Economics 2 Professor Christina Romer Spring 2019 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2019 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2019 Professor David Romer LECTURE 6 FIRMS AND PROFIT MAXIMIZATION FEBRUARY 7, 2019 I. F IRMS AND THE D ECISIONS T HEY M AKE A. What is a firm? B. Three decisions a firm has to make C. Profit

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Economics 2 Professor Christina Romer Spring 2019 Professor David Romer LECTURE 6 FIRMS AND PROFIT MAXIMIZATION FEBRUARY 7, 2019 I. FIRMS AND THE DECISIONS THEY MAKE

  • A. What is a firm?
  • B. Three decisions a firm has to make
  • C. Profit maximization as a key goal
  • D. Economic profits vs. accounting profits
  • 1. The definition of economic profits
  • 2. Implicit costs
  • II. PERFECT COMPETITION
  • A. The definition of perfect competition
  • B. How relevant is perfect competition?
  • C. The demand curve facing a competitive firm
  • III. SHORT-RUN PROFIT MAXIMIZATION
  • A. The constraints that firms face
  • B. Marginal revenue
  • C. Marginal cost
  • D. Optimization
  • E. The irrelevance of fixed costs
  • IV. WHY SUPPLY CURVES SLOPE UP
  • A. How a firm responds to an increase in the market price
  • B. Individual and market supply curves
  • C. Two interpretations of the market supply curve
  • 1. The sum of individual firms’ supply curves (“horizontal” interpretation)
  • 2. The industry’s marginal cost curve (“vertical” interpretation)

V. WHY SUPPLY CURVES SHIFT

  • A. A change in technology
  • B. A change in the cost of an input
  • C. Entry or exit
  • D. Other influences
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LECTURE 6 Firms and Profit Maximization

February 7, 2019

Economics 2 Christina Romer Spring 2019 David Romer

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Announcements

  • The Economics Department offers drop-in Econ 2
  • tutoring. Information about hours and locations is at

https://www.econ.berkeley.edu/undergrad/home/ tutoring.

  • The Student Learning Center offers drop-in Econ 2

tutoring, M–Th 10AM–2PM in the SLC Atrium at the Cesar Chavez Student Center. Additional formats of service can be found at http://slc.berkeley.edu/econ.

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Announcements

  • A detailed answer sheet to Problem Set 1 will be

posted this evening.

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I. FIRMS AND THE DECISIONS THEY MAKE

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Three Decisions a Firm Has to Make

  • Short-run choice of output: How much to produce

today with the existing set-up?

  • Long-run choice of output: Expand or contract?

Exit the industry? Enter the industry?

  • Both short-run and long-run – the choice of input

mix: What combination of inputs (labor, capital, raw materials, and so on) to use to produce the

  • utput?
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Profit Maximization

  • We assume that firms’ objective is to maximize

their economic profits.

  • The definition of economic profits:

Profits = Total Revenue – Total Costs, where:

  • Total Revenue = Price Quantity
  • Total Cost = Opportunity Cost of All Inputs
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  • II. PERFECT COMPETITION
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Perfect Competition

  • Each firm can sell as much or as little as it wants at

the prevailing market price.

  • Three reasons for starting our study of firm

behavior with the case of perfect competition:

  • It’s a reasonable description of important

parts of the economy.

  • It’s relatively simple.
  • It’s an important reference point.
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Individual-Household and Market Demand Curves

P q Individual Household P Q Market

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Market and Individual-Firm Demand Curves

P Q Market P q Individual Firm

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  • III. SHORT-RUN PROFIT MAXIMIZATION
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Marginal Revenue: The Additional Revenue Associated with Producing One More Unit

q MR (in $)

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Different Types of Costs

  • Fixed costs: Costs that do not depend on how much

is produced.

  • Variable costs: Costs that do vary with how much is

produced.

  • Total costs: The sum of fixed and variable costs.
  • Marginal cost: The change in total costs from

producing one more unit.

  • Note: Since fixed costs do not change when
  • ne more unit is produced, marginal cost is

also equal to the change in variable costs from producing one more unit.

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Marginal Cost: The Additional Cost Associated with Producing One More Unit

q mc (in $)

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The Profit-Maximizing Level of Output for a Perfectly Competitive Firm

q P

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Condition for Profit-Maximization

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  • IV. WHY SUPPLY CURVES SLOPE UP
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Impact of a Rise in the Market Price

q P mc mr1 P1 q1

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Market and Individual-Firm Supply Curves

P Q Market P q Individual Firm

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Two Interpretations of the Market Supply Curve

  • The sum of individual firms’ supply curves

(“horizontal” interpretation).

  • The industry’s marginal cost curve (“vertical”

interpretation).

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The Industry Supply Curve Is the Industry Marginal Cost Curve – Example

  • Suppose there are 100 firms. Each has MC at 1000 units of

$5, MC at 2000 units of $6, etc. Q $ 1 2 3 4 6 7 5 100K 200K 300K q $ 1 2 3 4 6 7 5 1K 2K 3K mci (also si)

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  • V. WHY SUPPLY CURVES SHIFT
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An Improved Production Technology

P Q Market P q Individual Firm mc1 S1

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An Increase in the Price of an Input

P Q Market P q Individual Firm mc1 S1

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Entry of New Firms

P Q Market P q Individual Firm mc1 S1

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Other Possible Reasons the Supply Curve Could Shift