Transcript ECON 1001 AB Introduction to Economics I Dr. Ka

Chapter 6
Perfectly Competitive Supply:
The cost side of the market
Odd-numbered Qs.
Q.3, 9 Please refer to “tutorial materials”
Problem #1, Chapter 6 (1)
• Zoe is trying to decide how to divide her time between her job
as a wedding photography, which pays $27 per hours for as
many hours as she chooses to work, and as a fossil collector,
in which her pay depends both on the price of fossils and the
number of them she finds. Earnings aside, Zoe is indifferent
between the two tasks, and the number of fossils she can find
depends on the number of hours a day she researches, as
shown in the table below.
Problem #1, Chapter 6 (2)
Hours per day
Total fossils per day
1
5
2
9
3
12
4
14
5
15
Solution to Problem #1 (1)
• Derive a table with a price in dollar increments from $0 to $30
in the first column and the quantity of fossils Zoe is willing to
supply per day at that price in the second column
Solution to Problem #1 (2)
• In the first hour, Zoe can collect 5 fossils
• If the price of a fossil is $5, Zoe can make a total $25 in an
hour if she devotes all her time to collecting fossils, which is
less than the money she can earn from photography
• Thus, she won’t collect fossil if the price of a fossil is less than
$5
• If the price of a fossil is $6 Zoe should devote all her time to
photography, as she can make $30 an hour from photography
Solution to Problem #1 (3)
• An additional hour would yield only 4 additional fossils or $24
additional revenue, so she should not spend any further time
looking for fossils
• If the price of fossils rises to $7, however, the additional hour
gathering fossils would yield an additional $28, so gathering
fossils during that hour would then be the best choice, and
Zoe would therefore supply 9 fossils per day
Solution to Problem #1 (4)
Price of fossils ($)
# of fossils supplied / day
0–5
0
6
5
7, 8
9
9 – 13
12
14 – 26
14
27+
15
Solution to Problem #1 (5)
• Plot these points in a graph with price on the vertical axis and
quantity per day on the horizontal. What is this curve called?
• The curve will depict a price-quantity supplied relationship for
fossils as follows
• In other words, it is SUPPLY CURVE for fossils
Solution to Problem #1 (6)
Zoe's Supply Curve for Fossils
Price ($/fossil)
35
30
25
20
15
10
5
0
0
5
10
Nu mb er o f fo ssils
15
20
Problem #5, Chapter 6
• The supply curve for the only two firms in a competitive
industry are given by P=2Q1 and P= 2+Q2, where Q1 is the
output of firm 1 and Q2 is the output of firm 2. What is the
market supply curve for this industry? (Hint: graph the two
curves side by side, then add their respective quantities at a
sample of different prices.)
Solution to Problem #5 (1)
• Horizontal summation means holding price fixed and adding
the corresponding quantities
Firm 1
P
P =2Q1
6
Market supply curve
Firm 2
P
P =2+Q2
6
P
S
6
P= (4/3) + (2/3)Q for P>2
4
4
4
2
2
2
Q1
1
2
3
Q2
2
4
P= 2Q for P<2
1
4
Q
7
Problem #7, Chapter 6
• For the pizza seller whose marginal, average variable, and
average total cost curves are shown in the accompanying
diagram, what is the profit-maximizing level of output and
how much profit will this producer earn if the price of pizza is
$2.50 per slice?
Solution to Problem #7 (1)
Price ($/slice)
MC
2.50
ATC
AVC
1.40
0
570
Quantity (slices/day)
Solution to Problem #7 (2)
Price ($/slice)
MC
ATC
2.50
AVC
1.40
0
570
Quantity (slices/day)
Wrong! MC cuts ATC at its minimum.
Solution to Problem #7 (3)
Price ($/slice)
MC
ATC
2.50
AVC
1.40
0
570
Quantity (slices/day)
Wrong! MC cuts AVC at its minimum.
Solution to Problem #7 (4)
Price ($/slice)
MC
ATC
2.50
AVC
1.40
0
570
Quantity (slices/day)
Wrong! AVC and ATC approaches each other as quantity increases.
Solution to Problem #7 (5)
• Assume it is a perfectly competitive market
• Firms are earning a zero economic profit
• Firms should always charge at a price that is equal to their
marginal cost
Solution to Problem #7 (6)
• If P > ATC > AVC, the firm operates with a profit
• If ATC > P > AVC, the firm still operates but with a loss- the
operation can cover part of its fixed cost
• If ATC > AVC > P, the firm should shut down as it cannot even
cover part of its fixed cost
Solution to Problem #7 (7)
• To maximize profit, the firm will produce 570 slices of pizza a
day
• Why?
• At 570 slices of pizza per day, the difference between the
marginal cost (MC) and the average total cost (ATC) is
maximized
• The associated profit is (P or MC – ATC)*Q
– ($2.5 / slice - $1.4 / slice) * 570 slices / day
– $627 / day