Download Week 6 – Finish up cost curves…on to Perfect Competition

Week 6 – Finish up cost curves…on to Perfect
Competition
What does the typical graph of cost curves
look like (in the short run)?
E.g., TC = 400 + 5q + q2
FC = 300
VC =
Find minimum of AC, AVC
Check value of MC at min AC and min AVC
Graph MC, AC, AVC and think of the
kindergarten kids…
How will these costs affect profit
maximization by the individual firm?
We assume btw that firm’s objective is to
maximize profit
Π = TR – TC
Notice that this must include all costs
e.g., video store operated by owner and his
family
every week: $2500 in rental income, pay out
$1000 for rental of space, $800 for new
videos
Accounting profit = $700
Economic profit must include costs of all
resources used by the business that have
alternative opportunities (i.e., the labour of
the owner and family, perhaps interest on
owner-invested capital)
In general Accounting profit > Economic
profit
Zero economic profit generally means positive
accounting profits.
Back to my question:
How will these costs affect profit
maximization by the individual firm?
Π = TR – TC
To max: dΠ/dq = dTR/dq – dTC/dq = MR – MC
Set = 0, so MR – MC = O or MR = MC
We know what MC is, what about MR?
Let’s say that to the individual firm, P was a
constant.
Then, since TR = P x q, dTR/dq = P
Then the rule for maximizing profit is to set
P = MC (i.e., choose the quantity at which P =
MC). This will be the profit maximizing
amount of output to produce.
Graph:
How does this compare to the Optimal Hiring
Rule?
Remember that?
Optimal Hiring Rule said that firm should hire
workers until the marginal contribution of the
last worker hired to the revenues of the firm
was just equal to the marginal cost of hiring
that last worker. (or, hire labour as long as
one more worker adds more to revenue than it
does to costs).
Or hire workers until PG x MPL = PL
As Prof. Krashinsky showed you,
MC = PL/MPL
So, if the rule for determining the profit
maximizing output is P = MC
Therefore, the rule is P = PL/MPL
Or, since P is the price of the good (PG), we
have
PG x MPL = PL
So, the two rules are the same – one focuses
on the decision to use workers, the other on
the decision to produce output.
We have been talking about short run costs
and short run profit maximization. What
about long-run costs?
In LR, choose optimal amount of capital (all
choices open).
Each SRAC (or SAC) is associated with one
level of capital
“Envelope”
General shape of LRAC (or LAC)
U-shaped
qMES = output associated with minimum
efficient scale
Regions: IRTS, CRTS, DRTS
More on LR in discussion of perfect
competition.
Perfect Competition
1.
Many buyers, many sellers
(price takers)
2. Homogeneous good (no brand
loyalty)
3. Free entry and exit (no
barriers to competition)
4. Perfect information (no
mistakes)
The closer the situation to this ideal, the
better this model will apply to a real-world
situation
Examples?
How does individual PC firm behave?
It faces market price (no control). It has
known best-practice technology, can buy
inputs at same price as other firms. Wants to
maximize profit.
What does its demand curve look like?
How does the individual PC firm behave?
Must choose amount of inputs and output to
maximize profit.
Short run situation faced by individual PC firm
Supply curve of individual PC firm is ?
Why?
Breakeven price?
Shut-down price?
Supply curve of PC industry in SR is?
Algebraic example
Market Demand: P = 154 - .06Q
Total cost function of each PC firm:
TC = 3q2 + 10q + 432
FC = 384
So, TVC = 3q2 + 10q + 48
MC =
AC =
AVC=
Where does AC reach minimum?
Where does AVC reach minimum?
Therefore, supply curve of individual PC firm
in this industry is?
If there are 100 identical firms in industry
then PC industry supply curve is?
Therefore, for PC industry in SR
Demand: P = 154 - .06Q
Supply: P = 10 + .06Q
SR equilibrium where D and S intersect
Q0* = 1200, Po* = $82
Each PC firm in this industry produces?