CDAE 254 - Class 26 Nov 30
Last class: 7. Profit maximization and supply
8. Perfectly competitive markets
Today:8. Perfectly competitive markets9. Applying the competitive models
Next class:9. Applying the competitive modelsQuiz 8 (Chapters 7 and 8)Quiz 9 (optional and take home, due Thursday, Dec. 7 )
Readings:Chapter 8 and Chapter 9
CDAE 254 - Class 26 Nov 30
Important dates:Problem set 7 due Tuesday, Dec. 5 Problems 7.1, 7.2., 7.3 and 7.8 from the textbook
Final exam: 3:30 – 6:30pm, Friday, Dec. 15
7. Profit maximization and supply 7.1. Goals of a firm
7.2. Profit maximization 7.3. Marginal revenue and demand 7.4. Marginal revenue curve 7.5. Alternatives to profit maximization 7.6. Short-run supply 7.7. Applications
7.6. Short-run supply by a price-taking firm
(1) Profit maximizing decision: MC = MR = P (2) The firm’s supply (3) Shutdown decision:
STC = SFC + SVCIf TR < SVC, the company should shut down SAC = SAFC + SAVCi.e., If the price is less than the short-run average variable cost (SAVC), the firm will shut down the production.(4) The firm’s supply curve: SMC above the SAVC
7.6. Short-run supply by a price-taking firm
(5) Practice questions according to handout graph (a) Where is the firm’s supply curve
(b) What are the break-even price & output (c) What is the shutdown price level? (d) What is the total profit at the shutdown price? (e) What is the total profit when P= 100? ( f ) What is the total short run fixed cost (SFC)?
Application: Steel trap
U.S. steel firms were very slow in leaving the market• Youngstown Sheet & Tube and U.S. Steel Corporation at
Youngstown did not close until the late 1970s • The next big firm closed in 1982• Steel firms continued to operate aging, inefficient, and
unprofitable plants
Application: Steel trap
Huge cost to close a steel firm:• pay to dismantle mill and terminate contracts • union contracts:
– pay to workers after the firm is closed – supplemental unemployment benefits– payments to cover additional future pensions and insurance– generally, union members eligible for pensions when age + years
of service = 75– workers laid off due to plant closings are eligible for a pension
when age + years of service = 70
Application: Steel trap
The estimated costs to close a steel firm in the U.S.:• $650 million ($415 million labor related or $37,000
per laid-off worker) in 1979• Have increased at least 45% since then
Application: Steel trap
• Because they avoided shutting down since 1970s, U.S. steel mills sold some products at prices below AC or AVC
• For example:In 1986:– AVC of hot-rolled sheets per ton = $305– AC = $406– price = $273
Application: Steel trap
International trade and policy:-- New import tax on steel products in Feb. 2002
-- Reactions from steel exporters -- Debate under WTO
8. Perfect competition 8.1. Basic concepts
8.2. Supply in the very short run 8.3. Short-run supply 8.4. Short-run price determination 8.5. Shifts in supply and demand curves 8.6. Long-run supply 8.7. Applications
8.3. Short-run supply (1) Short-run: The number of firm is fixed but the
existing firms can change their output levels in response to changes in the market.
(2) Supply curve: Relationship between market price and quantity supplied.
(3) Short-run supply curve of an individual firm:SMC above the SAVC (Ch. 7).
(4) Short-run supply curve in a market (Fig. 8.2)(5) Notations
8.3. Short-run supply (6) Short-run elasticity of supply
(a) Recall our general definition of elasticity
Elasticity of Y with respect to X
=
(b) Short-run supply elasticity
=
Xin change Percentage
Yin change Percentage
Pin change Percentage
Qin change Percentage s
8.3. Short-run supply (6) Short-run elasticity of supply
(c) Estimation of supply elasticities: -- From two observations -- From a supply equation
8.4. Short-run price determination (Fig. 8.3) (1) Supply and demand in a market
(2) Market equilibrium(3) An example(4) Effect of an increase in market demand
Class Exercise Suppose a market has 100 identical producers and each producer has
the following supply function:q = - 2 + 0.5 P
(a) Graph the supply curve for one firm and then graph the supply curve for the market(b) Calculate the supply elasticity for the market when P=12
If the demand function for the market is Q = 1000 – 30 P, (c) Derive the market equilibrium P* and Q*(d) Calculate the demand and supply elasticities at the market equilibrium price and quantity
8.5. Long run supply (1) Constant cost market
(2) Increasing cost market(3) Decreasing cost market (4) Examples
p, $ per unit
150
LRAC
LRMC
(a) Firm
q, Hundred metric tons of oil per year
10
S1
0
p, $ per unit (b) Market
Q , Hundred metric tons of oil per year
Long-run market supply10
0
Long-Run Market Supply in a Constant-cost Market
Long-Run Market Supply in an Increasing-Cost Market
p, $ per unit
q1 q2 Q1 = n1q1 Q2 = n2q2q, Units per year Q, Units per year
p1
p2
e2
e1
E2
S
E1
p, $ per unit
(a) Firm (b) Market
AC2
MC 2
MC1
AC1
Long-Run Market Supply in an Decreasing-Cost Market
p, $ per unit
q1 q2 Q1 = n1 q1 Q2 = n2 q2q, Units per year Q, Units per year
p1
p2
e2
e1
E2
S
E1
p, $ per unit
(a) Firm (b) Market
AC2
MC2MC1
AC1
LR supply: examples
• downward-sloping LR supply curves: prepared feeds, aircraft, construction equipment, computers, TVs, DVD players, etc.
• upward-sloping LR supply curves: tires, drugs, paints, glass, etc.
• flat LR supply curves: plumbing and heating products, floor coverings, etc.
• on average across all industries: LR supply curves have only slight upward slope
Upward-Sloping Long-Run Supply Curve for Cotton in the world market
0.71
Price, $ per kg
0 1 2 3
Iran
United States
Nicaragua, Turkey
BrazilAustralia
Argentina
Pakistan
4 5 6 6.8
Cotton, billion kg per year
1.081.15
1.27
1.43
1.56
1.71 S
9. Applying the competitive model 9.1. Consumer and producer surplus
9.2. Impact of price interventions 9.3. Tax incidence analysis 9.4. Trade restrictions 9.5. Applications
9.1. Consumer and producer surplus (1) Consumer surplus (review)
-- Definition (interpretation) -- How to calculate it at a particular price? -- How to calculate the change in consumer surplus due to a tax or a change in price?
9.1. Consumer and producer surplus (2) What is producer surplus?
Example: A firm with a supply functionqs = -10 + P
--------------------------------------------------------------------------- Minimum price to Cumulative
P qs supply the last unit “revenue” -------------------------------------------------------------------------- < 10 0 = 11 1 11 11 = 12 2 12 23 = 13 3 13 36 = 14 4 14 50
9.1. Consumer and producer surplus (2) What is producer surplus? Example: A firm with a supply functionqs = -10 + P Cumulative “revenue” from 4 units = $50 Total actual revenue from 4 units = 4 x 14 = $56 The difference = 56 - 50 = $6 (producer surplus)
Producer surplus: The extra value producers get for a good in excess of the opportunity costs of producing the good.
9.1. Consumer and producer surplus (3) Economic efficiency (Fig. 9.1.)
The sum of producer surplus and consumer surplus is at the maximum when the market is at equilibrium.
(4) How to estimate consumer & producer surplus? e.g., QD = 10 - P and QS = 0.5 P - 2
At the equilibrium: Q* = 2 and P* = 8 Consumer surplus = 0.5 x 2 x 2 = 2 Producer surplus = 0.5 x 4 x 2 = 4
What will be the change in CS and PS if Q is restricted to be 1.5 units by a quota?
If the government wants to reduce Q to 1.5 units by a sales tax, what should be the tax rate per unit?
9.2. Impact of price interventions (1) Price interventions: (2) Impacts of a price ceiling
-- If the ceiling price is above the equ. price -- If the ceiling price is below the equ. price
QuantityPriceConsumer surplusProducer surplusEfficiency
-- Examples:
9.2. Impact of price interventions (3) Impacts of a price floor
-- If the floor price is below the equilibrium price -- If the floor price is above the equ. price
QuantityPriceConsumer surplusProducer surplusEfficiency
-- Examples