ECO 365

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ECO 365 Intermediate Microeconomics

• Lecture Notes

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Firm Supply in Competitive Markets

• Market Environment ways firms interact in making
  pricing and output decisions.
• Possibilities (1) Perfect Competition
• (2) Monopoly
• (3) Oligopoly
• (4) Imperfect Competition (monopolistic)
• In P.C. pfixed for the producer
• Why? gt small firms, identical products, large
  number of firms
• Examples

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• Firms are price takers at market prices

Dont usually worry about p lt p since these
firms are typically smaller and cant produce much
OR
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• The firms problem is to max ? py - c(y)
• Is this a long run or a short run problem?
• ?R p ? y ? p y gt ?R/ ?y p MR
• But p MR
• Why?
• ?C/ ? y MC
• Choose to produce where MRMC
• Why does this make sense?

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• Exceptions to the Rule
• A point of ? minimization
• Why?
• MC downward sloping gt increasing y, decreasing
  mc gt
• Decreasing C MRgt ? increases as y increases
• B point of ? maximization

A
B
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• (1) any movement from A increases ?
• (2) any movement from B decreases ?
• Idea of second order conditions
• What does that mean?
• First order conditions MRMC
• Second order condtions slope of MC gt 0
• Or slope of MC gt Slope of MR o
• gt B is the correct point

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• 2nd ExceptionShut Down
• Short-Run if shut down gt lose fixed costs (F)
• When is this better than operating?
• ? -F if y 0
• ? py Cv (y) F if ygt0
• So if F gt py Cv(y) F gt shutdown or
• Cv(y) gt py
• Or Cv(y)/(y) gt p or p lt AVC gt shutdown
• Similarly in the Long Run ? 0 if shutdown
• ? py C(y) or p lt AC

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• A Short Run shut down point
• B Long Run shut down point

B
A
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A

• A LR shut-down point
• Short Run Supply portion of MC
• Above point A in 1st graph
• Also LR Supply portion of LRMC above LRAC
• loss minimization

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• Profit (graphically)

• Also Inverse Supply
• 2 Choices
• Ps S (y)
• y S (P)

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• Profit the shaded area in the graph
• py - AC(y) y
• TR TC
• Since AC(y) TC(y)/y
• Now more carefully define producer surplus.
• Recall

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Y
Producer Surplus the shaded area in the graph
Why are the two graphs equivalent?
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• Why is Producers Surplus relevant if profit
  matters?
• In SR must be true that ?PS??
• Why? Fixed costs dont change as y changes in SR
• L-R Supply Curve
• S-R Supply Curve MC above AVC
• Where MRMC P MC (y, k) k is fixed
• L-R Supply Curve same with K variable
• gt where MR MC
• P MC (y, k(y))
• K is optimal

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• In L-R ? gt 0 or Py C(y) gt 0
• Or p gt c(y)/y or P gt ATC

What is LR Supply?
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• Relationship between long-run and short-run
  supply curve for a given firm is given by

SLR
Y1
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• Why would SLR be more elastic (more responsive to
  price changes)?
• Can change both K L optimally in the L-R gt
• Increase y at lower cost beyond y1 in the LR
• Note (Producer Surplus)LR ?LR since all inputs
  are variable.

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• In the short-run, firms can be found with 3
  different situations where y gt 0.

1) p gt 0, y gt 0
2) p 0, y gt 0
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3) p lt 0, y gt 0 why is ygt0?

• What is the short-run industry supply?
• S S Si (P) S MCi for all i firms.
• Recall that firm short-run supply firms MC
  curve above AVC.

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• Long-Run Equilibrium in Perfect Competition
• No fixed inputs.
• Free entry and exit.
• Consider firms of type 3 above ( p lt 0 but p gt
  AVC) who still produce in short-run. What
  happens?
• No fixed costs gt observe exit in the market and
  p rises to zero.
• Consider firms of type 1 above (p gt 0). What
  happens?
• The positive p serves as a signal to other firms
  to enter gt p falls to zero.
• The long equilibrium occurs where p equals 0.
• What does this look like, assuming all firms have
  the same costs?

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• Notice that y must occur where LRAC is at its
  minimum. Why?
• Also p C(y) gt p 0.

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• What does LR industry supply curve look like if
  firms are large relative to the market?
• Assume that all firms are the same gt industry
  supply in SR S MCi nMC where in (i.e., n
  the the total number of firms.
• Suppose that there are 4 possible firms then get

D1
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• Notice that equilibrium p and y is given by the
  lowest possible price where p1 p and y is at
  that intersection.
• Thus, if D D1 then p p1 and Y Y1
• If D D2 the p p1 and Y Y2

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• With large plants then long-run supply looks like

• P the minimum LRAC.
• The above is with only 4 firms total.

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• What if firms are all very small with respect to
  the market?

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• Taxes
• The graph below shows the SLR both before and
  after a tax is imposed.

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• Where is the equilibrium?
• For that must have Demand and SSR

• Short-run Equilibrium is at P1 therefore, both
  firms and consumers pay tax.
• Long-run Equilibrium is at P tax therefore
  only consumers pay tax in long-run.

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• Before assumed that costs were constant with
  entry.
• Is that a reasonable assumption?

Increasing costs with entry
Decreasing costs with entry
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• Economic Rent
• Suppose that we look at the rent earned by a
  highly paid sports or entertainment individual.
• Do D and S still determine price?
• Yes.

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• D and S still determine price but what economic
  rent is the player getting?
• That is, due to a talent restriction, there is no
  free entry for the players.
• Can profit be driven to zero under these
  conditions?
• Suppose fixed supply of Peyton Manning and his
  opportunity cost 100,000 but his MP in
  football 10 m.
• Profits are driven to zero just for the firm
  producing the product (i.e., NFL team).
• The economic rent is the payment for the fixed
  factor(s) total fixed costs.
• What is rent seeking behavior?

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• What affects the size of the rent?
• Depends upon the fixed supply for the talent
  market (Peyton Manning) and the no-talent market
  (me).

Talent Market
NoTalent Market
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• Final notes on Perfect Competion
• Assume that we generally having an increasing
  cost industry with an upward sloping long-run
  industry supply.
• This leads to an equilibrium that is allocatively
  efficient.
• One that maximizes net surplus (i.e., MSB MSC
  or no deadweight losses).