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Today Perfect competition Profit-maximization in the SR The firm’s SR supply curve The industry’s SR supply curve Perfect Competition Chapter 21 Market Structure Market Structure: the key features of a market, including: – # of firms – type of product – nature of firm’s cost – # of buyers Market structure is usually defined in terms of sellers. Four Basic Models A Rule of Thumb The fewer the firms in the market, the more control each firm has over price. Perfect Competition Perfect Competition: Five Assumptions Homogeneous Product: Goods produced by different sellers are perceived to be identical by consumers. Perfect Information about Prices Given the first two assumptions, will a seller be able to sell his product for a price higher than his competitors? Assumptions 3-5 The market is large enough to support many sellers. The firms are price takers: they acts as if their own output has no effect on price. No barriers to entry: firms can enter and exit the market freely. Examples of Perfectly Competitive Industries wheat, corn, etc. steel coal Revenue (assuming fixed price per unit) Total Revenue (TR) = price x quantity sold (PQ) Average Revenue (AR) = (TR/Q) = (PQ/Q) = P Marginal Revenue (MR) = DTR/DQ the change in TR when output rises by one unit. Profits = TR - TC (or TR - TFC - TVC) Note on Marginal Revenue The above definition is a general definition of MR that works for all industry structures. In perfect competition, since firms are price takers, MR = P = AR. For any other market structure, MR < P. Demand for a Particular Firm’s Output P Typical Firm P d = AR = MR P* Industry or Market S P* D q Q* The price-taking firm faces a perfectly elastic demand for its product at the market price. Q Short-Run Production Decisions Decision 1 Should the firm produce anything? Produce if: profit producing > profit not producing TR - TFC - TVC > 0 - 0 -TFC TR > TVC TR/Q > TVC/Q Produce in SR if P > AVC Graph of Decision 1 P Typical Firm AV C P1 Produce P2 Don’t Produce q Decision 2 If the firm does produce in the SR, then: Decision 2: How much should it produce in the SR? max profits = max (TR - TFC - TVC) Given TFC do not vary with output, we can ignore them when choosing output. If we choose q to maximize TR- TVC, we will also be maximizing profits. Total Revenue on Graph of Marginal Revenue P P = AR = MR q TR is the area under MR. Total Variable Cost on Graph of Marginal Cost P MC q TVC is the area under MC. Total Revenue Minus Total Variable Cost on Graph P Profit over operating costs. MC MR = P = AR q q* If we maximize TR - TVC then we will maximize profits. TR - TVC is maximized when MR = MC. The Firm’s Profit-Maximizing Rule Choose quantity where MR = MC (given MC is sloping upward and AVC are covered). Price-Taking and ProfitMaximization For price-taking firms, MR = P. Maximize profits by choosing q where MC = P. The Firm’s Supply Curve The firm’s supply curve tells how much the firm will produce in the short run at every possible price, given a fixed plant size. Graphing the Firm’s Supply Curve P MC AVC P0 q Graphing the Firm’s Supply Curve P MC AVC P1 P0 q Graphing the Firm’s Supply Curve P MC AVC P2 P1 P0 q Graphing the Firm’s Supply Curve P P3 MC AVC P2 P1 P0 q Graphing the Firm’s Supply Curve P P3 SRS MC AVC P2 P1 P0 q Firm’s SR Supply Curve The firm’s supply curve is equal to its MC curve above AVC. P1 is sometimes called the “shutdown point” because if price falls below P1, the firm shuts down in the short run. Industry Short Run Supply Curve Industry SR Supply Curve: tells us how much the industry will produce at every possible price, given fixed plant sizes and a fixed number of firms. Deriving Industry Supply P Firm 1 3 P mc1 P Firm 2 mc2 Industry SRS 2 1 10 22 15 15 20 17 q 25 32 42 Q The industry supply curve is the horizontal summation of the firms’ marginal cost curves (above their AVC curves). Next Time SR market equilibrium Changes in equilibrium LR equilibrium Group Work The firm’s SR supply curve. The Industry’s SR supply curve. The Price-Taking Firm’s SR Supply Curve Look at the graph (next slide) to answer these questions: In the short run, if the market price is $3, what quantity will the firm produce? _____ In the short run, if the market price is $5.25, what quantity will the firm produce? _____ In the short run, if the market price is $7.50, what quantity will the firm produce? _____ Trace out the firm's short-run supply curve. Firm’s SR Supply Curve $/q 12 MC 10 8 ATC AVC 6 4 2 0 0 2 4 6 8 10 12 14 16 18 20 22 24 Quantity Short Run Industry Supply Suppose that there are 100 price-taking firms in this industry and all have identical cost curves to the firm depicted in the graph. Draw the short-run industry supply curve in the right-hand panel of the next slide. Be sure to use the scale provided. Short Run Industry Supply $/q 12 MC Typical Firm Industry 10 8 ATC 6 AVC 4 2 0 0 2 4 6 8 10 12 Quantity 0 200 400 600 800 1000 Quantity