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Chapter 6

Chapter 6 Full Notes

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ECON 1131
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Chapter 6: Supply and Marginal Cost  Supply: the amount of a product that a firm is willing and able to sell over a certain period of time Which Firms Have Supply Curves?  Different firms make their decisions about how much output they will supply to a market in very different ways  One important difference is that small, localized firms tend to operate in more competitive markets than do the giant corporations, which sell their products nationwide/internationally  Competitive market: a market in which a large number of firms sell very similar or identical products, consumers are well informed about the price that each firm charges for its product, and resources move easily into and out of the market in response to profits and losses  The market environment that giant corporations operate is often not very competitive in two respects: o (1) Afew large firms sometimes dominate the market and limit the options for consumers o (2) Resources do not always move easily in and out of markets dominated by large corporations  The market environment in which firms operate affects the nature of their economic problems Firms’Objectives  The assumption that firms strive to maximize profit applies much more accurately to the small, localized firms than to the giant corporation  Profits come more easily to the large national firms, on average, b/c they are more protected from competition  The giant corporation are interested in making a profit from their stockholders TheAbility to Control Price  The giant corporations determine the prices that they will charge for their products- they are price setters  Small, local firms generally have far less latitude in setting the prices of their products- tend to be price takers (firms or individuals that have no influence over the o Price is more nearly determined for them by the combined interaction of all consumers and all firms in the marketplace  Only highly competitive markets operate according to the Laws of Supply and Demand  Between 60-80% of all products are sold in markets that are competitive enough to be reasonably well modeled by the Laws of Supply and Demand  Competitive markets that operate according to the Laws of Supply and demand best satisfy society’s twin goals of efficiency and equity Supply and the Firm’s Economic Problems  The firm’s objective is to achieve the maximum amount of profit  The firm faces two sets of alternatives: o What to produce and in what amounts o How to product each product  The firm has three constraints: o The production technologies available to the firm for producing each product o The prices of the various factors of production associated with each technology o The demand for each product, which determines the price at which the firm can sell each product  The production technologies establish the physical link between the firm’s inputs and outputs. They indicate the amounts of various factors of production need to produce the quantities of each product supplied  The factor prices include the prices of various kinds of labor, the material inputs purchased from other firms. The factor prices along with chosen production technology, determine the total cost of producing whatever quantity of product the firm chooses to supply.  The price of the product determines the total revenue received for whatever quantity of the product the firm chooses to supply.  The prices of all other products the firm is capable of supplying determine the total revenue from supplying those products The Individual Firm’s Supply Curve  Individual firm’s supply schedule: the quantity that the firm is willing and able to supply at each price, ote  Individual firm’s supply curve: a graphical representation of the individual firm’s supply curve  Supply curves slope up and to the right, indicating that price and quantity supplied are directly related The Law of Supply  Law of Supply: ote, the lower the price of a product, the smaller the quantity supplied; the higher the price of a product, the larger the quantity supplied  Why must price rise in order to induce firms to supply more of a product?- the answer lies in the pattern of the typical firm’s cost of production, marginal cost  Marginal cost: the addition to total cost of producing an additional unit of output; in general, the change in total cost divided by the change in output  Marginal cost is directly relevant to the supply decision because firms compare price with marginal cost when deciding whether to increase output  Supply curves are upward sloping because of the cost of producing additional output (marginal cost) increases for most firms the more output the firm is already producing- have to charge higher prices to cover the higher costs Behind the Law of Supply: Solving the Firm’s Economic Problem  Proposition 1:A competitive, price taking firm’s supply curve is its marginal cost curve  Proposition 2:A competitive firm’s supply curve is expected to be upward sloping in the short run Proposition 1: Supply Curves and Marginal Cost  The firm knows what its total revenue is for every quantity that it chooses to sell, the only remaining question relates to the cost side of the profit relationship Individual Firm’s Demand Curve  The firms demand curve indicates, at every price, the total quantity demanded by all the firm’s customers. It lies somewhere between an individual consumer’s demand curve and the market demand curve  The market demand curve from the business’s perspective is called the industry demand curve Marginal Cost  Firm wants to know: what quantity maximizes profit (total rev-total cost)? o Answer depends on how cost increases as quantity increases  Marginal costs (MC) is defined as the change in total cost (TC) divided by the change in output (q) o MC=ΔTC/Δq  Marginal cost curve: a graphical representation of marginal cost, showing at each output the addition to total cost of producing an additional unit of output  Goal = *profit maximization* The Firm’s Best-profit Supply Rule  Supply rule for maximizing profit: a competitive, price-taking firm should produce the output at which price (marginal revenue) equals marginal cost The Marginal Benefit=Marginal Cost Principle  An activity should be continued to the point at which the marginal benefit of the activity equals the marginal cost of the activity  Marginal benefit: the additional benefit, in terms of the objectives, of the next unit of an activity  Cost = opportunity cost in economic analysis o If the benefit of the next unit of activity exceeds its cost, then the scare resources employed in the next unit of the activity are better used in that activity than elsewhere  The marginal benefit in this context is the marginal revenue: the increase in total revenue from selling one more unit of output; equal to price for a competitive firm  Equating price and marginal cost of producing and selling the product is the same as equating the marginal benefit and the marginal cost of that activity The Supply Curve as Marginal Cost Curve  The two are equivalent because of the price=marginal cost best profit supply rule  Asupply curve indicates the quantity the firm wants to supply at every price, with the objective of maximizing its profit Proposition 2: Supply Curves are Upward Sloping Short Run Versus the Long Run  Short run: period
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