Firm Supply

1. Firm Supply

2. Firm Supply • How does a firm decide how much product to supply? This depends upon the firm’s • technology • market environment • competitors’ behaviors

3. Market Environments • Are there many other firms, or just a few? • Do other firms’ decisions affect our firm’s payoffs?

4. Market Environments • Monopoly: Just one seller that determines the quantity supplied and the market-clearing price. • Oligopoly: A few firms, the decisions of each influencing the payoffs of the others.

5. Market Environments • Dominant Firm: Many firms, but one much larger than the rest. The large firm’s decisions affect the payoffs of each small firm. Decisions by any one small firm do not noticeably affect the payoffs of any other firm.

6. Market Environments • Monopolistic Competition: Many firms each making a slightly different product. Each firm’s output level is small relative to the total. • Pure Competition: Many firms, all making the same product. Each firm’s output level is small relative to the total.

7. Market Environments • Later chapters examine monopoly, monopolistic competition, oligopoly, and the dominant firm. • This chapter explores only pure competition.

8. Pure Competition • A firm in a perfectly competitive market knows it has no influence over the market price for its product. The market price is independent of its own product decisions. The firm is a marketprice-taker. • It only has to decide how much to produce. Any quantity produced by the firm can be sold at the market price.

9. Pure Competition • Purely competitive markets are markets where typically there is an homogenous good produced by many competing firms.

10. Pure Competition • The firm is free to vary its own price. • If the firm sets its own price above the market price then the quantity demanded from the firm is zero. • If the firm sets its own price below the market price then the quantity demanded from the firm is the entire market quantity-demanded.

11. Pure Competition • So what is the demand curve faced by the individual firm? • The demand curve facing the firm gives the relationship between the price set by the firm and the amount of output it sells. It differs from the market demand curve, since the latter just depends on the consumer’s behavior, while the demand curve facing the curve depends also on the actions of the competing firms.

12. Pure Competition €/output unit Market Supply pe Market Demand Y

13. Pure Competition €/output unit Market Supply p’ At a price of p’, zero is demanded from the firm. pe Market Demand y

14. Pure Competition €/output unit Market Supply p’ At a price of p’, zero is demanded from the firm. pe p” Market Demand y At a price of p” the firm faces the entire market demand.

15. Pure Competition • So the demand curve faced by the individual firm is ...

16. Pure Competition €/output unit Market Supply p’ At a price of p’, zero is demanded from the firm. pe p” Market Demand y At a price of p” the firm faces the entire market demand.

17. Pure Competition €/output unit p’ pe p” Market Demand Y

18. Smallness • What does it mean to say that an individual firm is “small relative to the industry”?

19. Smallness €/output unit Firm’s MC Firm’s demand curve pe y The individual firm’s technology causes italways to supply only a small part of the total quantity demanded at the market price.

20. The Firm’s Short-Run Supply Decision • Each firm is a profit-maximizer and in a short-run. • Q: How does each firm choose its output level?

21. The Firm’s Short-Run Supply Decision • Each firm is a profit-maximizer and in a short-run. • Q: How does each firm choose its output level? • A: By solving

22. The Firm’s Short-Run Supply Decision What can the solution ys* look like?

23. The Firm’s Short-Run Supply Decision What can the solution ys* look like?ys* > 0 (interior case): P(y) ys* y

24. The Firm’s Short-Run Supply Decision For the interior case of ys* > 0, the first-order maximum profit condition is That is, So at a profit maximum with ys* > 0, themarket price p equals the marginalcost of production at y = ys*.

25. The Firm’s Short-Run Supply Decision • If p < MC(y) then the firm is spending more money in producing the last unit of output sold than it gets from selling it. Thus, the firm would be better-off by reducing output. • If p > MC(y) then the firm is getting more money for its output than the cost incurred to produce it. So, the firm can increase its profits by increasing production until the rule of price equal to marginal cost is satisfied.

26. The Firm’s Short-Run Supply Decision • The rule p = MC(y) is necessary but not sufficient for profit-maximization.

27. The Firm’s Short-Run Supply Decision For the interior case of ys* > 0, the second-order maximum profit condition is That is, So at a profit maximum with ys* > 0, thefirm’s MC curve must be upward-sloping.

28. The Firm’s Short-Run Supply Decision €/output unit pe MCs(y) y’ ys* y

29. The Firm’s Short-Run Supply Decision At y = ys*, p = MC and MCslopes upwards. y = ys* is profit-maximizing. €/output unit pe MCs(y) y’ ys* y At y = y’, p = MC and MC slopes downwards.y = y’ is profit-minimizing.

30. The Firm’s Short-Run Supply Decision At y = ys*, p = MC and MCslopes upwards. y = ys* is profit-maximizing. So a profit-max. supply level can lie only on the upwards sloping part of the firm’s MC curve. €/output unit pe MCs(y) y’ ys* y

31. The Firm’s Short-Run Supply Decision • The supply curve of a competitive firm must always be upward sloping.

32. The Firm’s Short-Run Supply Decision • But not every point on the upward-sloping part of the firm’s MC curve represents a profit-maximum.

33. The Firm’s Short-Run Supply Decision • But not every point on the upward-sloping part of the firm’s MC curve represents a profit-maximum. • The firm’s profit function is • If the firm chooses y = 0 then its profit is

34. The Firm’s Short-Run Supply Decision • So the firm will choose an output level y > 0 only if

35. The Firm’s Short-Run Supply Decision • So the firm will choose an output level y > 0 only if • I.e., only ifEquivalently, only if

36. The Firm’s Short-Run Supply Decision €/output unit MCs(y) ACs(y) AVCs(y) y

37. The Firm’s Short-Run Supply Decision €/output unit MCs(y) ACs(y) AVCs(y) y

38. The Firm’s Short-Run Supply Decision p > AVCs(y) ys* > 0. €/output unit MCs(y) ACs(y) AVCs(y) y

39. The Firm’s Short-Run Supply Decision p > AVCs(y) ys* > 0. €/output unit MCs(y) ACs(y) AVCs(y) y p < AVCs(y) ys* = 0.

40. The Firm’s Short-Run Supply Decision p > AVCs(y) ys* > 0. €/output unit MCs(y) ACs(y) AVCs(y) The firm’s short-runsupply curve y p < AVCs(y) ys* = 0.

41. The Firm’s Short-Run Supply Decision €/output unit Shutdown point MCs(y) ACs(y) AVCs(y) The firm’s short-runsupply curve y

42. The Firm’s Short-Run Supply Decision • The shut-down condition says that when the revenue from the sale does not even cover the variable costs then the firm is better-off by not producing. • So, the short-run supply curve of a competitive firm corresponds to the portion of the MC curve that lies above the AVC curve.

43. The Firm’s Short-Run Supply Decision • Shut-down is not the same as exit. • Shutting-down means producing no output (but the firm is still in the industry and suffers its fixed cost). • Exiting means leaving the industry, which the firm can do only in the long-run.

44. The Firm’s Long-Run Supply Decision • The long-run is the circumstance in which the firm can choose amongst all of its short-run circumstances. • How does the firm’s long-run supply decision compare to its short-run supply decisions?

45. The Firm’s Long-Run Supply Decision • A competitive firm’s long-run profit function is • The long-run cost c(y) of producing y units of output consists only of variable costs since all inputs are variable in the long-run.

46. The Firm’s Long-Run Supply Decision • The firm’s long-run supply level decision is to • The 1st and 2nd-order maximization conditions are, for y* > 0,

47. The Firm’s Long-Run Supply Decision • Additionally, the firm’s economic profit level must not be negative since then the firm would exit the industry. So,

48. The Firm’s Long-Run Supply Decision €/output unit MC(y) AC(y) y

49. The Firm’s Long-Run Supply Decision €/output unit MC(y) p > AC(y) AC(y) y

50. The Firm’s Long-Run Supply Decision €/output unit MC(y) p > AC(y) AC(y) y