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Transcript of Chapter 8Slide 1 Topics to be Discussed Perfectly Competitive Markets Profit Maximization Marginal...
Chapter 8 Slide 1
Topics to be Discussed
Perfectly Competitive Markets
Profit Maximization
Marginal Revenue, Marginal Cost, and Profit Maximization
Choosing Output in the Short-Run
Chapter 8 Slide 2
Topics to be Discussed
The Competitive Firm’s Short-Run Supply Curve
Short-Run Market Supply
Choosing Output in the Long-Run
The Industry’s Long-Run Supply Curve
Chapter 8 Slide 3
Perfectly Competitive Markets
Characteristics of Perfectly Competitive Markets
1) Price taking
2) Product homogeneity
3) Free entry and exit
Chapter 8 Slide 4
Profit Maximization
Do firms maximize profits?
Possibility of other objectivesRevenue maximizationDividend maximizationShort-run profit maximization
Chapter 8 Slide 5
Profit Maximization
Do firms maximize profits?
Implications of non-profit objectiveOver the long-run investors would not
support the companyWithout profits, survival unlikely
Chapter 8 Slide 6
Marginal Revenue, Marginal Cost,and Profit Maximization
Determining the profit maximizing level of outputProfit ( ) = Total Revenue - Total Cost
Total Revenue (R) = Pq
Total Cost (C) = Cq
Therefore:
)()()( qCqRq
Chapter 8 Slide 7
Marginal revenue is the additional revenue from producing one more unit of output.
Marginal cost is the additional cost from producing one more unit of output.
Marginal Revenue, Marginal Cost,and Profit Maximization
Chapter 8 Slide 8
Profits are maximized when MC = MR.
Marginal Revenue, Marginal Cost,and Profit Maximization
R(q)
0
Cost,Revenue,
Profit$ (per year)
Output (units per year)
C(q)
A
B
q0 q*
)(q
Chapter 8 Slide 9
orq
C
q
R 0
q
: whenmaximized are Profits
MC(q)MR(q)
MCMR
thatso0
Marginal Revenue, Marginal Cost,and Profit Maximization
Chapter 8 Slide 10
The Competitive Firm
Price taker
Market output (Q) and firm output (q)
Market demand (D) and firm demand (d)
R(q) is a straight line
Marginal Revenue, Marginal Cost,and Profit Maximization
Chapter 8 Slide 11
q0
Lost profit forqq < q*
Lost profit forq2 > q*
q1 q2
A Competitive FirmMaking a Positive Profit
10
20
30
40
Price($ per
unit)
0 1 2 3 4 5 6 7 8 9 10 11
50
60MC
AVC
ATCAR=MR=P
Outputq*
At q*: MR = MCand P > ATC
ABCDor
qx AC) -(P *
D A
BC
q1 : MR > MC andq2: MC > MR andq0: MC = MR but
MC falling
Chapter 8 Slide 12
Would this producercontinue to produce with a loss?
A Competitive FirmIncurring Losses
Price($ per
unit)
Output
AVC
ATCMC
q*
P = MR
B
F
C
A
E
DAt q*: MR = MCand P < ATCLosses = P- AC) x q* or ABCD
Chapter 8 Slide 13
Choosing Output in the Short Run
Summary of Production Decisions
Profit is maximized when MC = MR
If P > ATC the firm is making profits.
If AVC < P < ATC the firm should produce at a loss.
If P < AVC < ATC the firm should shut-down.
Chapter 8 Slide 14
Price($ per
unit)
MC
Output
AVC
ATC
P = AVC
P1
P2
q1 q2
S = MC above AVC
A Competitive Firm’sShort-Run Supply Curve
Shut-down
Chapter 8 Slide 15
The short-run market supply curve shows the amount of output that the industry will produce in the short-run for every possible price.
Consider, for simplicity, a competitive market with three firms:
The Short-Run Market Supply
Chapter 8 Slide 16
MC3
Industry Supply in the Short Run
$ perunit
0 2 4 8 105 7 15 21
MC1
SSThe short-runindustry supply curve
is the horizontalsummation of the supply
curves of the firms.
Quantity
MC2
P1
P3
P2
Question: If increasingoutput raises inputcosts, what impactwould it have on market supply?
Chapter 8 Slide 17
Perfectly inelastic short-run supply arises when the industry’s plant and equipment are so fully utilized that new plants must be built to achieve greater output.
Perfectly elastic short-run supply arises when marginal costs are constant.
The Short-Run Market Supply Curve
Chapter 8 Slide 18
Producer Surplus in the Short RunFirms earn a surplus on all but the last unit
of output.
The producer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.
The Short-Run Market Supply Curve
Chapter 8 Slide 19
AA
DD
BB
CC
ProducerProducerSurplusSurplus
Alternatively, VC is thesum of MC or ODCq* .R is P x q* or OABq*.Producer surplus =
R - VC or ABCD.
Producer Surplus for a Firm
Price($ per
unit ofoutput)
Output
AVCAVCMCMC
00
PP
qq**
At q* MC = MR.Between 0 and q ,
MR > MC for all units.
Chapter 8 Slide 20
Producer Surplus in the Short-Run
The Short-Run Market Supply Curve
VC- R PS Surplus Producer
FC - VC- R - Profit
Chapter 8 Slide 21
DD
PP**
QQ**
ProducerProducerSurplusSurplus
Market producer surplus isthe difference between P*
and S from 0 to Q*.
Producer Surplus for a Market
Price($ per
unit ofoutput)
Output
SS
Chapter 8 Slide 22
Choosing Output in the Long Run
Entry and ExitThe long-run response to short-run profits
is to increase output and profits.
Profits will attract other producers.
More producers increase industry supply which lowers the market price.
Long-Run Competitive EquilibriumLong-Run Competitive Equilibrium
S1
Long-Run Competitive Equilibrium
Output Output
$ per unit ofoutput
$ per unit ofoutput
$40LAC
LMC
D
S2
P1
Q1q2
Firm Industry
$30
Q2
P2
•Profit attracts firms•Supply increases until profit = 0
Chapter 8 Slide 24
Choosing Output in the Long Run
Long-Run Competitive Equilibrium
1) MC = MR
2) P = LAC
No incentive to leave or enter
Profit = 0
3) Equilibrium Market Price
Chapter 8 Slide 25
Choosing Output in the Long Run
Economic RentEconomic rent is the difference between
what firms are willing to pay for an input less the minimum amount necessary to obtain it.
Chapter 8 Slide 26
Choosing Output in the Long Run
An Example
Two firms A & B
Both own their land
A is located on a river which lowers A’s shipping cost by $10,000 compared to B.
The demand for A’s river location will increase the price of A’s land to $10,000
Chapter 8 Slide 27
Choosing Output in the Long Run
An Example
Economic rent = $10,000
$10,000 - zero cost for the land
Economic rent increases
Economic profit of A = 0
If the opportunity cost of the input (rent) is not taken into consideration it may appear that economic profits exist in the long-run.
AP1
AC
P1
MC
q1
D1
S1
Q1
C
D2
P2P2
q2
B
S2
Q2
Economic profits attract newfirms. Supply increases to S2 and
the market returns to long-run equilibrium.
Long-Run Supply in aConstant-Cost Industry
Output Output
$ per unit ofoutput
$ per unit ofoutput
SL
Q1 increase to Q2.Long-run supply = SL = LRAC.
Change in output has no impact on input cost.
Chapter 8 Slide 29
Effect of an Output Tax on a Competitive Firm’s Output
Price($ per
unit ofoutput)
Output
AVC1
MC1
P1
q1
The firm willreduce output to
the point at whichthe marginal cost
plus the tax equalsthe price.
q2
tt
MC2 = MC1 + tax
AVC2
An output taxraises the firm’s
marginal cost by theamount of the tax.
Chapter 8 Slide 30
Effect of an OutputTax on Industry Output
Price($ per
unit ofoutput)
Output
DD
P1
SS1
Q1
P2
Q2
SS2 = S1 + t
t
Tax shifts S1 to S2 andoutput falls to Q2. Price
increases to P2.
Chapter 8 Slide 31
Summary
In the short run, a competitive firm maximizes its profit by choosing an output at which price is equal to (short-run) marginal cost.
The short-run market supply curve is the horizontal summation of the supply curves of the firms in an industry.
Chapter 8 Slide 32
Summary
The producer surplus for a firm is the difference between revenue of a firm and the minimum cost that would be necessary to produce the profit-maximizing output.
Economic rent is the payment for a scarce resource of production less the minimum amount necessary to hire that factor.
Chapter 8 Slide 33
Summary
In the long-run, profit-maximizing competitive firms choose the output at which price is equal to long-run marginal cost.
The long-run supply curve for a firm can be horizontal, upward sloping, or downward sloping.