Marginal Revenue_ Marginal Cost_ Supply and Demand - PowerPoint

Document Sample
Marginal Revenue_ Marginal Cost_ Supply and Demand - PowerPoint Powered By Docstoc
					Marginal Revenue, Marginal
 Cost, Supply and Demand
               Scenario
• Here is the supply and demand at various
  prices for product X

      Price     Demand    Supply
      $1        9         5
      $2        8         6
      $3        7         7
      $4        6         8
                             Graph
• Here is what the supply and demand graph look
  like – what is equilibrium?

            $5
            $4
            $4
            $3
    Price




            $3                                       Demand
            $2                                       Supply
            $2
            $1
            $1
            $0
                 4   5   6      7       8   9   10
                             Quantity
                     Costs
• Now, here are the total, fixed and variable costs
  at each point on the supply curve

        Supply    Total     Variable   Fixed
                  Cost      Cost       Cost
        5         15        5          10
        6         17        7          10
        7         20        10         10
        8         24        14         10
        Marginal Revenue and Marginal
                    Cost
Price    Quantity    Total    Marginal     Units    Variable   Fixed   Total   Marginal   Profit
          Sold      Revenue   Revenue    Supplied    Cost      Cost    Cost     Cost
        (demand)                         (supply)


$1         9         $9                    5         $5        $10     $15                ($6)

$2         8        $16        $7          6         $7        $10     $17      $2        ($1)

$3         7        $21        $5          7        $10        $10     $20      $3        $1

$4         6        $24        $3          8        $14        $10     $24      $4        $0


    As you can see, at a Price of $3 MR>MC, and at a Price of $4, MC>MR.
 Therefore the profit maximization point (mr=mc) is somewhere between $3 and
                             $4 – let varify it visually!
                                                   Visually
                           8
                           7
                           6
            Price (cost)




                                                                          Marginal Revenue
                           5
                                                                          Marginal Cost
                           4
                                                                          Demand
                           3
                           2                                              Supply
                           1
                           0
                               0   1   2   3   4   5   6   7   8   9 10
                                               Quantity


As you can see, the equilibrium of supply and demand is at a quantity of 7 and a price of
$3 (in this case, supply = marginal cost) – the Profit maximization point (where marginal
revenue reaches and equals marginal cost) is close to a quatity of 8 and price of $3.50.
However, since we are dealing with whole dollars, the best we can do is the equilibrium
           More about Costs
• When economist look at costs, they also
  look at average costs
  – Average total costs
    • The total cost divided by the units of output
  – Average fixed costs
    • The Fixed cost divided by the units of output
  – Average variable costs
    • The Variable cost divided by the units of output
                      In this example
 Units     Variable    Average    Fixed   Average   Total   Average
Supplied    Cost       Variable   Cost     Fixed    Cost     Total
                        Cost               Costs             Cost



(supply)

   5         $5         $1.00     $10      $2.00    $15      $3.00

   6         $7         $1.17     $10      $1.67    $17      $2.83

   7         $10        $1.43     $10      $1.43    $20      $2.86

   8         $14        $1.75     $10      $1.25    $24      $3.00
                                              Visually
                            4.5
                              4                              Marginal Cost
                            3.5
             Price (cost)



                              3                              Average Total Cost
                            2.5
                              2                              Average Variable
                            1.5                              Cost
                              1                              Average Fixed
                            0.5                              Costs
                              0
                                  4   5   6     7    8   9
                                          Quantity


This graph shows us that when the marginal cost, or next unit cost is below the average
total cost, the average cost decreases. When marginal cost goes above average cost,
the average cost begins to increase.
Why does the average variable increase? Why does the average fixed cost decrease?
What is happening to the average total cost? Why?
                                   So what?
• Take a look at this graph, showing the cost
  curves from the previous graph with the
  marginal revenue, supply and demand.
                 $8
                 $7
                 $6
  Price (Cost)




                 $5                                       Demand
                 $4
                                                          Supply
                 $3
                                                          Marginal Revenue
                 $2
                 $1                                       Marginal Cost
                 $0                                       Average variable cost
                      5   6   7              8   9   10   Average Fixed Costs
                                  Quantity                Average Total Cost
                                  With your group…
•              Study this graph for ten minutes, and answer the tough questions on the next slide


               $8
               $7
               $6
Price (Cost)




               $5                                                                       Demand
               $4
                                                                                        Supply
               $3
                                                                                        Marginal Revenue
               $2
               $1                                                                       Marginal Cost
               $0                                                                       Average variable cost
                    5         6          7              8       9          10           Average Fixed Costs
                                             Quantity                                   Average Total Cost
1. What is the equilibrium profit?
2. What is the profit maximization price and quantity, and what is the profit at
   that point?
3. Why does the average total cost begin to rise at a quantity of 7?
4. Draw out the average variable, fixed and total costs, as well as marginal
   revenue to a quantity of ten. What does it mean when each line is crossed?
   At which corssings should production continue? At which crossings should
   production not continue?
             Now you try…
• With your group, graph the following
  information (on the next slide) and find:
  – The profit maximization point
  – The equilibrium profit
  – The point at which the firms should continue
    is the short run
  – The point at which the firms should not
    continue in the short run
P    D    R   MR    S     VC     AVC     FC    AFC     TC   ATC   MC


$1   24             5      $2           $12

$2   19             6      $4           $12

$3   13             7      $7           $12

$4   6              8     $11           $12


               Fill in the blanks above, then graph…

				
DOCUMENT INFO