Economics Module 5 Notes Module 5 1 Producers By the end of this module you should be able to 1 Relate a supply curve to a supply schedule table 2 Calculate an individual s producer surplus given the price they receive and their minimum willingness to accept total producer surplus for multiple sellers from a table of values and in a table of values how price changes impact producer surplus 3 Explain why individual rms in a perfectly competitive market are price takers 4 Distinguish between the market industry demand curve and the individual rm s demand curve in perfect competition 5 Calculate total xed and variable costs from a table of values 6 Calculate average total cost average xed cost average variable cost and marginal cost 7 Use marginal and total revenue and marginal costs to nd the level of output that will maximize the rm s pro ts with table of value 8 Calculate the price elasticity of supply given the percentage change in quantity supplied and the percentage change in price 9 Explain why the price elasticity of supply is always positive 10 Recognize how slopes of linear supply curves are related to relative price elasticity of demand steeper more inelastic atter more elastic 11 Give examples of inelastic and elastic supply in the real world Module 5 2 What is Supply and the Law of Supply Review materials in Module 3 speci cally 3 3 What is Demand And Law of Demand 3 6 Changes in Supply vs Changes in Quantity Supplied Module 3 3 What is Demand and the Law of Demand Demand the relationship between prices and quantities demanded The Law of Demand speci es that all else equal there is an inverse relationship between prices and quantities demanded This means that prices and quantities demanded move in the opposite direction and demand curves slope downward Module 3 6 Changes in Supply vs Changes in Quantity Supplied When economists refer to supply they mean the relationship between a range of prices and the quantities supplied at those prices a relationship that we can illustrate with a supply curve or a supply schedule A change in quantity supplied is a movement along the supply curve in response to A change in supply is a shift of the entire supply curve in response to a change in a change in price something other than price Module 5 3 Producer Surplus Imagine how nice it would be to sell something for more money than you would have been willing to accept Producer surplus PS the amount that individuals actually get paid minus the minimum price they were willing to sell for It represents a net bene t to the producer Module 5 4 What is perfect competition Few markets are truly perfectly competitive but it s a good benchmark to compare with other market structures Perfect competition occurs when there are many sellers there is easy entry and exiting of rms products are identical from one seller to another and sellers are price takers Price takers take price that s given Firms are in perfect competition when the following conditions occur many rms produce identical products many buyers are available to buy the product and many sellers are available to sell the product sellers and buyers have all relevant information to make rational decisions about the product that they are buying and selling rms can enter and leave the market without any restrictions in other words there is free entry and exit into and out of the market Module 5 5 Perfectly Competitive Firms and Industries Perfectly competitive rms Because there are so many rms selling identical products with free entry and exit it implies that the rm faces a perfectly elastic demand curve for its product buyers are willing to buy any number of units of output from the rm at the market price There are two demand curves to consider when we study rms in perfect competition the market demand curve and the demand curve for an individual rm The market industry demand curve is downward sloping the demand curve for an individual perfectly competitive rm is horizontal Module 5 6 Production in the Short Run vs Long Run Every rm must choose the optimal quantity to produce the one that maximizes pro t In this section we introduce concepts related to production Production is simply the act of turning inputs into outputs Some inputs are xed and others are variable In the short run at least one input is xed and the rm can only change variable inputs In the long run all inputs are variable so all inputs can be changed Module 5 7 Fixed Variable and Total Costs Pro t revenue costs Total Cost Total Variable Cost Total Fixed Cost Total Variable Costs are zero when there is no quantity produced and then increase as quantity produced increases Total Fixed Costs do not vary with output they are the same regardless of the quantity produced even when the quantity is zero Module 5 8 Average and Marginal Costs Average Variable Cost Total Variable Cost Quantity Average Fixed Cost Total Fixed Cost Quantity Average Total Cost Total Cost Quantity Average Total Cost Average Variable Cost Average Fixed Cost Marginal Cost Change in Total Cost Change in Quantity Average Variable Costs typically have u shape decreasing to a minimum point then increasing as quantity increases Average Fixed Costs are downward sloping as total xed costs are spread out over more units as quantity increases Marginal Costs represent the additional costs of production Module 5 9 Pro t Maximization in a Perfectly Competitive Market Total Pro t Total Revenue Total Cost Total Revenue Price X Quantity Marginal Pro t Change in Total Pro t Change in Quantity Marginal Revenue Change in Total Revenue Change in Quantity Module 5 10 Price Elasticity of Supply Price Elasticity of Supply measures how responsive the quantity supplied of a good is to changes in its price Price Elasticity of Supply Change in Quantity Supplied Change in Price Note Because of the Law of Supply price and quantity supplied always move in the same direction so Price Elasticity of Supply is always positive Module 5 11 Degrees of Price Elasticity of Supply Elastic Inelastic Unitary Perfect Elastic when Price Elasticity of Supply is equal to In nity Relatively Elastic when Price Elasticity of Supply is greater than one Unitary Elastic when Price Elasticity of Supply is equal to one Relatively Inelastic when Price Elasticity of Supply is less than one Perfect Inelastic when Price Elasticity of Supply is equal to zero