Transcript Chap011
Chapter 11: Managerial
Decisions in Competitive Markets
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Perfect Competition
• Firms are price-takers
• Each produces only a very small portion of
total market or industry output
• All firms produce a homogeneous product
• Entry into & exit from the market is
unrestricted
11-2
Demand for a Competitive
Price-Taker
• Demand curve is horizontal at price determined
by intersection of market demand & supply
• Perfectly elastic
• Marginal revenue equals price
• Demand curve is also marginal revenue curve
(D = MR)
• Can sell all they want at the market price
• Each additional unit of sales adds to total revenue an
amount equal to price
11-3
Demand for a Competitive
Price-Taking Firm (Figure 11.2)
Price (dollars)
Price (dollars)
S
P0
P0
D = MR
D
0
Q0
Quantity
Panel A –
Market
0
Quantity
Panel B – Demand curve
facing a price-taker
11-4
Profit-Maximization in the
Short Run
•
In the short run, managers must make two
decisions:
1. Produce or shut down?
If shut down, produce no output and hires no variable
inputs
If shut down, firm loses amount equal to TFC
2. If produce, what is the optimal output level?
If firm does produce, then how much?
Produce amount that maximizes economic profit
Profit = π = TR - TC
11-5
Profit-Maximization in the
Short Run
• In the short run, the firm incurs costs that
are:
• Unavoidable and must be paid even if output
is zero
• Variable costs that are avoidable if the firm
chooses to shut down
• In making the decision to produce or shut
down, the firm considers only the
(avoidable) variable costs & ignores fixed
costs
11-6
Profit Margin (or Average Profit)
• Level of output that maximizes total profit
occurs at a higher level than the output that
maximizes profit margin (& average profit)
• Managers should ignore profit margin (average
profit) when making optimal decisions
( P ATC )Q
Average profit
Q
Q
P ATC Profit margin
11-7
Short-Run Output Decision
• Firm will produce output where P = SMC
as long as:
• Total revenue ≥ total avoidable cost or total
variable cost (TR TVC)
• Equivalently, the firm should produce if
P AVC
11-8
Short-Run Output Decision
• The firm will shut down if:
• Total revenue cannot cover total avoidable cost
(TR < TVC) or, equivalently, P AVC
• Produce zero output
• Lose only total fixed costs
• Shutdown price is minimum AVC
11-9
Fixed, Sunk,& Average Costs
• Fixed, sunk, & average costs are irrelevant
in the production decision
• Fixed costs have no effect on marginal cost or
minimum average variable cost—thus optimal
level of output is unaffected
• Sunk costs are forever unrecoverable and
cannot affect current or future decisions
• Only marginal costs, not average costs,
matter for the optimal level of output
11-10
Profit Maximization: P = $36
(Figure 11.3)
11-11
Profit Maximization: P = $36
(Figure 11.3)
11-12
Profit Maximization: P = $36
(Figure 11.4)
Break-even point
Panel A: Total revenue
& total cost
Break-even point
Panel B: Profit curve
when P = $36
11-13
Short-Run Loss Minimization:
P = $10.50 (Figure 11.5)
Profitcost
= $3,150
Total
= $17 -x$5,100
300
= -$1,950
= $5,100
Total revenue = $10.50 x 300
= $3,150
11-14
Summary of Short-Run
Output Decision
• AVC tells whether to produce
• Shut down if price falls below minimum
AVC
• SMC tells how much to produce
• If P minimum AVC, produce output at
which P = SMC
• ATC tells how much profit/loss if
produce
π = (P – ATC)Q
11-15
Short-Run Supply Curves
• For an individual price-taking firm
• Portion of firm’s marginal cost curve above
minimum AVC
• For prices below minimum AVC, quantity
supplied is zero
• For a competitive industry
• Horizontal sum of supply curves of all
individual firms; always upward sloping
• Supply prices give marginal costs of
production for every firm
11-16
Short-Run Producer Surplus
• Short-run producer surplus is the amount
by which TR exceeds TVC
• The area above the short-run supply curve
that is below market price over the range of
output supplied
• Exceeds economic profit by the amount of
TFC
11-17
Computing Short-Run
Producer Surplus (Figure 11.6)
Producer surplus TR TVC
$9 110 $5.55 110
$990 $610
$380
Or, equivalently,
Producer surplus = Area of trapezoid edba in Figure 11.6
= Height Average base
80 110
($9 $5)
2
$380
$380 multiplied by 100 firms ($380 100) $38,000
11-18
Short-Run Firm & Industry Supply
(Figure 11.6)
11-19
Long-Run Profit-Maximizing
Equilibrium (Figure 11.7)
Profit = ($17 - $12) x 240
= $1,200
11-20
Long-Run Competitive Equilibrium
• All firms are in profit-maximizing
equilibrium (P = LMC)
• Occurs because of entry/exit of firms in/out
of industry
• Market adjusts so P = LMC = LAC
11-21
Long-Run Competitive Equilibrium
(Figure 11.8)
11-22
Long-Run Industry Supply
• Long-run industry supply curve can be flat
(perfectly elastic) or upward sloping
• Depends on whether constant cost industry or
increasing cost industry
• Economic profit is zero for all points on the
long-run industry supply curve for both
types of industries
11-23
Long-Run Industry Supply
• Constant cost industry
• As industry output expands, input prices remain
constant, & minimum LAC is unchanged
• P = minimum LAC, so curve is horizontal
(perfectly elastic)
• Increasing cost industry
• As industry output expands, input prices rise, &
minimum LAC rises
• Long-run supply price rises & curve is upward
sloping
11-24
Long-Run Industry Supply for a
Constant Cost Industry (Figure 11.9)
11-25
Long-Run Industry Supply for an
Increasing Cost Industry (Figure 11.10)
Firm’s output
11-26
Economic Rent
• Payment to the owner of a scarce, superior
resource in excess of the resource’s
opportunity cost
• In long-run competitive equilibrium firms that
employ such resources earn zero economic
profit
• Potential economic profit is paid to the resource
as economic rent
• In increasing cost industries, all long-run producer
surplus is paid to resource suppliers as economic
rent
11-27
Economic Rent in Long-Run
Competitive Equilibrium (Figure 11.11)
11-28
Profit-Maximizing Input Usage
• Profit-maximizing level of input usage
produces exactly that level of output that
maximizes profit
11-29
Profit-Maximizing Input Usage
• Marginal revenue product (MRP)
• MRP of an additional unit of a variable input is the
additional revenue from hiring one more unit of the
input
TR
MRP
P MP
L
• If choose to produce:
• If the MRP of an additional unit of input is greater
than the price of input, that unit should be hired
• Employ amount of input where MRP = input price
11-30
Profit-Maximizing Input Usage
• Average revenue product (ARP)
• Average revenue per worker
TR
ARP
P AP
L
• Shut down in short run if ARP < MRP
• When ARP < MRP, TR < TVC
11-31
Profit-Maximizing Labor Usage
(Figure 11.12)
11-32
Implementing the
Profit-Maximizing Output Decision
• Step 1: Forecast product price
• Use statistical techniques from Chapter 7
• Step 2: Estimate AVC & SMC
• AVC = a + bQ + cQ2
• SMC = a + 2bQ + 3cQ2
11-33
Implementing the
Profit-Maximizing Output Decision
• Step 3: Check shutdown rule
• If P AVCmin then produce
• If P < AVCmin then shut down
• To find AVCmin substitute Qmin into AVC
equation
Qmin
b
2c
2
AVCmin a bQmin cQmin
11-34
Implementing the
Profit-Maximizing Output Decision
• Step 4: If P AVCmin, find output where
P = SMC
• Set forecasted price equal to estimated
marginal cost & solve for Q*
P = a + 2bQ* + 3cQ*2
11-35
Implementing the
Profit-Maximizing Output Decision
• Step 5: Compute profit or loss
• Profit = TR – TC
= P x Q* - AVC x Q* - TFC
= (P – AVC)Q* - TFC
• If P < AVCmin, firm shuts down & profit
is -TFC
11-36
Profit & Loss at Beau Apparel
(Figure 11.13)
11-37
Profit & Loss at Beau Apparel
(Figure 11.13)
11-38