EC202_Lecture_8

Page 1: Lecture Introduction

• Course: EC 202 Intermediate Microeconomics

• Lecture: 8

• Semester: Autumn 2024

• Coverage: Chapter 24 from Varian

Page 2: Marking Criteria

• Assessment components:

  • A. Autumn Multiple Choice (Coursework)

  • B. Test in February (Coursework)

  • C. Summer Final Exam

Page 3: Recap of Previous Lecture

• Topic: Profit Maximization for Individual Firms

• Key concepts discussed:

  • Derivation of firm’s supply curve from marginal cost curve

  • Definition of shutdown point as the minimum average cost

  • Unconditional demands for factors

  • Assessment of substitution and output effects due to changes in factor prices

• Keywords:

  • Profit function

  • Supply curve

  • Economic average cost

  • Unconditional demand for factors

Page 4: Lecture Outline

• Conditions for existence of competitive markets

• Market equilibrium in short run

• Economic profit and producer surplus

• Market equilibrium in long run

• Evidence on market dynamics

• Market equilibrium with heterogeneous firms

• Economic rent

• Extra topics: Multi-product firms, Multi-plant firms

Page 5: Definition of Perfectly Competitive Market

• Characteristics:

  • Identical products produced by firms

  • Individual firm’s output is small relative to overall market demand, having no impact on market price

Page 6: Formal Assumptions of Perfect Competition

• Main assumptions:

  • Firms produce undifferentiated products perceived as identical

  • Consumers possess perfect information about seller prices

  • Buyer’s purchases are too small to affect market price

  • Seller’s sales do not impact market price and input purchases are unaffected

  • Equal access to resources (technology, inputs) for all firms

Page 7: Implications of Perfect Competition

• Law of One Price:

  • Single price resulting from assumptions of identical products and perfect information

• Price Takers:

  • Buyers/sellers accept the market price when making decisions

• Free Entry:

  • Identical long-run cost functions for all firms

Page 8: Short-Run Equilibrium in Perfectly Competitive Market

• Topics covered:

  • Transition from individual supply functions to market supply curve

  • Determining market equilibrium

  • Understanding economic profit and producer surplus

• Note: Number of firms is fixed in the short run

Page 9: Transition from Individual Supply to Market Supply

• Market supply function computation:

  • Formula: !"(P) = ∑ᵢ 𝑠ᵢ(P)

  • For identical firms: !"(P) = n × s(P)

Page 10: Continuation of Market Supply Function

• Emphasis on identical production:

  • Market supply function reflects horizontal addition of individual supply curves

Page 11: Graphical Representation of Supply

• Graph illustrating:

  • Individual firm's supply and industry supply

Page 12: Market Equilibrium Illustration

• Diagram:

  • Intersection of demand (QD) and supply (QS) curves

• Price (P*) and output (Q*) levels shown

Page 13: Definition of Producer Surplus

• Producer Surplus:

  • Area above market supply curve and below market price

  • Monetary benefit to producers from product sales

  • Each unit sold incurs short-run marginal cost

Page 14: Visual Representation of Producer Surplus

• Graph depicting producer surplus relative to individual firm and market

Page 15: Include Fixed Costs in Producer Surplus

• Importance:

  • In short run, fixed costs are not opportunity costs

  • Thus, producer surplus reflects short-run economic profit instead of accounting profit

Page 16: Example Deriving Short-Run Market Equilibrium

• Scenario: 300 identical firms

• Supply and demand functions provided

• Inquiry on short-run equilibrium and profits

Page 17: Continuation of Example

• Further elaboration on 300 identical firms with focus on equilibrium determination

Page 18: Example Solution for Short-Run Equilibrium

• Profit maximization condition:

  • P = MC

• Equations setup for calculation

Page 19: Continued Calculation for Short-Run Equilibrium

• Clarification on equations for equilibrium determination

Page 20: Positive Profits at Market Equilibrium

• Calculation outline for per-firm profit and producers’ surplus evaluated

Page 21: Long-Run Equilibrium in Perfect Competition

• Analysis of long-run individual supply with homogeneous firms

Page 22: Long-Run Market Supply Curve Definition

• Definition:

  • Total quantity of output supplied at various market prices considering long-run adjustments

Page 23: Deriving Long-Run Market Supply Curve

• Explanation of individual supply curve contributions

• Note: Number of firms is flexible in long run

Page 24: Conceptual Graph of Long-Run Equilibrium

• Price levels and profit conditions relevant to firms

Page 25: Free Entry and Long-Run Supply for Identical Firms

• Mechanisms:

  • Entry of firms as long as profits are positive

• Description of market equilibrium conditions

Page 26: Dynamics of Market Conditions

• Profit conditions and implications for entry and exit among firms

Page 27: Additional Graph: Free Entry and Long-Run Equilibrium

• Visual representation showing firm and market interactions

Page 28: Example: Calculating Long-Run Equilibrium

• Function: !"(Q) = 40Q – Q² + 0.01Q³

• Inquiry for equilibrium output, price, and firm count

Page 29: Continued Example Calculation

• Additional steps provided for equilibrium determination and solutions outlined

Page 30: Further Breakdown of Long-Run Example

• Detailed calculations including minimal points and total outputs

Page 31: Summary of Long-Run Equilibrium Equations

• Conditions for equilibrium outlined for clarity

Page 32: Derivation of Long-Run Equilibrium

• Solved for crucial relationships and equilibrium parameters

Page 33: Evidence of Market Dynamics in US Manufacturing

• Observation of entry and exit trends in firms

Page 34: Free Entry with Heterogeneous Firms

• Analysis of firm types with cost discrepancies

Page 35: Supply Functions with Low-Cost Firms

• Methodology to construct supply functions for equilibrium determination

Page 36: Market Dynamics with Low-Cost and High-Cost Firms

• Discussion on market equilibrium impacts of varying firm costs

Page 37: Graphical Illustration of Market Supply Dynamics

• Indication of market equilibrium transition showing profit distributions

Page 38: Economic Profit and Economic Rent

• Discussion of source of profits among high-cost firms

Page 39: Premium Charged by Landowners

• Explanation of how the economic rent arises and impacts firms

Page 40: Definition of Economic Rent

• Clarification of terms related to economic rent and profit context

Page 41: Challenge of Multi-product Firms

• Analysis of assumptions about product offerings

Page 42: Demand and Production Links

• Importance of understanding both demand-side and production-side links

Page 43: Focus on Production Links

• Concentration on cost impacts tied to production decisions

Page 44: Economies of Scope

• Definition:

  • Cost advantages in producing multiple products via a single firm

Page 45: Instances of Economies of Scope

• Examples of how economies of scope manifest in various industries

Page 46: Structure of Multi-plant Firms

• Overview of multi-plant operational structures and cost functions

Page 47: Profit Function Overview

• Expression of profit calculation in multi-plant structures

Page 48: Marginal Cost Equalization Across Plants

• Explanation of the cost-determination principle

Page 49: Additional Plant Dynamics

• Summary of profit distribution over multiple plants

Page 50: Using Limited Plant Number for Output

• Discussion on implications of operational choices regarding plant usage.