Download 7. Profit maximization and supply

CDAE 254 - Class 24 Nov. 15
Last class:
7. Profit maximization and supply
Today:
7. Profit maximization and supply
8. Perfectly competitive markets
Class exercise
Quiz 7 (take-home)
Next class:
8. Perfectly competitive markets
Important dates:
Problem set 6: due today
Final exam: 3:30-6:30pm, Tuesday, Dec. 11
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 + SVC
If TR < SVC, the company should shut down
SAC = SAFC + SAVC
i.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 the graph
on the handout
(a) Where is the firm’s supply curve
(b) What is the break-even production level
(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=38?
(f) What is the total fixed cost?
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 even 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 competitive markets
8.1.
8.2.
8.3.
8.4.
8.5.
8.6.
8.7.
Basic concepts
Supply in the very short run
Short-run supply
Short-run price determination
Shifts in supply and demand curves
Long-run supply
Applications
8.1. Basic concepts
(1) An overview of an economy
(2) Market structures
-- Perfectly competitive market
-- Monopoly
-- Oligopoly
(3) Supply response: The change in quantity of
output in response to a change in demand
conditions.
(4) Very short run, short run, and long run
8.2. Supply in the very short run
(1)
(2)
(3)
(4)
A graphical analysis (Fig. 8.1)
Market equilibrium
Impact of a shift in demand
Impact of trade, inventories, and government
interventions
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)
For example, there are only two firms in a
market: qa = - 2 + 0.5P, qb = -6 + 1 P
(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
Percentage change in Y
= Percentage change in X
(b) Short-run supply elasticity
Percentage change in Qs
=
Percentage change in P
8.3. Short-run supply
(6) Short-run elasticity of supply
(c) Estimation of supply elasticities:
-- From two observations
For example: the supply in the market
increased from 100 to 120 units when the
price increased from $2.0 to $2.6. What is
the supply elasticity?
-- From a supply function:
For example: Q = -10 + 0.6P, what is the
supply elasticity when P = 40?
8.4. Short-run price determination (Fig. 8.3)
(1)
(2)
(3)
(4)
Supply and demand in a market
Market equilibrium
An example
Effect of an increase in market demand