CDAE 254 - Class 25 Nov 28

Last class:Result of Quiz 7

7. Profit maximization and supply

Today: 7. Profit maximization and supply

8. Perfectly competitive markets

Next class:8. Perfectly competitive markets

Readings:Chapter 7 and Chapter 8

CDAE 254 - Class 25 Nov 28

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

Result of Quiz 7

N = 43 Range = 5 – 10 Average = 8.52

1. How will a company change L and K when w/v is not equal to the RTS?

2. Returns to scale and calculate TC, AC and MC(1) Returns to scale(2) Calculate TC, AC and MC

3. Draw a graph AND use the graph to explain why the TC in the short run is likely to be higher than that in the long run for the same level of output

4. Major difference between accounting cost and opportunity cost

5. For a given TC function (1) Returns to scale (2) AC = MC =

6. Relation between MC and q returns to scale

Class exercise

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 (current price is 4)?

7.5. Alternatives to profit maximization

(1) TR maximization -- A graphical analysis -- Comparison of profit maximization and TR

maximization:Output level:Total profit:

(2) Markup pricing: -- P = AC + markup -- Markup and price elasticity of demand

(e.g, textbooks vs. general books)

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)? (g) What is the total variable 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) A graphical analysis (Fig. 8.1)

(2) Market equilibrium (3) Impact of a shift in demand

(4) 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

=

(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