MB MC
Chapter 6,Perfectly Competitive Supply Slide 1
Lecture 15 (2005.11.8)
Chapter 5
choices
Chapter 6
p141----150
MB MC
Perfectly Competitive
Supply,The Cost
Side of The Market
MB MC
Chapter 6,Perfectly Competitive Supply Slide 3
Overview
Chapter 6 presents the supply side of the market,
using an approach parallel to that of the demand
side of the market in Chapter 5,The chapter
presents the material in a way that illustrates the
second core principle of the textbook,that
marginal benefits should equal marginal costs.
Chapter 5 presents the demand curve as derived
from marginal benefit and Chapter 6 presents the
supply curve as derived from marginal costs.
These two chapters provide the details behind the
principle that MC = MB and give students a solid
basis for understanding and applying it in a variety
of situations.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 4
Overview
The chapter illustrates concepts using recycling as
an example,First,individual supply decisions are
discussed,followed by discussion of the supply
decision of a perfectly competitive firm,The
determinants of supply are revisited in the chapter
and price elasticity of supply is presented (e.g.
definition,calculation,ranges,determinants).
Finally,the chapter uses the production
possibilities curve from chapter 3 to generate
supply curves using the PPC model.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 5
Thinking About Supply,The
Importance of Opportunity Cost
Example 6.1
How much time should Harry spend
recycling soft drink containers?
Harry is choosing between washing
dishes for $6/hour and collecting
containers at 2 cents each.
Opportunity cost of collecting cans is
$6/hour.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 6
Thinking About Supply,The Importance of
Opportunity Cost
Search time
(hours/day)
0 0
1 600
2 1,000
3 1,300
4 1,500
5 1,600
Total number of
containers found
Additional number of
containers found
600
400
300
200
100
Example 6.1
MB MC
Chapter 6,Perfectly Competitive Supply Slide 7
Thinking About Supply,The Importance of
Opportunity Cost
Costs and Benefits
1 hour collecting cans = (600)(.02) = $12
Benefit ($12) > Opportunity Cost ($6)
2nd hour benefit ($8) > Opportunity Cost ($6)
3rd hour benefit ($6) = Opportunity Cost ($6)
MB MC
Chapter 6,Perfectly Competitive Supply Slide 8
Thinking About Supply,The Importance of
Opportunity Cost
Question
What is the lowest redemption price that
would induce Harry to recycle 1 hour/day?
Solution
600 containers x 1 cent = $6 = opportunity
cost of washing dishes
MB MC
Chapter 6,Perfectly Competitive Supply Slide 9
Thinking About Supply,The Importance of
Opportunity Cost
Reservation Price
6$ Qp
MB MC
Chapter 6,Perfectly Competitive Supply Slide 10
Thinking About Supply,The Importance of
Opportunity Cost
Reservation Price
1 hour recycling = p(600) = $6 p= 1 cent
2 hours recycling = p(400) = $6 p= 1.5 cents
3 hours recycling = p(300) = $6 p= 2 cents
4 hours recycling = p(200) = $6 p = 3 cents
5 hours recycling = p(100) = $6 p= 6 cents
MB MC
Chapter 6,Perfectly Competitive Supply Slide 11
An Individual Supply Curve for Recycling Services
Recycled cans
(100s of cans/day)
De
po
sit
(ce
nts
/ca
n)
0 6 10 13 16
6
3
2
1
1.5
15
Harry’s Supply Curve
MB MC
Chapter 6,Perfectly Competitive Supply Slide 12
The Market Supply Curve for Recycling Services
Recycled cans
(100s of cans/day)
Recycled cans
(100s of cans/day)
De
po
sit
(c
en
ts
/ca
n)
+
+
De
po
sit
(c
en
ts
/ca
n)
6 10 13 16
6
3
2
1
0
1.5
15
Harry’s Supply Curve
6 10 13 16
6
3
2
1
0
1.5
15
Barry’s Supply Curve
MB MC
Chapter 6,Perfectly Competitive Supply Slide 13
Recycled cans
(100s of cans/day)
De
po
sit
(c
en
ts
/ca
n)
12 20 26 32
6
3
2
1
0
1.5
30
=
=
The Market Supply Curve for Recycling Services
Market Supply Curve
MB MC
Chapter 6,Perfectly Competitive Supply Slide 14
Thinking About Supply,The Importance of
Opportunity Cost
What do you think?
Why is the supply curve upward sloping?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 15
The Market Supply Curve with 1,000 Identical Sellers
Recycled cans
(100,000s of cans/day)
De
po
sit
(c
en
ts
/ca
n)
6 10 13 16
6
3
2
1
0
1.5
15
Market Supply Curve
MB MC
Chapter 6,Perfectly Competitive Supply Slide 16
Profit-Maximizing Firms in Perfectly
Competitive Markets
Profit Maximization
Profit =Total Revenue - All Costs (explicit &
implicit)
Profit-Maximizing Firms
_____Goal of the firm is to maximize the
difference between total revenues and total
costs
MB MC
Chapter 6,Perfectly Competitive Supply Slide 17
Profit-Maximizing Firms in Perfectly
Competitive Markets
The Perfectly Competitive Market
A market in which no individual supplier
has significant influence on the market
price of the product
A Price Taker
A firm that has no influence over the price
at which it sells its product
MB MC
Chapter 6,Perfectly Competitive Supply Slide 18
Profit-Maximizing Firms in Perfectly
Competitive Markets
The Characteristics of Perfect Competition
1,All firms sell the same standardized product.
2,The market has many buyers and sellers,
each of which buys or sells only a small
fraction of the total quantity exchanged.
3,Productive resources are mobile
4,Buyers and sellers are well informed.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 19
The Demand Curve Facing Perfectly
Competitive Firm
P0
Q0
S
D
Market Quantity
(units/month)
Pr
ice
($
/u
nit)
Market supply and demand
MB MC
Chapter 6,Perfectly Competitive Supply Slide 20
DiP0
The Demand Curve Facing a Perfectly
Competitive Firm
Pr
ice
($
/u
nit)
Individual Firm’s Quantity
(units/month)
Individual firm demand
MB MC
Chapter 6,Perfectly Competitive Supply Slide 21
Profit-Maximizing Firms in Perfectly
Competitive Markets
Concepts of production
Factor of production
An input used in the production of a good or
service
Short run
A period of time sufficiently short that at least
some of the firm’s factors of production are
fixed (VC+FC)
Long run (VC)
MB MC
Chapter 6,Perfectly Competitive Supply Slide 22
Profit-Maximizing Firms in Perfectly Competitive
Markets
Concepts of production
Fixed factor of production
An input whose quantity cannot be altered in
the short run
Variable factor of production
An input whose quantity can be altered in the
short run
MB MC
Chapter 6,Perfectly Competitive Supply Slide 23
Profit-Maximizing Firms in Perfectly
Competitive Markets
Assume
A company makes glass bottles
Two factors of production
Labor (variable factor)------ $12/worker
Capital -----A bottle-making machine(fixed
factor)----- $40/day
MB MC
Chapter 6,Perfectly Competitive Supply Slide 24
Profit-Maximizing Firms in Perfectly
Competitive Markets
Some Important Cost Concepts
Fixed cost
The sum of all payments made to a firm’s fixed
factors of production
Example
The cost of the bottle making machine is
$40/day and it is a fixed cost.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 25
Profit-Maximizing Firms in Perfectly Competitive
Markets
Some Important Cost Concepts
Variable cost
The sum of all payments made to the firms
variable factors of production
Example
The cost of labor is $12/worker and is a
variable cost.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 26
Employment and Output for a Glass Bottle Maker
Total number of employees per day Total number of bottles per day
0 0
1 80
2 200
3 260
4 300
5 330
6 350
7 362
Observation
Output gains from each
additional worker begins
to diminish with the
third employee
MB MC
Chapter 6,Perfectly Competitive Supply Slide 27
Profit-Maximizing Firms in Perfectly
Competitive Markets
Law of Diminishing Returns
A property of the relationship between the
amount of a good or service produced and
the amount of a variable factor required to
produce it
It says that when some factors of
production are fixed,increased production
of the good eventually requires ever-larger
increases in the variable factor
MB MC
Chapter 6,Perfectly Competitive Supply Slide 28
Fixed,Variable,and Total Costs of Bottle
Production
0 0 40 0 40
1 80 40 12 52
2 200 40 24 64
3 260 40 36 76
4 300 40 48 88
5 330 40 60 100
6 350 40 72 112
7 362 40 84 124
Employees
per day
Bottles
per day
Fixed cost
($/day)
Variable cost
($/day)
Total cost
($/day)
Marginal cost
($/bottle)
0.15
0.10
0.20
0.33
0.40
0.60
1.00
MB MC
Chapter 6,Perfectly Competitive Supply Slide 29
Profit-Maximizing Firms in Perfectly
Competitive Markets
Some Important Cost Concepts
Total Cost
Fixed cost + variable cost
Marginal Cost
Measures how total cost changes with a
change in output
O u t p u t
TC
MC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 30
Output,Revenue,Costs,and Profit
0 0 0 40 -40
1 80 28 52 -24
2 200 70 64 6
3 260 91 76 15
4 300 105 88 17
5 330 115.50 100 15.50
6 350 122.50 112 10.50
7 362 126.70 124 2.70
Employees
per day
Output
(bottles/day)
Total revenue
($/day)
Profit
($/day)
Total cost
($/day)
MB =,35
MB =,35
MB =,35
MB =,35
MB =,35
MB =,35
MB =,35
MC =,15
MC =,10
MC =,20
MC =,33
MC =,44
MC =,60
MC = 1.00
Example 6.2
MB MC
Chapter 6,Perfectly Competitive Supply Slide 31
Profit-Maximizing Firms in Perfectly
Competitive Markets
What will happen to the profit maximizing
output if:
(a)
--------exercise 6.2
(b) employees receive a wage of $6/day;
--------exercise 6.3
(c) fixed costs are $45?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 32
Homework
Review question
(p162):
1;2;3;
Problems (p163),
1;2;3;5
Preview p150-155
MB MC
Chapter 6,Perfectly Competitive Supply Slide 33
Lecture 16 (2005.11.10)
Recap
p1-150
Chapter 6
p150-155
MB MC
Chapter 6,Perfectly Competitive Supply Slide 34
Recap
Perfectly Competitive Market
Price Taker
Profit-Maximizing Firms
Short run (VC+FC)
Long run (VC)
Law of Diminishing Returns
MB MC
Chapter 6,Perfectly Competitive Supply Slide 35
RECAP
* Quantities of Profit Maximization
____ profit=TR-TC (example 6.2)
____ (MB>=MC)
* Influence factors
____price (MB) (exercise 6.2)
____ variable factor (VC) (exercise 6.3)
MB MC
Chapter 6,Perfectly Competitive Supply Slide 36
0 0 40 0 40
1 80 40 12 52
2 200 40 24 64
3 260 40 36 76
4 300 40 48 88
5 330 40 60 100
6 350 40 72 112
7 362 40 84 124
Employees
per day
Bottles
per day
Fixed cost
($/day)
Variable cost
($/day)
Total cost
($/day)
Marginal cost
($/bottle)
0.15
0.10
0.20
0.33
0.40
0.60
1.00
Exercise 6.4
Profit-Maximizing Firms in Perfectly
Competitive Markets
MB MC
Chapter 6,Perfectly Competitive Supply Slide 37
Output,Revenue,Costs,and Profit
0 0 0 40 -40
1 80 8 52 -44
2 200 20 64 -44
3 260 26 76 -50
4 300 30 88 -58
5 330 33 100 -67
6 350 35 112 -77
7 362 36.2 124 -87.80
Employees
per day
Output
(bottles/day)
Total revenue
($/day)
Profit
($/day)
Total cost
($/day)
MC =,15
MC =,10
MC =,20
MC =,33
MC =,44
MC =,60
MC = 1.00
Example 6.2
MB MC
Chapter 6,Perfectly Competitive Supply Slide 38
Profit-Maximizing Firms in Perfectly
Competitive Markets
A Note on the Firm’s Shutdown
Condition
When producing at a loss,a firm must
cover its variable cost to minimize losses.
Short-run shutdown condition
QVCP x Q of l ev el s al l for?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 39
Profit-Maximizing Firms in Perfectly
Competitive Markets
Average Variable Cost and Average
Total Cost
Average Variable Cost
Variable cost divided by total output
AVC=
Q
VC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 40
Profit-Maximizing Firms in Perfectly
Competitive Markets
Average Variable Cost and Average
Total Cost
Short-run shutdown condition
AVCP of v a l u e m i m i m u m?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 41
Profit-Maximizing Firms in Perfectly
Competitive Markets
Average Variable Cost and Average
Total Cost
Average Total Cost
Total cost divided by total output
ATC =
Q
TC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 42
Profit-Maximizing Firms in Perfectly
Competitive Markets
Average Variable Cost and Average
Total Cost
Profits = TR – TC
or =(P x Q) - (ATC x Q)
To be profitable,P > ATC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 43
Average Variable Cost and Average Total Cost of Bottle
Production
Employees
per day
0 0 0 40
1 80 12 0.150 52 0.650
2 200 24 0.120 64 0.320
3 260 36 0.138 76 0.292
4 300 48 0.160 88 0.293
5 330 60 0.182 100 0.303
6 350 72 0.206 112 0.320
7 362 84 0.232 124 0.343
Bottles
per day
Variable
cost
($/day)
Average
variable cost
($/unit of
output)
Total
cost
($/day)
Average
total cost
($/unit of
output)
0.15
0.10
0.20
0.33
0.40
0.60
1.00
Marginal
cost
($/bottle)
Q VC AVC TC ATC MC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 44
80 200 260 300
330 350
362
Upward-sloping MC
corresponds to
diminishing returns
MC = AVC & ATC
at their minimum
points
MC
The Marginal,Average Variable,and Average Total
Cost Curves for a Bottle Manufacturer
Co
st
($
/b
ott
le)
0.05
Output (bottles/day)
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
0.65
ATC
AVC
Zero-profit
point
Shut-down point
MB MC
Chapter 6,Perfectly Competitive Supply Slide 45
MC
ATC
AVC
Price = Marginal Cost,The Perfectly
Competitive Firm’s Profit-Maximizing Supply Rule
Output (bottles/day)
Co
st
($
/b
ottl
e)
0.07
160
0.10
0.12
0.15
0.20
0.25
0.30
0.33
0.35
200 260 300
Price
Less than 260 bottles/day P > MC and output should be increased
More than 260 bottles/day P < MC and output should be decreased
Profit maximizing
output,P = MC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 46
0.12
Price = MC at 260 bottles/day
ATC =,12/bottle
TR = (.20)(260) = $52/day
TC = (.12)(26) = $31.20/day
Profit = $52 - $31.20 = $20.80/day
0.20
260
Price
Price = Marginal Cost,The Perfectly
Competitive Firm’s Profit-Maximizing Supply Rule
Output (bottles/day)
Co
st
($
/b
ottl
e)
MC
ATC
AVC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 47
0.10
Price =,08/bottle
P = MC at 180 bottles/day
ATC =,10/bottle
P < ATC by,02/bottle
Profit = -.02 x 180 = -3.60//day
180
Price0.08
A Negative Profit
Output (bottles/day)
Co
st
($
/b
ottl
e)
MC
ATC
AVC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 48
Profit-Maximizing Firms in Perfectly
Competitive Markets
The Law of Supply
The perfectly competitive firm’s supply
curve is its marginal cost curve
Every quantity of output along the market
supply represents the summation of all the
quantities individual sellers offer at the
corresponding price
MB MC
Chapter 6,Perfectly Competitive Supply Slide 49
Profit-Maximizing Firms in Perfectly
Competitive Markets
The Law of Supply
At every point along the market supply
curve,price measures what it would cost
producers to expand production by one
unit.
Recall
Demand measures the benefit side of the
market
Supply measures the cost side of the market
MB MC
Chapter 6,Perfectly Competitive Supply Slide 50
RECAP (p156)
The perfectly competitive firm faces a
horizontal demand curve for its product----
--it can sell any quantity it wishes at the
market price.
In the short run,the firm’s goal is to
choose the the level of output that
maximizes its profit,It will accomplish this
by choosing the output level for which its
MC is equal to the market price of its
product,provided that price exceeds AVC
MB MC
Chapter 6,Perfectly Competitive Supply Slide 51
RECAP (p156)
The perfectly competitive firm’s
supply curve is the portion of its MC
curve that lies above its AVC curve.
At the profit-maximizing quantity,the
firm’s profit is (P-ATC) X Q.
MB MC
Chapter 6,Perfectly Competitive Supply Slide 52
Exercises
P162,review question 4
P163,problem 4
MB MC
Chapter 6,Perfectly Competitive Supply Slide 53
Homework
P165,9
MB MC
Chapter 6,Perfectly Competitive Supply Slide 54
Lecture 17 (2005.11.15)
P156— 161
Choices
MB MC
Chapter 6,Perfectly Competitive Supply Slide 55
RECAP
MC
ATC
AVC
P
Q
MB MC
Chapter 6,Perfectly Competitive Supply Slide 56
Determinants of Supply Revisited
Determinants of Supply
Technology
Input prices
Number of suppliers
Expectations
Changes in prices of other products
MB MC
Chapter 6,Perfectly Competitive Supply Slide 57
Applying the Theory of Supply
Economic Naturalist
When recycling is left to private market
forces,why are many more aluminum
beverage containers recycled than glass
ones?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 58
Applying the Theory of Supply
Example 6.4
What is the socially optimal amount of
recycling of glass containers?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 59
The Supply Curve of Container
Recycling Services for Burlington,Vermont
Number of containers recycled
(1,000s of containers/day)
Re
de
m
pti
on
s p
ric
e
(c
en
ts
/co
nta
ine
r)
6 10 13 16
6
3
2
1
1.5
15
Market supply curve of glass
container recycling services
60,000 citizens would
pay 6 cents for each
container which
equals marginal
benefit
The local government
pays 6 cents/container
The optimal quantity of
containers is 16,000/day
where MC(.06) = marginal
benefit
MB MC
Chapter 6,Perfectly Competitive Supply Slide 60
Applying the Theory of Supply
What do you think?
Will all containers be removed from the
environment at $0.06/container?
Why is the optimal amount of removal
16,000/day?
Will private individuals choose to remove
16,000 containers/day?
MB MC
Chapter 6,Perfectly Competitive Supply Slide 61
Supply and Producer Surplus
Producer Surplus
The amount by which price exceeds the
seller’s reservation price
MB MC
Chapter 6,Perfectly Competitive Supply Slide 62
The Supply and
Demand in the Market for Milk
Quantity (1,000s of gallons/day)
Pr
ice
($
/g
all
on
)
1
.50
1.00
1.50
2.00
2.50
3.00
2 3 4 5 6 7 8 9 10 11 120
S
D
Equilibrium P = $2 & Q = 4,000
Producer surplus is the difference
between $2 and the reservation
price at each quantity
Producer surplus =
(1/2)(4,000 gallons/day)($2/gallon)
= $4,000/day
MB MC
Chapter 6,Perfectly Competitive Supply Slide 63
Producer Surplus in the Market for Milk
Quantity (1,000s of gallons/day)
Pr
ice
($
/g
all
on
)
1
.50
1.00
1.50
2.00
2.50
3.00
2 3 4 5 6 7 8 9 10 11 120
Producer surplus
= $4,000/day
S
D
MB MC
End of
Chapter