Intermediate Microeconomic Theory

1
Intermediate Microeconomic Theory

• Market Supply

2
Market Supply

• Similar to demand, market supply will simply be
  the summation of all the individual firm supply
  curves
• Qs(p) q1s(p) q2s(p) qns(p)
• Also similar to demand, a price change can change
  amount supplied on both the intensive and
  extensive margin.
• What is key to extensive margin?

3
Market Supply

• Given market supply curve, along with market
  demand curve, we can now define an equilibrium
  price.
• Equilibrium price the price that equates supply
  and demand in a given market
• (p such that Qd(p) Qs(p) ).

Qs(p)
Qd(p)
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Price and Costs in Equilibrium

• Note all profit maximizing firms that are
  supplying output to a given market must be
  operating at p MC(qs(p)).
• So while each firm may have quite different cost
  functions, all must have the same cost of
  producing their last unit of output.
• Therefore, in perfect competition, the price
  consumers pay for a good equals the cost
  (including opportunity costs) firms must incur to
  bring the marginal good to the market.

5
Profits

• What do we mean by economic profits as compared
  to accounting profits?

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Economic Profits

• Example The monthly market demand curve for
  Lemonade in Springfield is given by Qd(p) 89.8
  4p (Q measured in gallons)
• Suppose Lisa is the first person to sell iced tea
  in Springfield.
• For each gallon of tea she supplies, she needs 10
  tea bags (8.00/bag), 1 gallon of water
  (2.00/gal.). However, in making tea she gets
  tired, meaning the amount of tea she can make in
  a month is given by the production function q
  4L0.5 (L is hrs of her time).
• When she isnt making iced tea, she can work at
  Moes bar for 8hr. (paid at the end of each
  month)
• Any money she doesnt put into the business, she
  loans to Barney at a monthly interest rate of 2.
• Lisa gets her tea via mail order, which she has
  to pay for on the first of each month.
• What are Lisas monthly economic profits from
  this business?

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Economic Profits

• Apu offers Bart 16 for each hour he works at the
  Quickie Mart.
• Suppose Bart can also lend to Barney at 2 per
  month, faces the same cost of tea and water, and
  has same production function relating hrs of his
  time to tea sales as Lisa.
• Should Bart enter the Iced Tea business or should
  he just work for Apu?

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Market Supply in the Long-run

• So how will Industry Supply curve change over the
  long-run?
• Shape?
• Where will it lie?
• What does this mean about (economic) profits in a
  competitive market in the long-run?

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Profits in the Long-run

• So in short-run there are positive profits (or
  rents), but if there is free-entry the
  industry operates at zero (economic) profits in
  the long-run.
• However, it is still rational for suppliers to
  continue using resources to produce and supply
  goods to the market they are in.
• Zero economic profits simply means that there
  are no excess returns to be had by allocating
  further resources and inputs into that market.
• In the end, this is what venture capital and
  entrepreneurism is all about---finding a market
  niches that still allow for excess returns (i.e.
  economic profits).

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Profits in the Long-run

• How does this manifest itself in the real
  world?
• Gas stations?
• Agricultural Products?
• Car industry?
• Airline industry (The Unfriendly Skies)?

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Economic Rent

• How do we explain firms in mature industries
  making seeming economic rents (i.e. Exxon Mobil,
  Haliburton)?
• Assumption of free-entry in the long-run fails
  because some factor is fixed or limited.
• There are a fixed number of functioning oil
  wells.
• Provision of services to military awarded by
  government contract only.
• Fixed number of cab medallions in NYC.
• The implicit value of the fixed factor is what
  we call economic rent.

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Rent setting

• How is one of these assets that earns economic
  rent valued?
• Consider a taxi medallion.
• Say medallion is good for 2 years.
• Fare revenues each year equal 1 million (demand
  for fixed supply)
• You can hire drivers for 50,000 each year
• Gas and maintenance on cab costs 50,000 each
  year.
• Interest rate is 10
• Or consider a house.
• Say house will last 100yrs and you could rent it
  (or an equivalent house) for 20K/yr.

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Rent Seeking

• Millions are spent each year lobbying by firms or
  individuals in an attempt to somehow constrain
  entry into an industry.
• Often called rent seeking.
• Examples
• Limits on medical school slots,
• hair cutting licenses
• zoning restrictions.