Economics

Sellers and Incentives SR

Dept. of Economics @ NCKU

Weng, Ming-Hung
Question
Why and when
would the farmer
refuse to pluck
their cabbage and
leave them to
bloom in the farm?
 Outline
Firms SR decisions
What a firm needs to know
Production costs and Profit
Optimal decision
SR Supply curve

Firms LR decisions (Next Week)

 Running a small business
Possible startups
Ice
Drinks
Bakery
Taiwanese fried chicken
Taxi
Coffee shop
Ramen
apps
.
 Running a small business
Production Technology/efficiency
Fund
Costs
Shop/stand/car
Facilities/equipment
Material/input
Electricity/water
Labors
Revenue
 SR and LR decision makings
Short-run (SR) vs Long-run (LR)decisions
SR decisions
Output level/price, input amount, labor (hours) hired
LR decisions
Scale/shops/branches/facilities/factories decisions
Entry/exit decisions

Fixed costs (FC) vs variable cost (VC)

Costs varying with the production level in SR?
Costs of capital and labors
All costs are variable in the long run
Short-run costs for drink shops (*)
expenses on coffee
beans/ tea for drink
shops are considered
1. fixed costs
2. variable costs
Short-run costs for drink shops (*)
Monthly (annual) rent for shops is considered
1. fixed cost
2. variable cost
 Short-run costs for drink shops (*)
the utility (electricity/water) bills are
1. fixed costs
2. variable costs
Short-run costs for drink shops (*)
Expenses on (hourly)
labors are
1. fixed costs
2. variable costs
 Profit (*)
You borrowed Monthly Revenue
money and house $100 per cup, selling
from your parents to 1,000 cups of
sell coffee. Monthly costs
Are you making a $25,000 wages for
profit? your employees,
1. Yes $20,000 for utility bills
2. No $15,000 for misc. input
 Economic profit
Economic profit takes into account economic
costs instead of just accounting costs
Rent for your own house
Salary you give up
Interest payment for your fund

Sunk costs are those not to be recovered

Franchise fee
 Economic profit

Monthly rent: $10,000 Monthly Revenue

Monthly interest for $100 per cup, selling
borrowed money: $5000 1,000 cups of
Monthly salary: $30,000. Monthly costs
Economic profit? $25,000 wages for your
1. -5,000 employees,
2. 0 $20,000 for utility bills
3. 5,000 $15,000 for misc. input
4. 40,000
 Sunk cost (*)
You are a senior student majoring in economics
and you just realize you want to have a career
running a coffee shop. Suppose it does not need
any knowledge in economics, then you should
1. obtain the diploma in economics first since
youve invested more than 3 years in
economics education
2. Quit school right away to learn how to run a
coffee shop
 Sunk cost
After paying half million (NTD) franchise fee,
you find your tea shop in a constant economic
loss of $20,000 a month. If you expect the
situation to continue in the future. You should
1. Continue to run the business because you
have paid half million
2. Quit right away to prevent from further
loss
 Production/technology in the SR
Total Product Total output at Scale II
900
800
700
600 Total output at Scale I
500
400
300
200
100 Labor
1 2 3 4 5 6 7 8 hours
Total output expands when the firm
scales up (by investing more capital).
 Marginal Product & Cost
Total Product $80 to hire an additional labor hour
900 810
800
700
700
600
Marginal Product (MP)
500 of the (7th) additional
400 hour =110 $80 Marginal Cost
300
(MC) of these
200
100
units =80/110
Labor
1 2 3 4 5 6 7 8 hours
Law of diminishing returns (MP) implies
law of increasing marginal costs (MC)
 MP vs. MC
$80 to hire an additional labor hour
Output per Marginal Marginal
labor Total Cost
day Product cost
0 0 FC 150
65 1 VC=80 230 65 1.23
170 2 310 105 0.76
300 3 390 130 0.62
450 4 470 150 0.53
580 5 540 130 0.62
700 6 620 120 0.67
810 7 700 110 0.73
910 8 780 100 0.80
 SR Costs Revisit
Total cost= Fixed Cost + Variable Cost
TC=FC+VC
AC=AFC+AVC (TC/Q=FC/Q+VC/Q)
MC=TC/Q=VC/Q (Q: small increase in Q)
AC, AVC eventually goes up as Q if MC is
increasing in Q
Average Fixed Cost AFC=FC/Q
AFC approaches 0 as Q
AVC AC eventually close up
 SR costs
MC increases eventually due to diminishing MP
AC(AVC) increases eventually
AVC~AC eventually close up

AFC=AC-AVC
 Marginal vs. Average Grade (*)
After 2 midterms (70 & 90), youre facing a final,
the 3rd exam. The relationship between your
current average score (80) and the final score is
1. If the final score is higher than the average
score, the average score will be pulled up.
2. If the final score is lower than the average
score, the average score will be dragged
down.
3. All of above
4. None of above
 MC vs. AC
Suppose the firms current average cost is $20
when it produces 100 units. If the 101 unit
costs $22 to produce, the firms average cost
of 101 units will be
1. higher than $20.
2. exactly $20.
3. lower than $20
 Competitive Sellers SR decision
Facing the market price , , charged by other
sellers, what happen if a competitive seller
sets a price higher than ?
sets a price lower than ?
Profit maximizing is the goal to each firm
() = = ( )
= ()
= = for competitive sellers
= ( ) where is constant
Competitive Sellers SR decision
 Evaluating the profit level (*)
P
Suppose the market
price is P=$1.13. If
you produce 1,500
units, you are
1.13 P=MR=AR 1. making a profit
2. making a loss
3. break-even
 Evaluating the profit level
P
Suppose the market
price is P=$1.13. If
you produce 1,500
units, your profit is
(1.13-1)x1500=195
1.13 P=MR=AR
At which output
level will the firm
maximize its profit?
 Evaluating the profit level (*)
P
Suppose the market
price is $1.13 and
you produce 1,500
units. The production
of the 1501th unit
1.13 P=MR=AR
will
1. Increase profit
2. Reduce profit
3. Not change profit
 Optimal Output Choice
At any output level, for any firm
If MR>MC, profit will go up if output
expands as the additional revenue
outweighs the additional cost
If MR<MC, profit will go down if output
expands. Instead, the firm shall shrink
output.
For a competitive firm, P=MR,

MR=MC for optimal
When the
market price is
1.13, the
as optimal
for MR>MC quantity is
as around 1,225,
for MR<MC where P=MC.
 Profit maximization

as
for MR>MC

as
for MR<MC

is locally maximized but could be positive or negative.


at different prices
When the market
price goes up from
$1.13 to $1.41, the
firm produces
1. More
2. Less
3. The same level
 SR individual supply
Why would individual firms produce more when P?

MC= individual SR Supply

 SR Decision (*)
A friend owns a hotel that gets a lot of seasonal
business. The average total cost per day of
running a hotel room is $75 with $50 could be
saved if the room is unused. She tells you that
during the off-season (when there are a lot of
empty rooms) she had someone offer her $60 for
a room. She indignantly tells you she turned the
offer down since it was less than her average cost,
$75. How would you suggest her?
1. accept the offer 2. reject the offer
 SR Decision
A friend owns a hotel that gets a lot of seasonal
business. The average total cost per day of
running a hotel room is $75 with $50 could be
saved if the room is unused. She tells you that
during the off-season (when there are a lot of
empty rooms) she had someone offer her $40 for
a room. She indignantly tells you she turned the
offer down since it was less than her average cost,
$75. How would you suggest her?
1. accept the offer 2. reject the offer
 Shutting down
When producing at < ,
= =
< =

The firm is better off to shut down (Q=0)

when the market price is lower than the
minimum of AVC.
SR Decision

When the market price is

$0.6, at its optimal level
of output, the firm will
1. Make a profit
2. Make a loss but still
operating
3. Shut down (cease
operation)
temporarily
SR Decision

When the market price is

$0.8, at its optimal level
of output, the firm will
1. Make a profit
2. Make a loss but still
operating
3. Shut down (cease
operation)
temporarily
Question
Why would the
farmers refuse to
pluck their
cabbage or leave
them in the farm?
 Farmer refuses to sell oversupply
vegetables at low price
The weather has been stable recently, and oversupply has
sent cabbage prices plummeting. Some farmers in Yunlin
came up with a new idea to let consumers pick their own
cabbages, charging only NT$10 for each cabbage. They say
it's a win-win solution as farmers save up on labor cost and
transportation fees and people get to enjoy the fun of
cabbage picking. But not all the farmers agree with this
strategy.
Many people brought their own big bags to this Chinese
cabbage farm field in Yunlin County's Yuanchang Township.
Due to stable weather, the harvest of Chinese cabbages has
a supply over demand. Farmer was selling for a cheap price
at NT$10 each. (source: PTS news)
SR individual supply

Market supply is the horizontal sum

Individual and Market Supply

Market supply is the horizontal sum

 Increase in input price
If the price of silicon P
Supply (Curve)
wafer goes up, the
supply of IC chips will
P1
1. Increase; shift to
its right
P2
2. Decrease; shift to
its left
3. Remain unchanged Q1 Q2 Q
 Shifts of the Supply Curve
Supply (current) will increase if
1. input prices
go down
2. production technology
improves
3. the number and scale of sellers
increase
4. sellers expect the future price to
go down
 Conclusion
Economic profit takes into account (implicit)
opportunity cost
Diminishing MP implies increasing MC
The optimal (profit maximizing) rule for any
firm is to produce an output level where
MR=MC and p=MC in particular for
competitive firms when price is above AVC.
If price is lower than AVC, the firm will shut
down