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Lecture Notes: Oct. 9 |
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Econ. 103, Fall 2002, Prof. Nancy Folbre |
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Homework # 3 due this week. It covers chapters 4 and 5. Midterm is coming up, Wednesday night, October 23 at 7:30PM. If you have a conflict, the alternative time will be at 5PM the same day. You will have to let me know in advance if you are taking it at the alternative time. Exam questions will draw from homework-type problems, plus some multiple choice questions. The text website includes some quizzes called "pre-test" and "post-test" that are very good practice. Note: there are no homework problems for Chapters 6 and 7. This signals that I will put less emphasis on the technical material (e.g. graphs and calculations) for these two chapters. But note there are homework problems for Chapter 8 that you should work on before the exam, even though you may not be able to hand them into discussion section. I’ll go over them briefly on Wednesday before the exam as part of the review session. Today I want to go over a graph that helps explain a central point that I made in the last class: (also a key point in Ch. 8) capitalists try to maximize profits, but in the long run, competition tends to drive profits to zero. Also, I want to help explain the relationship between the material we are covering in the text and the History of Coca-Cola video. The key to understanding how competition drives down profits lies in graph 6. 4, the demand curve facing a perfectly competitive firm. Remember that profits are the product of price times quantity sold. Costs are the product of average cost times quantity sold. If many individual firms are making profits, new firms enter the industry, which shifts the supply curve downward and to the right. This lowers the market price. Under conditions of perfect competition, individual firms are price-takers–so this reduces their profits. Imagine that it reduces their profits so much that they are making a loss. In that case, firms exit the industry. This shifts the market supply curve to the left, raising the price... The long-run equilibrium under perfect competition is a situation where individual firms are earning zero profits, unless they have some secret ability to keep their costs lower than anyone else....or to protect themselves from the effects of competition. See Figures 8.2 and 8.3 in the text, and Powerpoint slide 8-6. By way of illustration of categories of costs, consider the following hypothetical balance sheet for a soda fountain in 1900.
The Coca Cola company sold one gallon of syrup for $1. This was enough for 64 servings. So the cost per serving of syrup was less than 2 cents per glass. A key strategic decision that Asa Candler made–one that helped promote soda fountain demand for Coca-Cola syrup, was that he set the price at 5 cents a glass. His contract with soda fountains required them to sell at this price. As a result, they couldn’t compete with each other by driving the price down. They were virtually guaranteed a profit of 3 cents per glass. |