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Perfect Competition Chapter 11 Profit Maximization • Economic profit is total revenue less total costs which consist of implicit and explicit costs. • Economic profit differs from accounting profit in that accounting profit does not consider implicit costs. • Normal profit is the opportunity cost of the resources owned by the firm • Assumption of profit maximization What is a perfectly competitive firm? A firm with the following attributes: 1. Standardized product 2. A price taker 3. Factors of production are mobile in the long-run 4. The firm and consumers have perfect information 2 assumptions about short-run production 1. Number of firms is fixed 2. Each firm has some fixed inputs Profit maximization in the short-run We ask the question: How does a firm choose a level of output in the short-run with the objective of maximizing profit? 1. Compare total revenue and total cost 2. Compare marginal revenue and marginal cost Where is the short-run supply curve? It is represented by the upward sloping section of the marginal cost curve beginning where AVC = MC. Short-run industry supply The horizontal aggregate of individual firm supply curves. The short-run competitive equilibrium How is price determined in the short-run? Is the short-run competitive equilibrium efficient? A competitive equilibrium is allocatively efficient when there is no room for further mutually beneficial exchange. Producer Surplus A measure of “how much better off a firm is as a result of having supplied its profit maximizing level of output”. Perfect Competition in the long-run Firms may enter and leave the industry. Firms may change their scale of production by changing all inputs. Firms earning a loss will shut down. Adjustment process from short-run to long-run How long will it take? Depends on • Degree that firms are identical in technology, cost structure, and efficiency. • How long does it take to adjust capital stock? • How long does it take for new firms to enter? Socially desirable properties of the long-run outcome • P=MC in short-run and long-run – Allocative efficiency • Mutual gains to buyers and sellers are maximized. • All firms earn an economic profit of zero – Buyers do not pay more than what it costs the firms to produce. There is no such thing as a free market • The market is not costless The long-run market supply curve Varies depending on cost conditions 3 cases – All firms have identical LAC curves – All firms have horizontal LAC curves – Changing input prices Price elasticity of supply • A measure of responsiveness of quantity supplied to changes in prices