Download 7. Profit maximization and supply

CDAE 254 - Class 23 Nov. 13
Last class:
Result of Quiz 6
7. Profit maximization and supply
Today:
7. Profit maximization and supply
8. Perfectly competitive markets
Next class:
8. Perfectly competitive markets
Quiz 7 (take-home)
Important date:
Problem set 6: due Thursday, Nov. 15
(Problems 6.1., 6.4., 6.6., 6.9., and 6.10 from the textbook)
7. Profit maximization and supply
7.1.
7.2.
7.3.
7.4.
7.5.
7.6.
7.7.
Goals of a firm
Profit maximization
Marginal revenue and demand
Marginal revenue curve
Alternatives to profit maximization
Short-run supply
Applications
Class exercise
(Tuesday, Nov. 6)
Suppose that the demand function for a
company’s product is estimated as q = 8 - 0.5 P
where q is the quantity and P is the price.
(1) Draw the demand curve
(2) Derive the MR function and draw the MR
curve
(3) What is the price elasticity of demand when
P=4?
(4) If the company wants to increase its market
share, should it increase or decrease its price?
7.5. Alternatives to profit maximization
(1) TR maximization
-- A graphical analysis
-- Comparison of profit maximization and
TR maximization:
Output level:
TR:
Total profit:
(2) Markup pricing:
-- P = AC + markup
-- Markup and price elasticity of demand
(e.g, textbooks vs. general books)
A quiz question:
Under which of the following conditions the
firm should shut down its production (i.e.,
q=0) in the short run?
(a)
(b)
(c)
(d)
When the profit is negative
When TR < SFC (short-run fixed cost)
When TR < FVC (short-run variable cost)
When TR < STC (short-run total cost)
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?
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
8.1. 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)
(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
-- From a supply equation
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
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