Chapter

6 Perfectly Competitive Supply: the cost side of the market

Answers to review questions
1 The principle of increasing opportunity cost, also known as the low-hangingfruit principle, says that the least costly options should be exploited first, with more costly options taken up only after the least costly ones have been exhausted. At low prices, only those with low opportunity costs of producing a product would find it worthwhile to offer it for sale. As prices rise, others with higher opportunity cost could profitably enter the market. This positive relationship between a products price and the quantity supplied is shown by an upward-sloping supply curve. Bus fares are determined by the interaction of the market demand for bus rides and the market supply of bus rides. In a perfectly competitive market, each individual travellers demand is so small compared to the size of the market that no single individuals decision has an effect on market demand or on the equilibrium price of a bus ride. Individual bus travellers are price-takers. Similarly, an individual apple growers decision about how much to supply at each price has no effect on total market supply or on the price of a kilo of apples. Individual apple growers are also price-takers in the market for apples.

Answers to problems
1 a If the price of a fossil is less than $6, Jo should devote all her time to photography because when the price is, say, $5 per fossil, an hour spent looking for fossils will give her 5($5) = $25, or $2 less than shed earn doing photography. If the price of fossils is $6, Jo should spend one hour searching, which will supply five fossils and earn Jo revenue of $30; that is, $3 more than she would earn from photography. However, an additional hour would yield only four additional fossils or $24 additional revenue, so Jo should not spend any further time looking for fossils. If the price of fossils rises to $7, however, the additional hour gathering fossils would yield an additional $28; gathering fossils during that hour would then be the best choice, and Jo would therefore supply nine fossils per day. Using this reasoning, we can derive Jos pricequantity supplied relationship for fossils as follows:
Price of fossils ($) 05 6 7, 8 913 Number of fossils supplied per day 0 5 9 12

1426 27+

14 15

If we plot these points, we get Jos daily supply curve for fossils:
Price ($/fos sil) 27

14 9 7 6 5 9 12 15 14 Number of fossils

The market supply curve (right) is the horizontal summation of the supply curves of the individual market participants (left and centre).

P 6

P=2Q 1 6

P=2+Q 2

P 6

Q 1

Q 2

Horizontal summation means holding price fixed and adding the corresponding quantities. For example, at a price of $4 per unit, a total of 2 + 2 = 4 units will be supplied. If you want to derive the market supply curve algebraically, rewrite each individual supply curve with quantity as the dependent variable and add.

Pay careful attention to the region for which the supply curves dont overlap (here, the region P<2). From P = 2Q1, get Q1 = P/2; from P = 2 + Q2, get Q2 = P 2. For the region P<2, the market supply is the same as Firm 1s supply: Q = P/2, or P = 2Q For P>2 we add Q1 + Q2 to get Q = P/2 + (P 2), which reduces to Q = (3P/2) 2. Rewriting this, we have P = (4/3) + (2/3)Q for P>2. Expressed algebraically, the market supply curve is thus: P = 2Q for P<2 and P = (4/3) + (2/3)Q for P>2