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Intermediate Microeconomic Theory

Intermediate Microeconomic Theory. Market Supply. Market Supply. Similar to demand, market supply will simply be the summation of all the individual firm supply curves: Q s (p) = q 1 s (p) + q 2 s (p) +…+ q n s (p)

aphrodite-griffin
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Intermediate Microeconomic Theory

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  1. Intermediate Microeconomic Theory Market Supply

  2. Market Supply • Similar to demand, market supply will simply be the summation of all the individual firm supply curves: Qs(p) = q1s(p) + q2s(p) +…+ qns(p) • Also similar to demand, a price change can change amount supplied on both the intensive and extensive margin. • What is key to extensive margin?

  3. Market Supply • Given market supply curve, along with market demand curve, we can now define an equilibrium price. • Equilibrium price: the price that equates supply and demand in a given market (p* such that Qd(p*) = Qs(p) ). Qs(p) Qd(p)

  4. Price and Costs in Equilibrium • Note: all profit maximizing firms that are supplying output to a given market must be operating at p* = MC(qs(p*)). • So while each firm may have quite different cost functions, all must have the same cost of producing their last unit of output. • Therefore, in perfect competition, the price consumers pay for a good equals the cost (including opportunity costs) firms must incur to bring the marginal good to the market.

  5. Economic Profits When does it make sense to enter a given industry?

  6. Economic Profits • Example: Should Lisa enter the tea business? • To do so, she needs gallon sized tea kettle ($20). • For each cup of tea she supplies, she needs 1 tea bag ($0.49/bag) • However, in making tea she gets tired, meaning the amount of tea she can make in a month is given by the production function q = 10L0.5 (L is hrs of her time). • When she isn’t making iced tea, she can work at Moe’s bar for $5hr. (paid at the end of each month) • Any money she doesn’t put into the business, she loans to Barney at a monthly interest rate of 2%. • Lisa gets her tea via mail order, which she has to pay for on the first of each month. • Suppose the going price for tea in Springfield is $3/cup. • What are Lisa’s monthly economic profits from this business? What does this say about whether she should enter?

  7. Economic Profits • How would her economic profit change if she could lend to Barney at an interest rate of 0.53/month?

  8. Market Supply in the Long-run • How will things change over the longer-run? • Think of the market demand/market supply graph. What is aggregate profit in graph? • What if there are a bunch more individuals like Lisa out there (specifically, Lisa with the lower return on her savings)?

  9. Market Supply in the Long-run • So how will Industry Supply curve change over the long-run? Why? • So what is long-run shape? • Where will it lie? • What does this mean about (economic) profits in a competitive market in the long-run?

  10. Profits in the Long-run • So in short-run there are positive economic profits (or “rents”), but if there is “free-entry” the industry operates at zero (economic) profits in the long-run. • However, it is still rational for suppliers to continue using resources to produce and supply goods to the market they are in (accounting profits are strictly positive) • Zero “economic” profits simply means that there are no excess returns to be had by allocating further resources and inputs into that market. • In the end, this is what venture capital and entrepreneurism is all about---finding a market niches that allow for (possibly “short-term”) excess returns (i.e. economic profits).

  11. Profits in the Long-run • How does selection from “Free: The Future of the Radical Price” relate to this discussion?

  12. Costs and Benefits of Competition • Our theory of the firm reveals the costs and benefits of competition. • Benefits? • Costs?

  13. Economic Rent • So economic profits in the short-run are part of our theory (essentially come from innovation and cost saving choices) • But how do we explain firms in mature industries making seeming economic rents (i.e. Exxon Mobil, Haliburton)? • Assumption of free-entry in the long-run fails because some factor is fixed orlimited. • There are a fixed number of functioning oil wells. • Provision of services to military awarded by government contract only • Any constraint that leads to a fixed number of suppliers. • Why are such barriers to entry so valuable?

  14. Rent setting • The implicit “value” of the fixed factor is what we call “economic rent”. • How is one of these assets that earns economic rent valued? • Consider a contract to supply troop meals in Afghanistan. • Contract will pay $1 million and requires meals 21 meals/day for 300K troops for 40 weeks. • Cost function is c(q) = q/300 • What will a company pay up to in order to win this contract?

  15. Rent Seeking • So we can see why millions are spent each year lobbying by firms or individuals in an attempt to somehow constrain entry into an industry. • Positive economic profits can be made if free-entry is limited. So, it might make sense for firms to pay lots of money to lobby for entry barriers. • Often called “rent seeking”. • Examples: • Limits on medical school slots • hair cutting licenses • zoning restrictions • Agricultural subsidies • Military contracts

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