YH

Sellers and Incentives

SELLERS AND INCENTIVES

  • Source: Copyright © 2022, 2018, 2014 Pearson Education, Inc. All Rights Reserved

SELLERS IN A PERFECTLY COMPETITIVE MARKET

  • A perfectly competitive market has specific conditions:
    • No buyer or seller is large enough to influence the market price.
    • Sellers produce identical goods.
    • There is free entry and exit in the market.

NO ONE SELLER TO RULE THEM ALL

  1. Influence on Market Price
    • There are so many consumers and producers that no single individual can affect the market price with their behavior.
    • Example: One corn farmer choosing to grow corn over soybeans does not cause price fluctuations. However, if every farmer decides to do similarly, that could result in dramatic price changes.

SAME GOODS, SAME PRICE

  • Homogenous Goods: Sellers produce identical goods, known as commodities.
  • Influence on Pricing:
    • An individual seller cannot change the market price by selling a unique product.
    • Example: If all bushels of corn are the same, a farmer cannot charge a higher price for their corn since many other farmers offer the same product.

COPING WITH BEING A PRICE TAKER

  • Investment in Grain Storage:
    • Many farmers invest in grain storage to avoid being price takers.
    • Storage allows farmers to control the timing of their sales and wait for better prices.

EASY COME, EASY GO

  1. Free Entry and Exit
    • Sellers can respond to potential profits by entering markets or exiting unprofitable ones.
    • Market implications: If many firms leave a market, the supply curve will shift, which will result in an increase in market price.

SELLERS' PROBLEM: WHAT AND HOW MUCH TO PRODUCE

  • Goal of the Seller: Maximize profit.
  • To achieve this goal, sellers must resolve three questions:
    1. How to make the product?
    2. What is the cost of making the product?
    3. How much can the seller sell the product for in the market?

COOKING UP PRODUCTION

  • Making the Product: Involves the conversion of inputs into outputs.

FROM INGREDIENTS TO FINISHED GOODS

  • Production: The process that transforms inputs (e.g., labor, machines) into outputs (e.g., goods, services).
  • Production Function: The mathematical relationship between the quantity of inputs used and the quantity of outputs produced.
  • Physical Capital: Any good used for production, including machines and buildings.

THE ECONOMIC DEFINITION OF SHORT RUN

  • Short Run: A time period when at least one of the firm's inputs cannot be changed.
    • Example: A bakery cannot instantly add another oven.
    • Example: A farmer cannot suddenly acquire more land in the short run.
    • Other inputs, like hiring more workers, can change in this period.

THE ECONOMIC DEFINITION OF LONG RUN

  • Long Run: A period where all inputs can be adjusted.
    • Example: In the long run, the firm can buy another oven or build another kitchen.

VARIABLE VS. FIXED: THE FACTORS OF PRODUCTION

  • Variable Factor of Production: An input that can change over a period of time and changes when the level of output changes.
  • Fixed Factor of Production: An input that cannot change in the short run and remains constant regardless of output levels.

CHEESE, WORKERS, AND OUTPUT: THE DATA BEHIND PRODUCTION

  • Production Data for The Wisconsin Cheeseman:
    • Recorded output per day, number of workers, and marginal product corresponding to each worker added lay within a structured table which includes multiple values.

UNDERSTANDING MARGINAL PRODUCT

  • Marginal Product: Defined as the change in total output associated with using one additional unit of input.

SPECIALIZATION: EARLY HIRES BRING BIG GAINS

  • Efficiency Through Specialization: Marginal product tends to increase with the initial workforce. Workers are more efficient when they specialize and collaborate.

WHEN THE CHEESE ROOM GETS CROWDED

  • Diminishing Returns:
    • Marginal product decreases after a certain level of utilization.
    • Law of Diminishing Returns: Each additional worker contributes less output than the previous one due to production bottlenecks when capital is fixed.
  • Point of Diminishing Returns: Observed with the addition of 4 workers.

WHEN MORE WORKERS = LESS OUTPUT

  • Negative Marginal Product: If more workers are added in a short-run context where capital is fixed, output could decrease due to inefficiencies.

THE SELLER'S PROBLEM (SHORT-RUN PRODUCTION FUNCTION)

  • A detailed breakdown of production functions examining the marginal product linked to workforce numbers and output, demonstrating relationships between workers and output results.

COSTS OF PRODUCTION

  • Incurred Costs: Firms using inputs incur production costs,
  • Total Cost: Defined mathematically as:
    Total Cost = Variable Cost + Fixed Cost

FIXED VS. VARIABLE COST

  • Variable Cost (VC): Cost associated with variable factors of production, changes with output levels.
  • Fixed Cost (FC): Costs associated with fixed factors that remain unchanged regardless of output, also known as overhead.

AVERAGE COSTS EXPLAINED

  • Average Total Cost (ATC): Calculated as total cost divided by total output.
  • Average Variable Cost (AVC): Calculated as variable cost divided by total output.
  • Average Fixed Cost (AFC): Calculated as fixed cost divided by total output.
  • Formula:
    Total Cost/Q = Variable Cost/Q + Fixed Cost/Q

UNPACKING THE COST TABLE

  • Analysis of production costs using empirical data for The Wisconsin Cheeseman, focusing on fixed costs, variable costs, and total costs.

UNDERSTANDING MARGINAL COST

  • Marginal Cost (MC): Change in total cost associated with the production of one additional unit of output.
  • Example of the Cheeseman's operations to illustrate how marginal cost translates to production profitability and operational efficiency.

MARGINAL COST AND AVERAGE COST DYNAMICS

  • A visual representation of cost dynamics across a range of produced goods detailing movements between MC, ATC, and AVC curves.

TEST YOUR UNDERSTANDING: WOULD YOU TAKE THE $70?

  • A scenario analyzing decision-making around accepting or declining offers below average costs when managing resources in short-run production environments.

IF THE VARIABLE COST IS HIGHER THAN WHAT'S BEING OFFERED

  • Decision analysis based on revenue levels versus cost thresholds including insights on opportunity costs when evaluating shutting down operations temporarily versus continuing production.

SOLVING THE SELLER'S PROBLEM

  • Breakdown of issues centered on determining what quantity of product to produce, including motivations for profit maximization and the implications of revenue on decision-making.
  • Revenue: Amount of money generated from product sales, expressed as Total Revenue = Price imes Quantity Sold.

MARGINAL REVENUE IN A COMPETITIVE MARKET

  • In competitive markets, marginal revenue derived from production aligns closely with market pricing, capturing the essence of economic interactions at the firm level.

CALCULATING MARGINAL REVENUE FOR A PRICE-TAKING FIRM

  • An issue-solving approach demonstrating means of computing marginal revenue and its effects on total revenue from product sales based on competitive pricing structures.

PROFIT MAXIMIZATION: THE SELLER'S ULTIMATE GOAL

  • The ultimate objective for sellers remains profit maximization captured by the formula:
    ext{Profit} = ext{Total Revenues} - ext{Total Costs}.

CORN VS. SOYBEANS: ACCOUNTING PROFIT OR ECONOMIC PROFIT?

  • Discussion comparing profits in agricultural scenarios of corn and soybean production, focusing on differentiated profit perspectives between accountant and economist views.

ACCOUNTING PROFIT VS. ECONOMIC PROFIT

  • Accounting Profit: Total revenue minus total costs (explicit costs only).
  • Economic Profit: Total revenue minus total costs (explicit and implicit).

OPPORTUNITY COSTS AND ECONOMIC PROFIT

  • Opportunity costs contextualized within income metrics and economic profit scenarios, examining what constitutes implicit costs and their influence on overall profitability measures.

MOVEMENT OF PRODUCTION TOWARD EQUILIBRIUM

  • Illustration depicting the movements in production efficiency relative to price points in market equilibrium, coupled with visual indicators of marginal revenue.

THE PROFIT-MAXIMIZING RULE FOR PERFECT COMPETITION

  • A walk-through on maximizing profits by ensuring production extends to the point where marginal revenue aligns with marginal cost, elucidating the price relationship in competitive markets.

STEPS TO COMPUTE ECONOMIC PROFITS

  • A structured methodology detailing how to assess economic profits, starting from determining optimal production quantity to calculating profit levels based on price and average total cost interactions.

PROFIT FORMULA: THE KEY RELATIONSHIP

  • A recap of the relationships among total revenue, total costs, and sustainability of profits metrics utilized in economic profit calculations.

PUTTING IT ALL TOGETHER: ECONOMIC PROFIT EXPLAINED

  • Consideration of whether economic profits genuinely signify additional economic viability above alternative resource allocations based on opportunity costs.

FROM SELLER'S PROBLEM TO THE SUPPLY CURVE

  • Discussion of transitioning from the theoretical seller's challenges to practical implications on market supply dynamics.

PRICE CHANGES AND OUTPUT DECISIONS

  • Explores how price fluctuations influence firm decisions on quantity supplied, articulating the complexities of adjusting production levels.

PRICE ELASTICITY OF SUPPLY

  • Defines elasticity as responsiveness to shifts in market pricing, emphasizing how producers react to price enhancements through changes in supplied quantity.

ELASTICITY FORMULA & SIGN

  • Describes the positive nature of price elasticity of supply (εs) as quantity increases alongside price rises, providing foundational understanding for elasticity calculations.

TYPES OF SUPPLY ELASTICITY

  • Classification of elasticity types, explaining:
    • Elastic Supply: (εs > 1) – Highly responsive quantity adjustments.
    • Inelastic Supply: (εs < 1) – Less responsive to price changes.
    • Unit-Elastic Supply: (εs = 1) – Equal percentage change in both price and quantity.

DETERMINANTS OF SUPPLY ELASTICITY

  • Analysis of critical factors influencing elasticity, including inventory levels, labor flexibility, and time horizons.

CORNFIELD COST DILEMMA

  • A scenario exploring the financial decisions farmers face at harvest involving cost analysis of production against market prices, prompting considerations around operational efficiencies and market conditions.

STAY OPEN OR SHUT DOWN?

  • Options available to firms given economic distress: evaluating fixed and variable costs during shutdown scenarios.

SHUTDOWN RULE

  • Conditions under which firms should cease operations temporarily defined by revenue failing to meet average variable costs.

SHORT-RUN SUPPLY CURVE OF A FIRM IN A PERFECTLY COMPETITIVE MARKET

  • Insights into the structure of the short-run supply curve shaped by the marginal cost curve that operates above the average variable cost curve.

SURPLUS, SCALE, AND LONG-RUN BALANCE

  • Discussion about producer surplus, price changes, and the implications for market supply dynamics within competitive frameworks.

PRODUCER SURPLUS

  • Computation and significance of producer surplus articulated around the difference between market pricing and the production willingness price, calculated graphically.

HOW PRICE CHANGES AFFECT PRODUCER SURPLUS

  • Visual analyses of supply surpluses and the responsiveness of trucking services in markets.

FROM SHORT RUN TO LONG RUN

  • Understood as the transition elasticity of production outputs emphasizing flexibility and changes in production capacities over time.

LONG RUN: THE BIG PLANNING STAGE

  • Long-run decision-making focuses on optimal capital and expansive planning across the production spectrum.

ECONOMIES OF SCALE

  • Defined as average total costs (ATC) decreasing as output increases, facilitating expanded production efficiencies under specific operational conditions.

CONSTANT RETURNS TO SCALE

  • Reasserting when ATC remains constant despite output fluctuations, showcasing stabilized productivity gains.

DISECONOMIES OF SCALE

  • Clarifies conditions under which ATC rises with increased output due to structural inefficiencies from over extension.

SHORT-RUN VS. LONG-RUN COST CURVES

  • Illustrates the relationships and divergences between short-run and long-run cost estimations affecting firm capacities and output decisions.

LONG RUN: FIRMS CAN ENTER OR EXIT AN INDUSTRY

  • Analysis of agricultural decisions illustrating market-driven choices surrounding resource allocation and the effects of firm entry into markets.

PROFITS ATTRACT NEW FIRMS WHEN THERE IS NO BARRIER TO ENTRY

  • Acknowledges how profitability draw in new entrants, shifting supply dynamics and affecting market pricing structure.

HOW NEW FIRMS SHIFT SUPPLY AND PRICES

  • Explores the effects on market equilibria resulting from transitions in firm counts and how they influence pricing strategies.

FREE ENTRY KEEPS PROFITS IN CHECK

  • Examines how open market access and increasing competition regulate price levels back towards equilibrium, impacting profits.

WHY ZERO ECONOMIC PROFIT = MARKET EQUILIBRIUM

  • Defines equilibrium conditions where firms make no economic profit despite accounting profits due to competitive market dynamics.

WHAT HAPPENS WHEN THE MARKET GETS FLOODED?

  • Addresses market responses as external factors affect supply chains, emphasizing farmer resiliency in production choices under shifting economies.

WHEN PROFITS TURN NEGATIVE

  • Examines scenarios wherein firm profits fall below break-even, analyzed through comparative agricultural scenarios.

EXIT AND SUPPLY SHIFT: HOW MARKETS SELF-CORRECT

  • Discusses how firm exits during downturns naturally self-correct market supply issues and return to equilibrated conditions efficiently.

WHY THE LONG-RUN SUPPLY CURVE IS HORIZONTAL

  • Rationalizes the structure of the long-run supply curve, grounding this assertion in market conditions that promote equality of average total costs.

ETHANOL SUBSIDIES AND PRODUCERS

  • Considers the implications of policy decisions such as subsidies on producer behavior and how they affect overall market dynamics.

EVIDENCE-BASED ECONOMICS

  • Snapshot of industry dynamics showcasing statistical assessments of existing and upcoming production facilities.