Transcript Intermediate Microeconomic Theory

Intermediate Microeconomic Theory
Market Supply
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Market Supply
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Similar to demand, market supply will
simply be the summation of all the
individual firm supply curves:
Qs(p) = q1s(p) + q2s(p) +…+ qns(p)
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Also similar to demand, a price change can
change amount supplied on both the
intensive and extensive margin.
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What is key to extensive margin?
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Market Supply
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Given market supply curve,
along with market demand
curve, we can now define an
equilibrium price.
Equilibrium price: the price
that equates supply and
demand in a given market
(p* such that Qd(p*) = Qs(p) ).
Qs(p)
Qd(p)
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Price and Costs in Equilibrium
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Note: all profit maximizing firms that are
supplying output to a given market must be
operating at p* = MC(qs(p*)).
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So while each firm may have quite different
cost functions, all must have the same cost
of producing their last unit of output.
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Therefore, in perfect competition, the price
consumers pay for a good equals the cost
(including opportunity costs) firms must
incur to bring the marginal good to the
market.
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Economic Profits
When does it make sense to enter a given industry?
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Economic Profits
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Example: Should Lisa enter the tea business?
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To do so, she needs gallon sized tea kettle ($20).
For each cup of tea she supplies, she needs 1 tea bag ($0.49/bag)
However, in making tea she gets tired, meaning the amount of tea she can make
in a month is given by the production function q = 10L0.5 (L is hrs of her time).
When she isn’t making iced tea, she can work at Moe’s bar for $5hr. (paid at the
end of each month)
Any money she doesn’t put into the business, she loans to Barney at a monthly
interest rate of 2%.
Lisa gets her tea via mail order, which she has to pay for on the first of each
month.
Suppose the going price for tea in Springfield is $3/cup.
What are Lisa’s monthly economic profits from this business? What does
this say about whether she should enter?
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Economic Profits
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How would her economic profit change if she could lend to Barney at an
interest rate of 0.53/month?
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Market Supply in the Long-run
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How will things change over the longer-run?
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Think of the market demand/market supply graph. What is aggregate
profit in graph?
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What if there are a bunch more individuals like Lisa out there
(specifically, Lisa with the lower return on her savings)?
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Market Supply in the Long-run
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So how will Industry Supply curve change over the long-run? Why?
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So what is long-run shape?
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Where will it lie?
What does this mean about (economic) profits in a competitive
market in the long-run?
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Profits in the Long-run
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So in short-run there are positive economic
profits (or “rents”), but if there is “free-entry”
the industry operates at zero (economic) profits
in the long-run.
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However, it is still rational for suppliers to
continue using resources to produce and supply
goods to the market they are in (accounting
profits are strictly positive)
Zero “economic” profits simply means that there
are no excess returns to be had by allocating
further resources and inputs into that market.
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In the end, this is what venture capital and
entrepreneurism is all about---finding a
market niches that allow for (possibly “shortterm”) excess returns (i.e. economic profits).
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Profits in the Long-run
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How does selection from “Free: The
Future of the Radical Price” relate to
this discussion?
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Costs and Benefits of Competition
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Our theory of the firm reveals the costs and benefits of competition.
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Benefits?
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Costs?
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Economic Rent
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So economic profits in the short-run are part of our theory
(essentially come from innovation and cost saving choices)
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But how do we explain firms in mature industries making seeming
economic rents (i.e. Exxon Mobil, Haliburton)?
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Assumption of free-entry in the long-run fails because some factor is
fixed or limited.
 There are a fixed number of functioning oil wells.
 Provision of services to military awarded by government contract
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 Any constraint that leads to a fixed number of suppliers.
Why are such barriers to entry so valuable?
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Rent setting
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The implicit “value” of the fixed factor is what we call
“economic rent”.
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How is one of these assets that earns economic rent valued?
Consider a contract to supply troop meals in Afghanistan.
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Contract will pay $1 million and requires meals 21 meals/day for 300K
troops for 40 weeks.
Cost function is c(q) = q/300
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What will a company pay up to in order to win this contract?
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Rent Seeking
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So we can see why millions are spent each year lobbying by firms or
individuals in an attempt to somehow constrain entry into an
industry.
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Positive economic profits can be made if free-entry is limited. So, it
might make sense for firms to pay lots of money to lobby for entry
barriers.
Often called “rent seeking”.
Examples:
 Limits on medical school slots
 hair cutting licenses
 zoning restrictions
 Agricultural subsidies
 Military contracts
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