Transcript To Minimize Total Costs Set MC

The True Importance
of the
P=MC Condition of Profit Maximization
How to Minimize the Total Costs of Corn
Production Across Two Farms
Farm Two
Farm One
MC1
$
Increase
in Costs
Savings
C = A-B
$
Decrease
in Costs
MC2
$200th unit
C
A
B
0
25
Quantity
(Bushels of Corn)
Cost of Producing
200th Unit
175 200
Quantity
(Bushels of Corn)
To Minimize Total Costs Set MC1=MC2
Farm Two
Farm One
MC1
$
$
MC2
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
A Much
Pat Sets
MorePDifficult
=MC1 , Alex
Problem.
sets PWhat
=MC2if we
don’t know
as a
the
result
MC of
MC
each
producer?
1=MC
2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
$2.50
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
The Role of Prices
A Price is a Signal
Wrapped Up
in an Incentive
The Invisible Hand
• “Every individual... neither intends to promote the
public interest, nor knows how much he is
promoting it... he intends only his own security; by
directing that industry in such a manner as its
produce may be of the greatest value, he intends
only his own gain, and he is in this, as in many
other cases, led by an invisible hand to promote
an end which was no part of his intention.”
• What is this invisible hand leading us?
The Role of Prices
• Price increases.
– It’s a signal that people want more of it.
– It’s an incentive for producers to provide more of it.
• Price decreases.
– It’s a signal that people don’t want as much of it.
– It’s an incentive for producers to provide less of it.
A Much
Pat Sets
MorePDifficult
=MC1 , Alex
Problem.
sets PWhat
=MC2if we
don’t know
as a
the
result
MC of
MC
each
producer?
1=MC
2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
$2.50
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
The True Importance of the P=MC Condition
is P=MC1=MC2 …=MCN
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
$2.50
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
So what?
• Not many markets are perfectly competitive.
– Agriculture represents < 2% of workforce.
• Same dynamics at play in non-competitive
markets.
– Always MR vs. MC; if P↑, MR↑, regardless of the
industry.
– As P↑, firms will produce more, because it will exceed
the MC for a larger amount (and for a larger number of
firms).
Consider the following markets
• In the last 5 years, what’s happened to the
amounts of:
• Bars/restaurants downtown, healthcare facilities,
3-D movies, movies starring James Franco,
reality television shows, social media sites, touch
screen phones/tablets?
• Newspapers, music stores, movie rental stores,
post offices, sitcoms, movies starring Keanu
Reeves?
• Why?
Prices, Signals and Incentives - The Invisible
Hand!
• Why Central Planning Doesn’t Work
– Even if mandating production were ‘ok’
• Couldn’t possibly know how much consumers want/need
of all different goods and services.
• Couldn’t possibly know all of the marginal costs of all
producers.
• So, couldn’t possibly efficiently allocate production
between firms, or goods/services between consumers.
• The allocative function of prices. What’s the big deal?
A Natural Experiment
• Suppose there were two
countries with the same
culture, the same people,
the same history, that are
about the same size and
have about the same
income. One of these
countries uses central
planning and one of
them uses market forces
(the invisible hand).
A lot of other factors at play…
• Maybe it’s not the invisible hand, but other factors…
So what if we could take one country, have them start with
central planning, then suddenly allow market forces to work?
What happened in 1978?