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UMass Amherst ECON 103 - Class 13 Supply Curves and Marginal Revenue Fall 2014

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Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22To attract more customers, you have to lower pricesSlide 24Slide 25Why MR < PriceSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32HarleyRocky likes economics!Supply Curves and Marginal RevenueHow 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=MCThe punch line and the real story: It ain’t necessarily so. Monopoly P and QPerfect Competitive P and QPriceOutputPerfectly competitive firms ignore their effect on market prices and think only of marginal costsThey act as if they face a perfectly flat demand curve where they can sell any amount at a constant pricePriceQuantityMCActual demand curveWhat they think. Perfect competitors thinks they can sell any amount at a fixed price.This is the price of output, where MU=MCWhy 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 CostMyopically, 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 priceSmarter 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 MCFirms profit on inframarginal outputDon’t produce!In perfect competition, excessive profits attracts new entrants to drive down prices and profitsWhat 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 Impossible1. 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 CostsM C a n d S u p p l y C u r v e :P e r f e c t C o m p e ti ti o n$ 0 . 0 0$ 2 . 0 0$ 4 . 0 0$ 6 . 0 0$ 8 . 0 01 2 3 4 5 6 7 8 9 1 0Q u a n ti t yPriceM C D e m a n d P r i c e A v e r a g e t o t a l c o s t sLoss between ATC and PriceTo stay in business, firms must cover marginal costs and fixed costsThey cannot do this if they are perfectly competitive and sell at MC!Our capitalist economy can only function if firms are monopolies.Right againHow 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 747-400erBoston and ParisPerfectly competitive firms are myopic.And dumb.They ignore the effect that increasing output has on the market priceFirms 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 pricesSome 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 moreBeer MU1 152 103 64 35 26 1.257 0.58 0.259 0If 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.AlgebraMR= P – Q * Δ PMarginal 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 < Price135791113151719212325 $(10.00) $(9.00) $(8.00) $(7.00) $(6.00) $(5.00) $(4.00) $(3.00) $(2.00) $(1.00) $-00 DemandMRDiscountSales Demand TR Discount MR1 $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) $-00 Selling more produces additional revenue equal to the price. But from this additional revenue must be deducted the discount given to previous (inframarginal) buyers. Marginal revenue is less than the price of output by this discount.That is why Marginal Revenue is less than the selling priceIf you sell on the demand curve, rather than the MR curve, you lose profitM o n o p o l y a n d P e r f e c t C o m p e ti ti o n$ 0 . 0 0$ 2 . 0 0$ 4 . 0 0$ 6 . 0 0$ 8 . 0 01 2 3 4 5 6 7 8 9 1 0Q u a n ti t yPriceM C D e m a n d A v e r a g e t


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