Harley Rocky likes economics Supply Curves and Marginal Revenue How perfectly competitive firms would set output If there are such firms The BIG ideas Perfectly competitive firms produce until MU MC This is irrelevant because there are no perfectly competitive firms Monopolies produce where MC Marginal Revenue At MU MC firms lose money on some output because are not accounting for fixed inputs Rational firms establish monopolies to raise prices reducing production until MC MR Orthodox bottom line Supply Curves slope up and firms produce where MU MC The punch line and the real story It ain t necessarily so Price Monopoly P and Q Perfect Competitive P and Q Output Perfectly competitive firms ignore their effect on market prices and think only of marginal costs They act as if they face a perfectly flat demand curve where they can sell any amount at a constant price Price Actual demand curve This is the price of output where MU MC MC What they think Perfect competitors thinks they can sell any amount at a fixed price Quantity Why do marginal costs rise 1 Because of diminishing marginal productivity 2 Because variable inputs have less and less with which to work 3 Because the MPL declines with additional workers 4 All of the above Perfectly competitive firms produce if Price or Marginal Cost Myopically they think they profit if produce at a marginal cost less than the selling price The myopic perfect competitor acts as if it faces a flat demand curve and can sell any amount at a constant price Smarter businesses know better At the PC Equilibrium 1 Independence market supply is the sum of each individual firm s output Add it up 2 Price leads firms to produce what consumers want at that price 3 More output comes with a higher price moving up the MC or PC Supply Curve 4 Less output at lower price if consumer demand declines moving down the MC or PC Supply Curve Output increases with higher prices along the Supply Curve because at higher prices firms can profit at higher MC Firms profit on inframarginal output Don t produce In perfect competition excessive profits attracts new entrants to drive down prices and profits What happens to prices under perfect competition if workers become more productive 1 They rise because of higher marginal costs 2 They fall because of lower marginal costs 3 Nothing because of constant fixed costs 4 Puppies I have no idea Trick question What happens to prices under perfect competition if firms lower fixed costs 1 They rise because of higher marginal costs 2 They fall because of lower marginal costs 3 Nothing because of marginal costs haven t changed 4 Kittens I still have no idea Perfect Competition is Impossible 1 Perfect competitors ignore sunk costs 2 They ignore the effect that increasing production and sales has on the market price Perfectly competitive firms go bankrupt Compare Marginal Costs with Average Total Costs M C a n d S u p p ly C u r v e P e r f e c t C o m p e ti ti o n Loss between ATC and Price 8 0 0 6 0 0 P r i 4 0 0 c e 2 0 0 0 0 0 1 2 3 4 5 6 7 8 Q u a n ti t y M C D em a nd Price A v e r a g e to ta l c o s ts 9 10 To stay in business firms must cover marginal costs and fixed costs They cannot do this if they are perfectly competitive and sell at MC Our capitalist economy can only function if firms are monopolies Right again How would you price airline tickets How much do you think it costs an airline to fly one more passenger from Boston to Paris 1 Marginal cost about 50 2 Average cost about 330 3 500 about the price of a ticket A Boeing 747 400er Boston and Paris Perfectly competitive firms are myopic And dumb They ignore the effect that increasing output has on the market price Firms sell their increased output by lowering prices Duh They get extra revenue from selling more but must discount this by the lower prices they now charge everyone else To attract more customers you have to lower prices Some people really like your stuff and will buy at high prices Others like your stuff and will buy if you give them a discounted price Some will only buy if you are really cheap Every time you lower prices you give a discount to those who would have paid more Beer 1 2 3 4 5 6 7 8 9 MU 15 10 6 3 2 1 25 0 5 0 25 0 If you sell 2 beers at 10 the first buyer is happy because she would have paid 15 To sell 3 beers you have to lower prices to 6 and both the first and second drinkers are very happy To sell 4 beers you lower prices to 3 and the first three drinkers are ecstatic And drunk Algebra MR P Q P Marginal revenue is the price you get for the new sale minus the discount you give on all your earlier sales Isn t math fun Why MR Price Sales Demand TR Discount MR 1 25 00 25 00 00 25 00 2 23 75 47 50 1 25 22 50 3 22 56 67 69 2 38 20 19 4 21 43 85 74 3 38 18 05 5 20 36 101 81 4 29 16 08 6 19 34 116 07 5 09 14 25 7 18 38 128 64 5 80 12 57 8 17 46 139 67 6 43 11 03 9 16 59 149 27 6 98 9 60 10 15 76 157 56 7 46 8 29 11 14 97 164 65 7 88 7 09 12 14 22 170 64 8 23 5 99 13 13 51 175 62 8 53 4 98 14 12 83 179 67 8 78 4 05 15 12 19 182 88 8 98 3 21 16 11 58 185 32 9 14 2 44 17 11 00 187 05 9 27 1 74 18 10 45 188 15 9 35 1 10 19 9 93 188 68 9 41 0 52 20 9 43 188 68 9 43 00 00 1 00 1 3 5 7 9 11 13 15 17 19 21 23 25 2 00 3 00 4 00 5 00 6 00 Demand MR Discount 7 00 8 00 9 00 10 00 Selling more produces additional revenue equal to the price But from this additional revenue must be deducted the discount given to previous inframarginal buyers Marginal revenue is less than the price of output by this discount That is why Marginal Revenue is less than the selling price If you sell on the demand curve rather than the MR curve you lose profit M o n o p o l y a n d P e r f e c t C o m p …