Download LECTURE #12: MICROECONOMICS CHAPTER 14

LECTURE #12: MICROECONOMICS
CHAPTER 14
Competitive Markets
Profit Maximization
Supply Function
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Firms in Competitive Markets
A. The Meaning of Competition
1. Competitive Market: a market with many
buyers and sellers trading identical products
so that each buyer and seller is a price taker.
2. There are three characteristics of a
[perfectly] competitive market
a. There are many buyers and sellers.
b. Goods offered by the sellers are largely the same.
c. Firms can freely enter or exit the market.
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Firms in Competitive Markets
B. The Revenue of a Competitive Firm
1. Total Revenue: Price times Quantity. TR = P
xQ
2. Average Revenue: Total Revenue divided by
Quantity sold. AR = TR / Q
3. Marginal Revenue: Change in Total Revenue
from additional unit sold.
MR = DTR / DQ
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Profit Maximization
Vaca Family Dairy Farm
Q
0
1
2
3
4
5
6
7
8
1.
2.
Total
Revenue
$0
6
12
18
24
30
36
42
48
Total
Cost
$3
5
8
12
17
23
30
38
47
Profit
$-3
1
4
6
7
7
6
4
1
Marginal
Revenue
---$6
6
6
6
6
6
6
6
Marginal
Cost
---$2
3
4
5
6
7
8
9
Change in
Profit
---$4
3
2
1
0
-1
-2
-3
Profit is maximized if the farm produces 4 or 5 gallons of milk
(see Profit column).
Profit-Maximizing quantity occurs when marginal revenue =
marginal cost.
a.
b.
c.
If MR exceeds MC, increasing output will increase profit
If MR is less than MC, firm will increase profit by decreasing
output.
Profit-maximization occurs where MR is equal to MC.
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Profit Maximization and
Competitive Firm's Supply Curve
B. The Marginal-Cost Curve and the Firm's
Supply Decision
1.
Cost curves have special features that are important
for our analysis.
a.
b.
c.
2.
3.
The marginal-cost curve is upward sloping.
The average-total-cost curve is U-shaped.
The marginal-cost curve crosses the average-total-cost
curve at the minimum of average total cost.
Marginal and average revenue can be shown by a
horizontal line at the market price
To find the profit-maximizing level of output, we
can follow the same rules that we discussed above.
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Profit Maximization
a.
If MR is greater than MC, the firm should increase its output.
–
b.
If MC is greater than MR, the firm should decrease its output.
–
c.
4.
MR1 > MC1
MR2 < MC2
IF MR = MC, then firm is at profit-maximizing level of output
These rules apply to competitive firms, and firms with market
power.
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Profit Maximization
4.
If market price changes, the firm would set its new
level of output by equating marginal revenue and
marginal cost.
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Decision to Shut-Down, Enter or Exit
A. The Firm's Short-Run Decision to Shut Down
1.
2.
In certain circumstances, a firm will decide to shut
down and produce zero output.
There is a difference between a temporary shutdown
and an exit from the market.
a.
b.
c.
d.
A shutdown refers to a short-run decision not to produce
anything during a specific period of time because of
current market conditions.
Exit refers to a long-run decision to leave the market.
If a firm shuts down temporarily, it still must pay fixed
costs.
If a firm exits the industry in the long run, it has no costs.
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Decision to Shut-Down, Enter or Exit
3.
4.
5.
6.
If a firm shuts down, it will earn no revenue and will
have only fixed costs
A firm will shut down if sales revenue less than its
variable costs of production: Shut down if TR < VC.
Because TR = P x Q and VC = AVC x Q, we can
rewrite this condition as: Shut down if P < AVC.
We now can tell exactly what the firm will do to
maximize profit (or minimize loss).
a.
b.
If the price is less than average variable cost, the firm will
produce no output.
If the price is above average variable cost, the firm will
produce the level of output where marginal revenue (price)
is equal to marginal cost
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Decision to Shut-Down, Enter or Exit
If P ≥ AVC, then Firm will set output where MR = MC
IF P < AVC, then Firm will Shut-Down – Zero Output
7.
Therefore, the competitive firm's short-run supply
curve is the portion of its marginal revenue curve
that lies above average variable cost.
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Decision to Shut-Down, Enter or Exit
B. The Firm's Long-Run Decision to Exit or Enter
a Market
1.
2.
3.
4.
If a firm exits the market, it will earn no revenue,
but it will have no costs as well.
Therefore, a firm will exit if the revenue that it
would earn from producing is less than its total
costs: Exit if TR < TC.
Because TR = P x Q and TC = ATC x Q, we can
rewrite this condition as: Exit if P < ATC.
A firm will enter an industry when there is profit
potential, so this must mean that a firm will enter if
revenues will exceed costs: Enter if P > ATC
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Decision to Shut-Down, Enter or Exit
5. In the long run, a firm will remain in a
market only if P ≥ ATC, the firm's long-run
supply curve will be that portion of its
marginal cost curve above the ATC.
If:
P > ATC
P = ATC
P < ATC
The Firm Will:
Enter because economic profits are earned
Not enter or exit because economic profits
are zero
Exit because economic losses are incurred
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Decision to Shut-Down, Enter or Exit
C. Measuring Profit in Our Graph for the
Competitive Firm
1. Recall that Profit = TR −TC.
2. Because TR = P x Q and TC = ATC x Q, we
can rewrite this equation:
Profit = (P – ATC) x Q.
3. Using the Profit equation, we can measure
the amount of profit (or loss) at the firm's
profit-maximizing level of output (or lossminimizing level of output)
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Decision to Shut-Down, Enter or Exit
14
Supply Curve in a Competitive Market
A.
The Short Run: Market Supply with a Fixed Number of
Firms
1.
2.
3.
Example: a market with 1,000 identical firms
Each firm's short-run supply curve is its MC curve above
average variable cost.
Market supply curve: add Q supplied by each firm in the
market at every given price.
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Supply Curve in a Competitive Market
B.
The Long Run: Market Supply with Entry and Exit
1.
If firms in an industry are earning profit, this will attract new
firms.
a.
b.
2.
If firms in an industry are incurring losses, firms will exit.
a.
b.
3.
The supply of the product will increase (the supply curve will shift
to the right).
The price of the product will fall and profit will decline.
The supply of the product will decrease (the supply curve will
shift to the left).
The price of the product will rise and losses will decline.
At the end of this process of entry or exit, firms that remain in
the market must be earning zero economic profit.
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Supply Curve in a Competitive Market
4.
5.
6.
7.
Because Profit = TR –TC, profit will be zero when TR = TC.
Because TR = P x Q and TC = ATC x Q, we can rewrite this as: P =
ATC.
Therefore, the process of entry or exit ends when Price and ATC
become equal.
This implies that the long-run equilibrium of a competitive market
must have firms operating at their efficient scale.
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Supply Curve in a Competitive Market
C. Why Do Competitive Firms Stay in
Business If They Make Zero Profit?
1. Profit is equal to total revenue minus total
cost.
2. To an economist, total cost includes all of
the opportunity costs of the firm.
3. When a firm is earning zero economic profit,
the firm's revenues are compensating the
firm's owners for their opportunity costs.
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Homework
A. Questions for Review: 1, 3, 4, 5 (4th Ed: 1,
2, 3, 4)
B. Problems and Applications: 3, 4, 6, 12
(4th Ed: 4, 5, 7, 11)
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