Download Q 1 - The Ohio State University

ECONOMICS 200
PRINCIPLES OF MICROECONOMICS
Professor Lucia F. Dunn
Department of Economics
1
Market Structure
• Refers to the degree of competitiveness in the
market for any commodity.
• The concept “market” is defined by a particular
kind of product or service.
— is interchangeable with the word “industry”.
2
Perfect Competition
A. Characteristics
1. Homogeneous Products
2. Customer Information
3. Output of firm at minimum of LRAC is
small relative to the industry.
4. Price Taker (or Quantity Searcher)
5. Free Entry and Exit
3
Perfect Competition
B. If firm is a price taker, its actions have no noticeable
impact on prices.
— Firm feels it must always sell at the going market price.
 So demand curve is horizontal  Perfectly Elastic
p

p
D
0
Q1
Q2
Q3
Q
4
Perfect Competition
C. Aggregate over all small competitive firms gives the
“industry” or “total market” demand curve.
p
Total Market Demand
0
Q
Competitive Industry Demand Curve
5
Perfect Competition
D. How is the going market price determined?
p
p
S


p
p
D
D
0
Q
Industry
0
Q
Individual Competitive Firm
6
Revenue Concepts
1. Total Revenue (or Total Expenditure)
TR  P  Q
2. Average Revenue
TR
P Q
AR 

 P
Q
Q
3. Marginal Revenue
MR = Change in revenue that comes from
selling an extra unit
TR
MR 
Q
7
Perfect Competition
For Competitive Firm: Demand = Price = AR = MR
p

D = AR = MR
p
0
Q
8
Rule for Profit-Maximization
(All Type of Firms)
I. Should shut down if:
TVC > TR or AVC > AR = P
So if AVC > P  Shut Down.
II. Firm should expand production up to the point
where:
MC = MR
9
Rule for Profit-Maximization (2)
(All Type of Firms)
p
MC
Loss
MR=AR=P=D

0
Q1 Q* Q2
Q
10
Profit-Maximization for Competitive Firm
p
MC
AVC
D=P=MR=AR
QE
0
Q
1. P > AVC
2. MC = MR or MC = P since MR = P
QE is an equilibrium point.
– Market forces will automatically keep the firm at that point.
11
Profit-Maximization for Competitive Firm
Supply for competitive firm is same as its MC curve above AVC.
p
MC
AVC
4
p4
p3
3
2
p2
1
p1
po
0
Q1 Q2Q3Q4
– with Po , firm will shut down.
D4 = MR4
D3 = MR3
D2 = MR2
D1 = MR1
Do = MR0
Q
12
Profit-Maximization for Competitive Firm
p
S
4
p4
p3
3
2
p2
1
p1
0
Q1
Q2 Q3Q4
Q
13
Profit-Maximization for Competitive Firm
Result:
The Supply Curve of a perfectly
competitive firm is identical to its
Marginal Cost curve in the range
above the average variable cost.
Wow!! MC
and Supply
Curve!!
14
Profit Short-Run Equilibrium of Competitive Firm
p
MC
ATC
B
p1
D1 = MR1
A
C
0
Q1
Q
 = TR – TC
TC =ATC  Q
So:  = OP1BQ1 – OACQ1
= AP1BC (Shaded Area)
15
Reaching Long-Run Equilibrium of Competitive Firm
With positive , new firms enter industry and price
will fall as supply shifts right.
p
S1
1
S2
p1
2
p2
D
Q
Price will fall.
16
Reaching Long-Run Equilibrium of Competitive Firm
So for individual firm :
p
MC
SRATC
p1
D1 = MR1
p2
D2 = MR2
A
p3
D3 = MR3
0
• Price and demand will continue to
shift downward until  = 0.
At Q3 : TR = OP3AQ3
Q3
Q
* For competitive firm there is zero
economic profit in the long-run
equilibrium.
TC = OP3AQ3
So:
=0
17
Short-Run Equilibrium of Competitive Firm with Losses
p
MC
SRATC
C
B
p1
A
0
D1=MR
Q1
Q
 = TR – TC
= OP1AQ1 – OBCQ1
= P1BCA (Shaded Area is loss)
18
Reaching Long-Run Equilibrium of Competitive Firm
When loss occurs, firms will exit industry.
 Supply will shift left.
p
S2
S1
2
p2
1
p1
D
Q
Price will rise.
19
Reaching Long-Run Equilibrium of Competitive Firm
So price and demand will rise until the loss is eliminated.
p
MC
SRATC
p3
D3 = MR3
p2
D2 = MR2
p1
D1 = MR1
0
Q3
Q
Things settle down and reach long-run equilibrium at Q3
with P3 and  = 0.
20
Profit-Maximization for Competitive Firm
NOTE: In the long run, the demand curve is just tangent to
SRATC curve.
 It will be tangent at the minimum point of SRATC.
(It is geometric fact that when a U-shaped curve is tangent
to a horizontal line, it is tangent at its minimum point).
SRATC3
SRATC2
SRATC1
$ (Costs)
LRATC
MC
0
QMIN
Q (Output)
21
Profit-Maximization for Competitive Firm
• So in the long run equilibrium in competitive
industries, firm produce at the minimum point of
both the short-run and long-run ATC curve.
 Very Efficient
Long-Run
Equilibrium
Is Efficient!
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