Perfectly competitive market
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Transcript Perfectly competitive market
Chapter 6
Production Decisions
in a
Perfectly Competitive
Market
Chapter 6
Production
Cost
Production decisions in a perfectly
competitive market
Production decisions
in other market structures
Monopoly
Monopolistic Competition
Oligopoly
Perfect Competition
Perfectly competitive market: all
participants are price-takers
Perfectly competitive industry: all
producers are price-takers
Price-taker: whose action has no effect on
market price
Price-taking producer: market price does
not change because of the quantity he sells.
Price-taking consumer: market price does
not change because of the amount he buys.
Perfect Competition: Characteristics
Many buyers and sellers
and each is so small that no one can affect
price individually (for sellers, no one has large
enough market share)
All firms produce a homogeneous product
(identical / standardized)
at least consumers think so
Free entry and exit
each firm has complete knowledge about
production and cost;no regulation limit
Producer Decision-Making:
Goal: Maximize Profit
= TR – TC
–TC = TFC + TVC = wL + rK
–ATC = TC / Q
–MC = Δ(TC)/ΔQ
Recall: Short-Run Costs - Summary
at Q=0, VC=0, but FC>0
when MC is declining, ATC and AVC
both decline at an increasing rate
when MC starts increasing, ATC and
AVC may both be decreasing but at a
decreasing rate
MC intersects AVC and ATC at their
minimum, respectively
The Relationship Between the Average
Total Cost and the Marginal Cost Curves
the four curves together:
More Realistic Cost Curves
Total Revenue: TR
TR = PQ
AR = PQ/Q = P
MR = Δ(PQ)/ΔQ
= (ΔP*Q)/ΔQ + (P*ΔQ)/ΔQ
= (ΔP /ΔQ ) Q + P(ΔQ/ΔQ )
= (ΔP /ΔQ ) Q + P
Perfect competition:
MR = P = AR (ΔP =0)
Short-Run optimal output level
in a perfectly competitive market
Goal: maximize profit
– Demand facing the industry: downward
sloping
– Demand facing the firm: horizontal at P
(all are price takers, and no one is large
enough to affect market price)
Optimal output level determined by
D=P=MR=MC
Profit-Maximizing Output
Decision rule:
is maximized when MR = MC
(think: why?)
profit is maximized at the quantity of
output where the marginal revenue of
the last unit produced is equal to its
marginal cost.
Short-Run Costs for Jennifer and Jason’s
Farm
Questions to consider:
How much is fixed cost?
Is marginal cost calculated based on
total cost or variable cost?
Why is marginal revenue constant at
$18?
What is net gain?
Is the goal to maximize net gain?
Again: under perfect competition
MR = Δ(PQ)/ΔQ
= (ΔP*Q)/ΔQ + (P*ΔQ)/ΔQ
= (ΔP /ΔQ ) Q + P(ΔQ/ΔQ )
When ΔP=0 (price taking)
MR =P
Decision rule:
is maximized when MR=P=MC
The Price-Taking Firm’s
Profit-Maximizing Quantity of Output
The profit-maximizing point is where the marginal cost curve
crosses the marginal revenue curve (which is a horizontal line at
the market price).
Profitability and Market Price
Costs and Production in the Short-Run
Profitability and Market Price
The Short-Run Production Decision
A firm will cease production in the short-run if the market price falls
below the shut-down price, which is equal to minimum average
variable cost.
Short-Run optimal output level: various
profit situations
Rule: produce at MR=P=MC.
– Positive Economic Profit:
when D=MR=P>ATC at MR=P=MC
– Operating at a loss:
when AVC<D=MR=P<ATC at MR=P=MC
– Shut Down:
when D=MR=P<AVC at MR=P=MC
The break-even price:
the market price at which the firm earns zero
profit (P=ATC).
Profit Maximization:MR=MC
MR>MC, expand
MR<MC, reduce
MR=MC, optimal
P
P1
MC
ATC
AVC
D=MR=P
P2
Q
Principles:
MC tells how much to produce (produce
up to the amount where MR=P=MC)
ATC tells how much profit or loss is
made if the firm decides to produce
(profit = (P - ATC) * Q).
AVC tells whether to keep producing
(keep producing only when P>AVC at
P=MC)
Summary
Also example: AVC and ATC
Table 6.4, P.176
Employees
per day
Bottles
per day
Variable
cost
($/day)
Average
variable cost
($/unit of
output)
Total
cost
($/day)
Average
total cost
($/unit of
output)
0
0
0
40
1
80
12
0.150
52
0.650
2
200
24
0.120
64
0.320
3
260
36
0.138
76
0.292
4
300
48
0.160
88
0.293
5
330
60
0.182
100
0.303
6
350
72
0.206
112
0.320
7
362
84
0.232
124
0.343
Marginal
cost
($/bottle)
0.15
0.10
0.20
0.30
0.40
0.60
1.00
The Marginal, Average Variable, and Average
Total cost Curves for a Bottle Manufacturer
Price = Marginal Cost: The Perfectly
Competitive Firm’s Profit-Maximizing Supply
Rule
Measuring Profit Graphically
Figure 6.7, P.178
A Negative Profit
Figure 6.8, P.179
The Short-Run Supply
A firm will cease production in the short-run if the market price falls below the
shut-down price, which is equal to minimum average variable cost.
Short-Run Supply
for the firm: supply curve is upward
sloping because of the law of increasing
cost (S=MC).
for the industry: the supply curve is
upward sloping, flatter than single firm
supply curve, and steeper than the
horizontal summation firm supplies.
The Short-Run Market Equilibrium
There is a short-run market equilibrium when the quantity supplied equals
the quantity demanded, taking the number of producers as given.
The Effect of an Increase in Demand in
the Short-Run and the Long-Run
D↑ P↑ non-zero profits entry S↑ P↓ back to zero profit
(on LRS curve)
Comparing the Short-Run and Long-Run
Industry Supply Curves
The long-run industry supply curve is always flatter—more elastic—than the
short-run industry supply curve. This is because of entry and exit:
Long-Run optimal output level:
All firms will be producing where
P=LMC=LAC and economic profit will
be zero because of free entry and exit.
Firms enjoy big economic rent if they
own the resources that have higher
productivity than similar resources
owned by others.
Long-Run Equilibrium
LMC
P
LAC
E
N
AR=MR
O
M
Q
The Long-Run Market Equilibrium
A market is in long-run market equilibrium when the quantity supplied
equals the quantity demanded, given that sufficient time has elapsed for entry
into and exit from the industry to occur.
Conclusions:
In a perfectly competitive industry in
equilibrium, the value of marginal cost is the
same for all firms.
In a perfectly competitive industry with free
entry and exit, each firm will have zero
economic profits in long- run.
The long-run market equilibrium of a perfectly
competitive industry is efficient: no mutually
beneficial transactions go unexploited.
Long-Run Supply:
For the firm: produce where
P=LMC=min LAC.
For a constant-cost industry: long-run
supply is horizontal.
For an increasing-cost industry: longrun supply is upward sloping.