Download Unit 6 - Profit Maximization in Pure Competition

Unit 6 - Profit Maximization of a
Purely Competitive Firm

Types of Industries
We distinguish between four types of industries:
1. Pure (Perfect) Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Pure Competition
1.
2.
3.
4.
A purely competitive
industry has the following
characteristics:
Many sellers
Low barriers to enter
Competitors’ products are identical
Buyers have perfect information
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Profit Maximization
Profit = Total Revenue (TR) - Total Cost (TC)
Example 1
A firm sells 100 products at $2.00 each. Its total
cost is $160. What is its profit?
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Profit Maximization
Example 1 answer
Profit = TR – TC
TR = P x Q = $2 x 100 = $200
Profit = $200 - $160 = $40
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Marginal and Average Revenue
Because one firm in pure competition is a small
part of the entire market, it can supply more
products to the market without significantly
affecting the supply and the price.
For example, if the market price is $2, then a
purely competitive firm can sell 100 products at
$2, 110 products at $2, or 120 products at $2.
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Marginal and Average Revenue
Marginal revenue is the additional revenue per
product. For example, if at Q = 100, TR =
$200, and at Q = 110, TR = $220, then MR =
$20 / 10, or $2.
Average revenue is the revenue per product. If
at Q = 100, TR = $200, then AR = $200 / 100,
or $2.
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Marginal and Average Revenue
Demand and revenue for a purely competitive firm, which
sells a product at $2 is as follows:
Q
Price TR
MR
AR
0
$2
$0
-
-
100
$2
$200 $2
$2
110
$2
$220 $2
$2
120
$2
$240 $2
$2
130
$2
$260 $2
$2
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

A Purely Competitive Firm’s Total Revenue Curve
Price,
Revenue
Total Revenue
240
220
200
100 110
120 Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

A Purely Competitive Firm’s Demand, Marginal,
and Average Revenue Curves
Demand,
AR, MR
2.00
D = MR = AR
100 110 120
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

A Purely Competitive Firm’s Cost and Revenue
Curves
AR, MR,
Price, Costs
MC
ATC
2.00
D = MR = AR
AVC
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Profit-maximizing Quantity
AR, MR,
Price, Costs
MR=MC
MC
ATC
2.00
D = MR = AR
AVC
Qpm
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Profit Area
AR, MR,
Price, Costs
MC
MR=MC
ATC
2.00
1.80
D = MR = AR
AVC
100
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Case of a Loss
AR, MR,
Price, Costs
MC
1.60
AVC
Ql
m
ATC
D = MR = AR
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Case of a Loss and a Shut-down
AR, MR,
Price, Costs
MC
ATC
AVC
1.20
D = MR = AR
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Long-run Equilibrium Price and Quantity
AR, MR,
Price, Costs
MC
ATC
AVC
1.75
D = MR = AR
Qlr
Quantity
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Farming Industry
Characteristics of farming industries in
industrialized countries include:
1. There are many farmers.
2. There are relatively low barriers to
enter the farming industry.
3. Farmers competing in the same market
sell identical or nearly identical products.
4. Buyers of agricultural products have significant
information about the product.
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Farming Industry and Elasticity
Supply of agricultural products has increased
considerably during the past century.
Demand for agricultural products has increased as
well, but not as much supply, because:
Income inelasticity of demand for food is low.
Price elasticity of demand for food is low.
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Farming Industry

Revenue (TR) of many farmers has decreased,
because real prices (P) have decreased.
TR = P x Q
P has decreased considerably. Q (quantity sold)
has increased, but less than proportionately.
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm

The Farming Industry
In industrialized countries, the following programs
have been implemented:
1. Price Supports
2. Acreage Restrictions
3. Target Prices
4. Direct Subsidies and Loan Programs
5. Foreign Import Restrictions
Microeconomics
Unit 6 - Profit Maximization of a
Purely Competitive Firm
Price
Per Bushel
D
surplus
S
$5.00
$3.00
10 12
Price Supports
15
Quantity
Demanded
of Wheat in
Hundreds
Unit 6 - Profit Maximization of a
Purely Competitive Firm
Price
Per Bushel
S2
S1
$6.00
$3.00
D
10
Acreage Restrictions
12
Quantity
Demanded
of Wheat in
Hundreds
Unit 6 - Profit Maximization of a
Purely Competitive Firm
Price
Per Bushel
D
S
$4.50
Deficiency
Payment of
$4.50 - $1.50
= $3.00
$3.00
$1.50
Target Prices
12
15
Quantity
Demanded
of Wheat in
Hundreds
Unit 6 - Profit Maximization of a
Purely Competitive Firm

Other Farm Subsidy Programs
Direct subsidies and soft loans to farmers increase
farmers’ incomes and raise taxes.
Import restrictions support domestic farmers by
restricting competition and supply. Consumers pay
higher prices.
Yearly cost of U.S. farm programs is
approximately $20 billion.
Microeconomics