Costs and supply. Perfect competition Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005.

Costs and Costs and supply. Perfect supply. Perfect

competitioncompetition

Lectures/DeianDoykov/International University/Foundation Year/Semester 1-2005

Perfect competitionPerfect competitionPerfect competitionPerfect competition

“The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it”

Adam Smith. The Wealth of Nations

2 November 05

Introduction to EconomicsIntroduction to Economics

3 October 05

Costs and supply. Perfect Costs and supply. Perfect

competitioncompetition Input and output. Costs and the choice of technique. Long run total, marginal and average costs. Returns to scale. Average cost and marginal cost.

Introduction to EconomicsIntroduction to Economics

4 October 05

Costs and supply. Perfect Costs and supply. Perfect

competitioncompetition The firm’s short and long run output decisions. Short run costs and diminishing marginal returns. Short run and long run costs. Perfect competition and perfectly competitive firm.

5 November 05

Costs and supply

Input and output

Input and outputInput and output

Factors of production

Labor and capital used to produce goods

and services Production function

The set of all technically efficient

Techniques Technological progress An increase in output without increasing inputs.

6 November 05

Costs and supplyCosts and supplyCosts and supplyCosts and supply

Economic cost versus Accounting cost

Economic cost (EC) Explicit costs plus implicit costs

Accounting cost (AC) Measures the explicit costs of operating a business

Explicit costs (Ex. C) The firm's actual cash payments for its inputs

Implicit costs (IC) The opportunity cost of nonpurchased inputs

Economic cost versus Accounting cost

Economic cost (EC) Explicit costs plus implicit costs

Accounting cost (AC) Measures the explicit costs of operating a business

Explicit costs (Ex. C) The firm's actual cash payments for its inputs

Implicit costs (IC) The opportunity cost of nonpurchased inputs

7 November 05

Costs and supplyCosts and supplyCosts and supplyCosts and supply

Short-run costs Total cost

Short-run costs Total cost

8 November 05

Costs and supplyCosts and supplyCosts and supplyCosts and supply

Short run

A period of time over which one or more factors of production is fixed; in most cases, a period of time over which a firm cannot modify an existing facility or build a new one Short-run average total cost (SATC)

Short-run total cost divided by the quantity of output, equal to AFC plus AVC. Short-run average variable cost (SAVC)

Variable cost divided by the quantity produced

9 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

Output(Q)

01234567

TFC(£)

1212121212121212

Total costs for firm XTotal costs for firm X

10 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TFC

Output(Q)

01234567

TFC(£)

1212121212121212

Total costs for firm XTotal costs for firm X

11 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TFC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

Total costs for firm XTotal costs for firm X

12 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TVC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

TFC

Total costs for firm XTotal costs for firm X

13 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TVC

TFC

Diminishing marginalreturns set in here

Total costs for firm XTotal costs for firm X

14 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TVC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

TFC

Total costs for firm XTotal costs for firm X

15 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TVC

TFC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

TC(£)

12222833405272

103

Total costs for firm XTotal costs for firm X

16 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TCOutput

(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

TC(£)

12222833405272

103

TVC

TFC

Total costs for firm XTotal costs for firm X

17 November 05

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TC

TVC

TFC

Diminishing marginalreturns set in here

Total costs for firm XTotal costs for firm X

18 November 05

Short-run costsShort-run costs

Marginal cost= TC / Q

Marginal cost= TC / Q

19 November 05

0

20

40

60

80

100

120

0 1 2 3 4 5 6 7

Deriving marginal costs

Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

QQ

Costs (£)

20 November 05

0

20

40

60

80

100

120

0 1 2 3 4 5 6 7

TC

Deriving marginal costs

Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

QQ

Costs (£)

21 November 05

0

20

40

60

80

100

120

0 1 2 3 4 5 6 7

TC

Deriving marginal costs

Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

QQ

Costs (£)

TC = 12

Q = 1

22 November 05

0

20

40

60

80

100

120

0 1 2 3 4 5 6 7

TC

MCDiminishingreturns set

in here

QQ

Costs (£) Deriving marginal costs

Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

23 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

MC

QQ

Costs (£) Deriving marginal costs

Diminishing marginalreturns set in here

24 November 05

Short-run costsShort-run costs

Average cost=TC / Q

Average cost=TC / Q

25 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

QQ

Costs (£)

26 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

Q TVC AVC0 0 -1 10 102 16 83 21 74 28 75 40 86 60 107 91 13

QQ

Costs (£)

AFC

27 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

QQ

Costs (£)

AFC

AVC

Q TVC AVC0 0 -1 10 102 16 83 21 74 28 75 40 86 60 107 91 13

28 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

Q TC AC0 12 1 22 222 28 143 33 114 40 105 52 10.46 72 127 103 14.7

QQ

Costs (£)

AFC

AVC

29 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

QQ

Costs (£)

AC

AFC

AVC

Q TC AC0 12 1 22 222 28 143 33 114 40 105 52 10.46 72 127 103 14.7

30 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

QQ

Costs (£)

31 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

MC

QQ

Costs (£) Q TC MC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

32 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

MC

Q TC MC AC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

-2214111010.41214.7

QQ

Costs (£)

33 November 05

0

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7

MC

QQ

Costs (£)

AC

Q TC MC AC0 12 1 22 2 28 3 33 4 40 5 52 6 72 7 103

10 6 5 7122031

-2214111010.41214.7

34 November 05

Output (Q)

Co

sts

(£)

AFC

AVC

MC

x

AC

z

y

Average and marginal costsAverage and marginal costs

35 November 05

Long-run costsLong-run costs

Long-run costs=TC / Q

Long-run costs=TC / Q

36 November 05

Long-run costsLong-run costs

Long run

A period of time long enough that a firm can change all the factors of production, meaning that a firm can modify its existing production facility or build a new one

Long-run average cost (LAC)

Long-run total cost divided by the quantity of output produced

Long-run total cost

The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size

37 November 05

Returns to scaleReturns to scale Economies of scale

A situation in which an increase in the quantity produced decreases the long-run average cost of production

Diseconomies of scale

A situation in which an increase in the quantity produced increases the long-run average cost of production

Constant returns to scale

The total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size

Minimum efficient scale

The output at which the long-run average cost curve becomes horizontal

38 November 05

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

OutputO

Co

sts

LRAC

Economies of Scale

39 November 05

OutputO

Co

sts

Diseconomies of ScaleLRAC

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

40 November 05

OutputO

Co

sts

LRAC

Constant costs

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

41 November 05

A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve

OutputO

Co

sts

LRAC

42 November 05

OutputO

Co

sts

LRACEconomiesof scale

Constantcosts

Diseconomiesof scale

A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve

43 November 05

Long-run average and marginal costs

OutputO

Co

sts

LRAC

LRMC

Economies of Scale

44 November 05

OutputO

Co

sts

LRAC

LRMC

Diseconomies of Scale

Long-run average and marginal costs

45 November 05

OutputO

Co

sts

LRAC = LRMC

Constant costs

Long-run average and marginal costs

46 November 05

OutputO

Co

sts

LRMC

LRAC

Initial economies of scale,then diseconomies of scale

Long-run average and marginal costs

47 November 05

Long-run costsLong-run costs

Relationship between short-run and long-run

AC curves

Relationship between short-run and long-run

AC curves

48 November 05

Deriving long-run average cost curves: factories of fixed size

SRAC3

Co

sts

OutputO

SRAC4

SRAC5

5 factories

4 factories3 factories2 factories

1 factory

SRAC1 SRAC2

49 November 05

SRAC1

SRAC3

SRAC2 SRAC4

SRAC5

LRAC

Co

sts

OutputO

Deriving long-run average cost curves: factories of fixed size

50 November 05

Co

sts

OutputO

Examples of short-runaverage cost curves

Deriving long-run average cost curves: choice of factory size

51 November 05

LRAC

Co

sts

OutputO

Deriving long-run average cost curves: choice of factory size

52 November 05

53 November 05

Perfect competition

Perfect competition and perfectly

competitive firm

Perfect Perfect CompetitionCompetition

54 November 05

Perfect competitionPerfect competition

Short-run equilibrium of firm and industry (profit maximising)

Short-run equilibrium of firm and industry (profit maximising)

55 November 05

O

£

(b) Firm

Q (thousands)

O

(a) Industry

P

Q (millions)

S

D

Pe

MC

ARD = AR

= MR

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect competitionShort-run equilibrium of industry and firm under perfect competition

56

Perfect competitionPerfect competition

The industrysupply curveThe industrysupply curve

57 November 05

O O

(a) Industry

P £

P1

Q (millions)

S

D1

(b) Firm

D1 = MR1

MC

P2

D2 = MR2

D2

P3

D3 = MR3

D3

Q (thousands)

Deriving the short-run supply curve

a

b

c

= S

58

Perfect competitionPerfect competition

Long-run equilibriumLong-run equilibrium

59 November 05

O O

P £

Q (millions)

S1

D

LRAC

PL

P1

QL

Se

AR1 D1

ARL DL

Q (thousands)

Long-run equilibrium under perfect competitionLong-run equilibrium under perfect competition

New firms enterSupernormal profitsProfits return

to normal

(a) Industry (b) Firm60

£

Q O

(SR)AC

(SR)MC

LRAC

AR = MR

DL

LRAC = (SR)AC = (SR)MC = MR = AR

Long-run equilibrium of the firm under perfect competitionLong-run equilibrium of the firm under perfect competition

61 November 05

62 November 05

Perfect competition

Profit Maximisation &

Loss Minimisation

Profit Profit MaximisatioMaximisatio

n n 63 November 05

Profit maximisationProfit maximisationNormal profit versus

Economic profit

Economic profit (EP) Total revenue minus the total economic cost Normal profit (NP) The portion of firm’s cost that is not included in accounting cost

EP = TR – TC

TR = P x Q

Normal profit versus Economic profit

Economic profit (EP) Total revenue minus the total economic cost Normal profit (NP) The portion of firm’s cost that is not included in accounting cost

EP = TR – TC

TR = P x Q64 November 05

Profit maximisationProfit maximisation

Using total cost and revenue curves

(a) Price taking firm

Using total cost and revenue curves

(a) Price taking firm

65 November 05

Total profit = £100 × 46 = £4600

TR

Costs andrevenue (£)

Quantity

600

500

400

300

200

100

00 10 20 30 40 50 60

Price-taking firm

TC

100

46

b

a

66

Profit maximisationProfit maximisation

Using total cost and revenue curves

(b) Firm facing downward sloping demand curve

Using total cost and revenue curves

(b) Firm facing downward sloping demand curve

67 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

Quantity

Finding maximum profit using total curves

68 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

TR

Quantity

Finding maximum profit using total curves

69 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

TR

TC

Quantity

Finding maximum profit using total curves

70 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

T

TR

TC

Quantity

Finding maximum profit using total curves

71 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

T

TR

TC

a

b

c d

Quantity

Finding maximum profit using total curves

72 November 05

-8

-4

0

4

8

12

16

20

24

1 2 3 4 5 6 7

TR

, TC

, T

(£

)

T

TR

TC

d

e

f

Quantity

Finding maximum profit using total curves

73 November 05

Profit maximisationProfit maximisation

Using average and marginal cost and

revenue curves

(a) Price taking firm

Using average and marginal cost and

revenue curves

(a) Price taking firm

74 November 05

Total profit= £16 x 40 = £640

AR = MR

MC50

40

30

20

10

00 10 20 30 40 50 60

Quantity

Costs andRevenue (£)

22

a

Price-taking firm

AC38

b

75

Profit maximisationProfit maximisation

Using average and marginal cost and

revenue curves

(b) Firm facing downward sloping demand curve

Using average and marginal cost and

revenue curves

(b) Firm facing downward sloping demand curve

76 November 05

-4

0

4

8

12

16

1 2 3 4 5 6 7Quantity

Co

sts

and

rev

enu

e (

£)

Finding the profit-maximising output using marginal curves

77 November 05

-4

0

4

8

12

16

1 2 3 4 5 6 7Quantity

Co

sts

and

rev

enu

e (

£)

MC

Finding the profit-maximising output using marginal curves

78 November 05

-4

0

4

8

12

16

1 2 3 4 5 6 7Quantity

Co

sts

and

rev

enu

e (

£)

e

MR

MC

Profit-maximisingoutput

Finding the profit-maximising output using marginal curves

79 November 05

-4

0

4

8

12

16

1 2 3 4 5 6 7Quantity

Co

sts

and

rev

enu

e (

£)

Measuring the maximum profit using average curves

MR

MC

80 November 05

-4

0

4

8

12

16

1 2 3 4 5 6 7Quantity

Co

sts

and

rev

enu

e (

£)

MR

MC

AR

Measuring the maximum profit using average curves

81 November 05

6.00

4.50

-4

0

4

8

12

16

1 2 3 4 5 6 7

MR

Quantity

Co

sts

and

rev

enu

e (

£)

MC

AC

AR

b

a

Total profit =£1.50 x 3 = £4.50

Measuring the maximum profit using average curves

T O T A L P R O F I TT O T A L P R O F I T

82 November 05

Loss Loss MinimisationMinimisation

83 November 05

O

Co

sts

and

rev

enu

e (

£)

Quantity

MC

AC

AR

MR

Q

AC

AR

Loss-minimising output

LOSSLOSS

84

Profit maximisationProfit maximisation

Short-runshut-down point

Short-runshut-down point

85 November 05

The short-run shut-down point

O

Co

sts

and

rev

enu

e (

£)

Quantity

AR

AVC

ACP =AVC

Q

86 November 05

Costs and supply. Perfect Costs and supply. Perfect competitioncompetition

Costs and supply. Perfect Costs and supply. Perfect competitioncompetition

Questions for discussions:1. Most supply curves are vertical ?2. So what is a firm ?3. To maximise profit, maximise sales ?4. Scale economies and the Internet ?5. Small is beautiful - big is again

beautiful ? 6. Firms making losses should quit at

once ?

Questions for discussions:1. Most supply curves are vertical ?2. So what is a firm ?3. To maximise profit, maximise sales ?4. Scale economies and the Internet ?5. Small is beautiful - big is again

beautiful ? 6. Firms making losses should quit at

once ?

87 November 05

Assignment for week # 6:Essay question: Productivity and

Technological changes ?

Assignment for week # 6:Essay question: Productivity and

Technological changes ?

Introduction to EconomicsIntroduction to EconomicsIntroduction to EconomicsIntroduction to Economics

88 November 05