Download Perfect Competition - Abernathy-ApEconomics-MPHS

Perfect Competition
Production and Profit
• Optimal output rule for price taking firms
▫ Price equals marginal cost at the price-taking
firm’s optimal quantity of output.
▫ Marginal revenue is equal to marginal price.
 A price taking firm cannot influence the market price
by its actions.
 This is only true in a perfect competition market.
▫ Marginal curve is horizontal line at market price.
 The firm can sell as much as it like at the market
price.
 Regardless if it sells more or less, market price is
unaffected.
• When is production profitable?
▫ Firms make their production decisions with the
goal of maximizing economic profit.
 A firm’s decision of how much to produce, and
whether or not to stay in business, should be based
on economic profit, not accounting profit.
• What determines whether a firm earns a profit
or loss?
▫ Look at market price. Is it more or less than a
firm’s minimum average total cost?
▫ You can use the average total cost curve and
marginal cost curve to show graphically the short
run options for a firm.
 These curves can be use to decide whether is
profitable or unprofitable.
 Shows 1 of 3 options
▫ If the firm produces a quantity at which total revenue is
great than total cost, the firm is profitable.
▫ If the firm produces a quantity at which total revenue
equals total cost, the firm breaks even.
▫ If the firm produces a quantity at which total revenue is
less than total cost, the firm incurs a loss.
This can be expressed in terms of
revenue and cost per unit of
output.
▫Profit/Q= TR/Q- TC/Q
▫TR/Q = is the market price
▫TC/Q = is average total cost
▫ A firm is profitable if market price for its products
is more than the average total cost of the quantity
the firm produces.
 If the firm produces a quantity at which P is greater
than ATC, the firm is profitable
 If the firm produces a quantity at which P = ATC, the
firm breaks even
 If the firm produces a quantity at which P is less
than ATC, THE FIRM INCURES A LOSS.
• GRAPHING PERFECT COMPETITION
▫ PROFIT: TR-TC= (TR/Q – TC/Q) X Q OR THE
EQUIVALENT PROFIT= (P-ATC) X Q
▫ HOW DOES A PRODUCER KNOW WHETHER
OR NOT ITS BUSINESS WILL BE PROFITABLE?
 YOU MUST COMPARE MARKET PRICE TO A
FIRM’S MINIMUM AVERAGE TOTAL COST
 A PRODUCER WILL MAXIMIZE HIS PROFIT OR
ACHIEVE ITS HIGHEST POSSIBLE PROFIT
WHEN THEY FIND THE QUANTITY WHERE
MARGINAL COST EQUALS PRICE.
 REQUIRES MARKET PRICE TO BE HIGHER
THAN MINIMUM AVERAGE TOTAL COST.
 IF MARKET PRICE IS LOWER THAN AVERAGE
TOTAL COST THERE IS NO OUTPUT AT WHICH
THE FIRM WILL BE PROFITABLE
▫ THE MINIMUM AVERAGE TOTAL COST OF A
PRICE-TAKING FIRM IS CALLED ITS BREAKEVEN PRICE.
 THIS IS THE PRICE WHERE IT EARNS ZERO
ECONOMIC PROFIT (NORMAL PROFIT)
 THREE THINGS TO REMEMBER
 WHENEVER MARKET PRICE EXCEEDS THE
MINIMUM AVERAGE TOTAL COST, THE
PRODUCER IS PROFITABLE
 WHENEVER MARKET PRICE EQUALS THE
MINIMUM AVERAGE TOTAL COST, THE
PRODUCER BREAKS EVEN
 WHENEVER THE MARKET PRICE IS LESS
THAN THE MINIMUM AVERAGE TOTAL COST,
THE PRODUCER IS UNPROFITABLE
• SHORT-RUN PRODUCTION
▫ SOMETIMES THE FIRM SHOULD PRODUCE EVEN
IF PRICE FALLS BELOW MINIMUM AVERAGE
TOTAL COST.
 TOTAL COST INCLUDES FIXED COST AND CAN ONLY
BE ALTERED IN THE LONG RUN.
 ALSO FIXED COST DOES NOT DEPEND ON THE
AMOUNT PRODUCED.
• SINCE IT CANNOT BE CHANGED IN THE SHORT
RUN, FIXED COST IS IRRELEVANT TO A FIRM’S
DECISION TO PRODUCE OR SHUT DOWN IN THE
SHORT RUN.
• THE SHUT DOWN PRICE
▫ WHEN THE MARKET PRICE IS BELOW THE
MINIMUM AVERAGE VARIABLE COST
 THE PRICE THE FIRM RECEIVES PER UNIT IS
NOT COVERING ITS VARIABLE COST PER UNIT
 FIRM SHOULD CEASE PRODUCTION
IMMEDIATELY BECAUSE THERE IS NO LEVEL
OF OUTPUT AT WHICH THE FIRM’S TOTAL
REVENUE COVERS VARIABLE COST
 IN THIS CASE THE FIRM STILL MAXIMIZES ITS
PROFIT BY NOT PRODUCING
 IT STILL HAS A FIXED COST IN THE SHORT RUN,
BUT WILL NO LONGER HAVE VARIABLE COST.
 THIS MEANS THAT THE MINIMUM AVERAGE
VARIABLE COST DETERMINES THE SHUT DOWN
PRICE.
▫ THE PRICE AT WHICH A FIRM CEASES PRODUCTION
IN THE SHORT RUN.
▫ WHEN THE MARKET PRICE IS GREATER
THAN OR EQUAL TO THE MINIMUM
AVERAGE VARIABLE COST
 THE FIRM MAXIMIZES PROFIT OR MINIMIZES
LOSS BY CHOOSING THE OUTPUT LEVEL AT
WHICH ITS MARGINAL COST IS EQUAL TO
MARKET PRICE.
• SHORT RUN INDIVIDUAL CURVE
▫ SHOWS HOW AN INDIVIDUAL FIRM’S
PROFIT- MAXIMIZING LEVEL OF OUTPUT
DEPENDS ON THE MARKET PRICE, TAKING
FIXED COST AS GIVEN.