Lecture Notes: Oct. 7

Econ. 103, Fall 2002, Prof. Nancy Folbre

Goal: More on Ch. 6 and start learning about The Real Thing, Coca-Cola.

Let’s start out by reviewing graph 6.4 from last time.

Why does the marginal cost curve tend to go up? Because in a world of scarcity, we usually do the most efficient (least costly) things first. We pick the "low-hanging fruit." We find the "easy to find" soft drink cans to recycle first. We use the most productive land first.

Another way of putting this is that we run into the law of diminishing returns. Which is also a law of increasing costs. Note that this also helps explain the shape of the production possibilities curve discussed in the last chapter.

Some vocabulary:

factor of production

fixed factors and fixed costs–land, plant, equipment

variable factors and variable costs–raw materials, labor

in the "short run," at least some factors are fixed.

because we define the "short run" as that period of time in which some factors are fixed.

(is that convenient, or what?)

thinking about costs more systematically, and recognizing that they tend to go up helps think about seemingly paradoxical things like "the optimal amount of litter" or the "optimal amount of pollution" or (if you recall my 9/11 lecture) "the optimal amount of money spent on air travel safety"

by optimal, we mean the quantity at which the marginal cost equals the marginal benefit. If we go past that point, the marginal cost exceeds the marginal benefit. If we stop short of that point, we’ve let some marginal net benefit go unrealized.

the capitalist applies this same logic in seeking to maximize profits.

note–this doesn’t mean that the capitalist always makes profits. This is (theoretically) determined by forces beyond his control. But he always tries to maximize profits.

profits are defined as revenues minus costs.

total revenues are equal to price (or average cost, also equal to marginal cost) times quantity sold.

total costs are equal to average cost times quantity sold

the profit maximizing point is where marginal cost equals marginal revenue (same as more general principle, just that capitalist is looking specifically at marginal revenue rather than the more general marginal benefit).

to really understand why marginal cost is so important, you need to recall the distinction between fixed costs and variable costs. Fixed costs don’t change–so they don’t affect marginal costs.

But you have to pay fixed costs no matter what level of production you are at (that’s what it means to say they are "fixed"–it's like the rent you have to pay for the pumpkin field, which doesn't change whether you grow 100 pumpkins or 1000. Only the cost of seed, fertilizer, and labor is going to go up when you expand pumpkin production–these are the variable costs.

suppose the price of pumpkins falls drastically because of a huge quantity of new imports from Argentina

suppose the price falls below the average cost to Mr. Hadley, pumpkin farmer.

this means he is going to have negative profits (that is, losses).

but he's going to have to pay rent for his farm land no matter how many pumpkins he grows. So–since he's already committed (ie. has already paid the rent), he should grow pumpkins as long as the price he gets is greater than the average variable cost...this means he is at least making enough money to help pay his fixed costs....

so, he still does best if he chooses the level of production where marginal cost equals marginal revenue.

if he goes beyond that point, he would do better to simply shut down operations...

back to elasticity–defined the same way for supply as for demand

one interesting fact: on a positively sloped line through the origin, the ratio of P to Q is the same at every point. As is the ratio of the change in P to the change in Q. So the price elasticity is always equal to 1 on a positively sloped supply curve that goes through the origin.

in the long run, supply can vary considerably in elasticity...

it's affected by flexibility of inputs, including substitutes, the mobility of inputs, and the time period. In the long run, most supply is elastic, because technological change can come into play.

But technological change can't create more paintings by Monet, or more Babe Ruths.

Some things are unique and essential. There are no substitutes for them. These are things that tend to command a high price even in the long run.