity costs for different sellers III. Profit Maximizing Firms and Perfectly Competitive Markets
A. Profit maximization
1. definition of profit (total revenue minus total cost) 2. ALL costs (explicit AND implicit)
B. Perfectly competitive markets 1. price takers
2. 4 conditions characteristic of perfect competition a. standardized product
b. many buyers and sellers
c. productive resources are mobile d. buyers and sellers are well informed C. Demand curve facing a perfectly competitive firm D. Short-run production
1. short-run versus long-run
2. factors of production and fixed versus variable factors 3. Law of Diminishing Returns
E. Profit maximizing output selection 1. applying the cost-benefit principle
2. shut down condition (if P<AVC at profit maximizing output) 3. ATC/AVC
4. graphical approach to profit maximization 5. the profit maximizing condition
E. The Law of Supply
1. Supply curve is essentially MC curve IV. Determinants of Supply Revisited
A. Technology B. Input prices
C. Number of suppliers D. Expectations
E. Change in the price of other products (that sellers might produce) V. Applying the Theory of Supply (Examples/Review)
A. Economic Naturalist 6.1: "When recycling is left to private market forces, why are many more aluminum beverage containers recycled than glass ones?"
B. Recycling examples (setting MC = MB)
1. socially optimal quantity of litter is NOT zero
2. as litter is picked up, MB decreases while MC increases
3. the market does not provide incentives to yield the socially optimal level of litter removal
4. the equilibrium principle VI. Producer surplus
A. Definition
Calculating producer surplus
Economic Naturalist Discussion Questions
1. Why do some people stop to pick up a penny on the ground, while others do not?
Why will more people stop to pick up a quarter than a penny? (because people have different opportunity costs of their time spent picking up the penny and different levels of marginal utility from an additional penny)
2. Will you ever clean up your room to the point where there is no possible cleaning left to do? When do you decide to stop cleaning your room? (The Law of Diminishing Returns -- when the marginal cost of cleaning equals the marginal benefit)
3. Around the fourth of July, small stands selling fireworks open up all over the United States. What does this tell you about the market for fireworks and the price elasticity of supply for fireworks? (it is competitive and has easy entry -- the price elasticity of supply is very elastic)
Answers to Text Questions and Problems
Answers to Review Questions1. The principle of increasing opportunity cost, also known as the low-hanging-fruit principle, says that the least costly options should be exploited first, with more costly options taken up only after the least costly ones have been exhausted. At low prices, only those with low opportunity costs of producing the product would find it worthwhile to offer it for sale. As prices rise, others with higher opportunity cost could profitably enter the market.
2. To build, or even rent, a new factory often takes years, certainly many months. By contrast, additional production workers can be hired in days, or at most weeks. So the factory is far more likely to be a fixed factor over the next two months.
3. Not enough seeds for the plants needed to feed 6 billion people would fit in a single flower pot, let alone develop into healthy plants with only a minuscule amount of soil available per seed.
4. An exception to the price = marginal cost rule occurs when market price is so low that total revenue is less than variable cost when price equals marginal cost. So FALSE.
5. To calculate producer surplus, we need to know the reservation price of sellers at every level of output. The vertical interpretation of the supply curve tells us marginal cost at every level of output, and marginal cost is the reservation price of sellers.
Answers to Problems
1. If the price of a fossil is less than $6, Zoe should devote all her time to photography because when the price is, say, $5 per fossil, an hour spent looking for fossils will give her 5($5) = $25, or $2 less than she’d earn doing photography. If the price of fossils is 6, Zoe should spend one hour searching, will supply 5 fossils, and will get $30 revenue, which is $3 more than she’d earn from photography. However, an additional hour would yield only 4 additional fossils or $24 additional revenue, so she should not spend any further time looking for fossils. If the price of fossils rises to $7, however, the additional hour gathering fossils would yield an additional $28, so gathering fossils during that hour would then be the best choice, and Zoe would therefore supply 9 fossils per day. Using this reasoning, we can derive a price-quantity supplied relationship for fossils as follows:
Price of fossils ($) Number of fossils supplied per day
0-5 0
6 5
7, 8 9
9-13 12
14-26 14
27+ 15
If we plot these points, we get Zoe’s daily supply curve for fossils:
Number o Price ($/fossil)
67
5 9
9 12 14
15 14
27
f fossils
2. The marginal cost of each of the first 6 air conditioners produced each day is less than
$120, but the marginal cost of the 7th air conditioner is $140. So the company should produce 6 air conditioners per day.
Air Conditioners/day Total Cost ($/day)
1 100
2 150
3 220
4 310
5 405
6 510
7 650
8 800
3a. As icated by the e s in the last c n of the tab low, the it-maximizing quantity of bats for Paducah is 20/day, which yields daily profit of $35.
b. Same ntity as in part a ow profit is $65 30 more than re.
Q Total Revenue Total labor cost Total cost Profit
ind ntrie olum le be prof
qua , but n , or $ befo
(bats/day) ($/day) ($/day) ($/day) ($/day)
0 0 0 60 -60
5 50 15 75 -25
10 100 30 90 10
15 150 60 120 30
20 200 105 165 35
25 250 165 225 25
30 300 240 300 0
35 350 330 390 -40
4. A tax of $10 per day would decrease Paducah’s fit by $10 per at every le f output. But the company would still maximize its profit by producing 20 bats per day. A tax that is independent of output does not change m inal cost, and does no
change the profit-maximizing level of output.
But a tax of $2 per bat has exactly the sam ect as any ot increase he marginal cost of making each bat. As we see in the last column of the table belo he company’s profit-maximizin l of output now to 15 bats pe . At that it earns exactly 0 profit, but at any other level of output it would sustain a loss.
pro day vel o
arg hence t
e eff her $2 in t
w, t
g leve falls r day level
Q (bats/day)
Total Revenue ($/day)
Total labor cost ($/day)
Total cost ($/day)
Profit ($/day)
0 0 0 60 -60
5 50 15 85 -35
10 100 30 110 -10
15 150 60 150 0
20 200 105 205 -5
25 250 165 275 -25
30 300 240 360 -60
35 350 330 460 -110
5. Producer surplus is the area of the shaded triangle, $18,000/day.
6
12 24 (1000s of slices per day) Price
($ per slice)
Supply
3
Demand
Quantity
6. The market supply curve (right) is the horizontal summation of the supply curves of the individual market participants (left and center).
6 which the supply curves don't overlap (here, the region P<2). From P = 2Q1, get Q1=
P/2; from P = 2+Q2, get Q2=P-2. For the region P<2, the market supply is the same as firm 1's supply Q = P/2, or P = 2Q. For P>2 we add Q1+Q2 to get Q = P/2+(P-2), which reduces to Q = (3P/2)-2. Rewriting this, we have P = (4/3)+(2/3)Q for P>2. Expressed algebraically, the market supply curve is thus P = 2Q for P<2 and P = (4/3)+(2/3)Q for P>2.
7. This firm will sell 570 slices per day, the quantity for which P = MC. Its profit will be (P-ATC)xQ = ($2.50/slice - $1.40/slice)x(570 slices/day) = $627/day.
4 7
2
1 2 1 2
Horizontal summation means holding price fixed and adding the
AVC
8. This firm will sell 360 slices per day, the quantity for which P = MC. Its profit will be (P-ATC)xQ = ($0.80/slice - $1.03/slice)x(360 slices/day) = -$82.80/day.
AVC ATC
$/slice
1.03
MC
slices/day 360
0.80
and AVC, so for that output level we can calculate TC = (260 ices/day)($1.18/slice) = $306.80/day and VC = (260 slices/day)($0.68/slice) =
$176.80/day. So fixed cost = $306.80/day - $176.80/day = $130/day. This producer’s profit is thus -$130.day.
9. Because price is less than the minimum value of AVC, this producer will shut down in the short run. He will thus experience a loss equal to his fixed cost. Fixed cost is the difference between total cost and total variable cost. For Q = 260 slices/day, we know both ATC
sl
AVC ATC
$/slice
slices/day 1.18
MC
260 0.50
0.68
10. This producer will sell 435 slices per day, the quantity for which P = MC. His total evenue will therefore be PxQ = ($1.18/slice)x(435 slices/day) = $513.30/day. His ariable cost is AVCxQ = ($0.77/slice)(435 slices/day) = $334.95/day. To this we add r
v
his fixed cost of $130/day to calculated using the method own in problem 9). So this producer’s profit is $513.30/day - $464.95/day =
obtain TC = $464.95/day ( sh
$48.35/day.
AVC ATC
$/slice MC
1.18
slices/day 260
0.50 0.68 0.77
435
Sample Homework Assignment
the informa u
earn $.50 f
1. Assume you can either work making $6 per hour in the college bookstore, or you can open your own fruit stand and sell fruit according to the following table. You must decide how much time each day to spend on each activity (up to 8 hours total). Use
tion in the table below to determine how you will allocate your time if yo or each piece of fruit sold.
Hours selling fruit Q fruit sold
1 20
2 38
3 54
4 68
5 78
6 88
7 96
8 99
_____________________________
2. You and your roommates (Lynese and Cedric) must provide cooking and cleaning for your household. The following table shows how many hours it takes each person to produce one unit of cooking or one unit of cleaning.
5 hours per week to devote to household cooking and cleaning, draw the individual production possibilities curves if each person does their own cooking and cleaning.
. Draw the supply curve for cooking in your household, where the vertical axis represents the price of cooking in terms of cleaning, if you and your roommates can choose between providing your cooking and cleaning and paying a service to do it.
king Time to produce 1 unit of cleaning a. If each person has 1
b
Time to produce 1 unit of coo
ou hours 3 hours
_____ _______ ____________________________
_________
edric 5 hours 1 hour
__________________________________________________________
onal fruit sold for each hour is 20, 18, 16, 14, 10, 10, 8, 1. The fruit sells for elling fruit exceeds the income from the alternative ($6) for the first 4 hours. Therefore,
elling fruit and 4 hours working in the college bookstore.
a.
Cooking
5
Cedric
3 5 15 Cleaning
Y 2
_______ __________ _
Lynese 3 hours 5 hours
_________________________________________________
C
Key
1. The additi
$.50, so the income earned for each hour spent selling fruit is $10, 9, 8, 7, 5, 5, 4, .50.
S
you will spend 4 hours s 2
7.5
You
3 Lynese
2b.
a
2.5 15.5 Quantity of cleaning
along with wages in manufacturing industries, even though service industry
orking in the service industry is the wage in the
in the manufacturing industry is the wage in the
. working in the service industry yields much more utility.
profit is equal to which of the following?
f its sales
venue minus marginal cost
rice of cooking P
in terms of
cle ning Supply of cleaning
5
3/5 2/3
7.5 1
Sample Quiz
Multiple Choice1. Which of the following best explains why wages in service industries have increased productivity has not increased as much? Because
a. the opportunity cost of w manufacturing industry.
b. the opportunity cost of working service industry.
c. the service and manufacturing industry are complements.
d
e. MC > MB for service industry workers.
2. A firm's a. the value o b. marginal re
c. total sales minus wages . total revenue minus total cost
haracteristic of a perfectly competitive firm?
ve
. many sellers
tics of perfectly competitive firms an a firm vary in the long-run?
. only one factor of production
n be altered in the short-run, the input is
. explicit.
ectly competitive firm will maximize profit when s total cost.
xceeds marginal cost.
inal cost.
. price equals marginal benefit.
wn when a. perfectly elastic demand cur b. price taker
c. control over market price d
e. all of the above are characteris 4. Which of the following c a. no factors of production b. all factors of production
c. all but one factor of production d
e. more information about the firm is needed to answer this question 5. When the quantity of an input ca
a. fixed.
a. total revenue exceed b. marginal revenue e c. price equals marg d
e. marginal benefit exceeds marginal cost.
7. A firm will shut do a. it is not earning a p b. price does not eq c
d. revenue is less than var
e. revenue is less than total costs.
An increase in supply could be caused by which of the following?
a. an improvement in technology c. a
d. an increase in the price of the product e. a
9. T ller receives and her marginal cost is known as
a. pr b. m
. producer surplus
10. e total cost and its average variable cost is its
a. profit.
b. marginal revenue.
c. average fixed cost.
d. producer surplus e. excess supply.
Proble
. Assume you can either work as an economics tutor on campus for $20 per hour or w much time each day to spend on each activity (up to 8 hours total). Use the information in table below to determine how you will allocate your time if you earn $5 for each t-shirt.
ours p day # T-shirts b. an increase in input prices
n increase in income
decrease in the number of suppliers he difference between the price a se ofit.
arginal revenue.
c. average fixed cost.
d
e. excess supply.
The difference between a firm’s averag
ms/Short Answer 1
work in your own business making college t-shirts. You must decide ho
H er
d your friend Keiko each work for your own businesses solving below shows how many hours it takes each ou to solve c ype of problem.
2. Assume you an
economics and math problems. The table
of y ea h t
Time to solve 1 economics problem Time to solve 1 math problem
ou 1 hour 2 hours
a. roduction possibilities
urves for you and Keiko.
. What is the price of an economics problem in terms of math problems for you and eiko?
. A firm is willing to pay for economics problems. Graph the supply curve for
conomics problems, where the vertical axis represents the price of economics problems terms of math problems.
ey amount earned is at least $20 (the amount earned tutoring). You spend 3 hours Y
Keiko 4 hours 1 hour
If each of you works 8 hours per day, draw the individual p c
making t-shirts and 5 hours tutoring for a total of 8 hours.
2a.
Econ 8
You
2
Keiko
4 8 Math
Problems
2b. For you, the price of economics problems in terms of math problems is 1/2. For Keiko, the price of economics problems in terms of math problems is 4.
2c.
Price
Supply of economics problems
4 1/2
8 10
Quantity
Problems