Download perfectly competitive firm`s supply curve

Economics 2010
Lecture 12
Perfect Competition
Competition
 Perfect
Competition
 Firms Choices in Perfect Competition
 The Firm’s Short-Run Decision
 The Firm’s Supply Curve
 The Industry Supply Curve
Perfect Competition
 Perfect
competition occurs in a market
where:




There are many firms, each selling an identical
product
There are many buyers
Firms in the industry have no advantage over
potential new entrants (no barriers to entry)
Firms and buyers are well informed about the
prices of the products of each firm in the industry
Perfect Competition
 In
perfect competition, each firm is a price
taker
 Examples of firms in perfect competition:



Wheat farms
Fisheries
Paper
Firms Choices in Perfect
Competition
 In
a perfectly competitive market, a firm
must make four key decisions:




Whether to enter the industry
If enter, whether to stay in the industry or
leave it
If stay, whether to produce or to temporarily
shut down
If produce, how much to produce (and how
to produce it)
Firms Choices in Perfect
Competition
 In


the short run we can only choose:
whether to produce or to temporarily shut
down
If we do produce, how much to produce
The Firm’s Short-Run
Decision
 All
decisions are about profit--which
action makes the maximum profit
Economic profit =
total revenue - total cost
 Total revenue = Price x Quantity
 [Remember, total cost includes normal
profit, an opportunity cost]
Normal profit
The entrepreneurial ability and time of the
entrepreneur needs to be rewarded by the
normal profit in an industry
 Risky industries, or industries which demand
high entrepreneurial skills are probably
paying off higher profits
 Also remember that any money you invest
has a opportunity cost because you could
have invested it in your next best option
instead

Revenue in Perfect Competition
 The
revenue curves in perfect
competition are:



Average revenue
Marginal revenue
Total revenue
 The
following figure shows the revenue
curves of a firm in perfect competition
Revenue in Perfect Competition
 First,
market’s
or industry’s
demand and
market supply
determine the
price that the
firm takes as
given
Revenue in Perfect Competition
 The
firm can
sell any
quantity it
chooses at
this price
Revenue in Perfect Competition
 The
demand
curve the firm
faces is
perfectly
elastic
 Average
revenue (AR)
= marginal
revenue (MR)
Revenue in Perfect Competition
 The
firm’s total
revenue curve is
linear
 An increase in
the quantity sold
brings a
proportional
increase in total
revenue (TR)
The Firm’s Short-Run Decision
 The
firm’s short-run problem is to
choose the output that maximizes
profit.
 We can solve this problem by
looking at either:


total cost and total revenue, or
marginal cost and marginal revenue
The Firm’s Short-Run Decision



This figure shows the
firm’s profit maximizing
output by using total
cost and total revenue
At low output rates, the
firm incurs an economic
loss
The reason is that it has
some fixed costs,
remember?
The Firm’s Short-Run Decision



At an output rate of
4 sweaters a day,
the firm breaks even
At output rates
above 12 sweaters
a day, the firm again
incurs an economic
loss
This time, the
reason is now
diminishing returns,
remember?
The Firm’s Short-Run Decision




At 12 sweaters a
day, the firm breaks
even
Between 4 and 12
sweaters a day, the
firm makes an
economic profit
The maximum profit
occurs at 9
sweaters a day
Here, total revenue
is $225, total cost is
$183, and economic
profit is $42
The Firm’s Short-Run Decision
 Here
we derive
the firm’s profit
maximizing
output by using
the profit curve
 The profit curve
reaches its
maximum at 9
sweaters a day
The Firm’s Short-Run Decision
 Now
we show
profit maximizing
output by using
marginal
analysis
 Marginal
revenue equals
marginal cost
The Firm’s Short-Run Decision
 Profit
maximization does not guarantee
a profit
 When price equals marginal cost,
average total cost, ATC, can be greater
than, equal to, or less than price
 Profit maximization can mean loss
minimization
The Firm’s Short-Run Decision
 The
following figures show the three
possible outcomes:



economic profit
break even
economic loss
ATC is less
than AR (price)
The Firm’s Short-Run Decision
 Here,
the firm
breaks even
 The price is $20
and the profitmaximizing
quantity is 8
 ATC equals AR
The Firm’s Short-Run Decision
 Here,
the firm
incurs an
economic loss
 The price is $17
and the profitmaximizing
quantity is 7
 ATC exceeds
AR
The Firm’s Short-Run Decision
 The
shutdown point is the point at which
the firm's maximized profit is the same
regardless of whether the firm produces or
temporarily shuts down
 The shutdown point is the point of
minimum average variable cost
The Firm’s Short-Run Decision
 If
price equals minimum AVC, the profit is
the same from producing as from shutting
down temporarily and paying the fixed
costs
 Either way, the firm incurs a loss equal to
total fixed cost
 If the firm produced with AVC greater than
price, its loss would exceed total fixed cost
The Firm’s Short-Run Decision
 Let
us show
the shutdown
decision and
the
shutdown
point
The Firm’s Supply Curve
A
perfectly competitive firm's supply
curve shows how the firm's profit
maximizing output varies as the market
price varies
 A perfectly competitive firm's supply
curve is the firm's marginal cost curve
above the point of minimum average
variable cost
The Firm’s Supply Curve
 This
shows
the firm’s
supply curve
 We begin
with the firm’s
cost curves in
part (a)
The Firm’s Supply Curve
 For
prices
above
minimum AVC,
a change in
price brings a
change in the
quantity
supplied along
the MC curve
The Firm’s Supply Curve
 At
minimum
AVC, the firm
is indifferent
between
supplying 7
and supplying
zero
 Both are points
on the firm’s
supply curve
The Firm’s Supply Curve




But nothing in
between 7 and zero
is on the supply
curve
The firm will never
supply 1,…,6
sweaters a day
At prices below
minimum AVC, the
quantity supplied is
zero
Let’s look at the
supply curve
The Firm’s Supply Curve
 At
prices below
minimum AVC,
the quantity
supplied is zero
along the price
axis.
 Then there is a
jump from zero
to the shutdown
point
The Firm’s Supply Curve
 And
at prices
above minimum
AVC, the
quantity
supplied is
traced by the
MC curve
The Industry Supply Curve
 The
short-run industry supply curve
 The horizontal sum of the firm’s supply
curves
The Industry Supply Curve
 This
figure
shows the
industry supply
curve
 It is like the
firm’s curve
except it has
no break at the
shutdown price
Next
Industry equilibrium
in the short run and
the long run