Transcript Profit

Chapter 8
Competition
Recall: Producer Decision-making
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Optimal behavior: choose the right input
combination or right production level
 Goal:
– Max production at given cost
– Min cost for given output level
Max profit
profit = TR – TC
TR = P Q
P: determined by market
Market Structures
Perfect competition
 Imperfect competition
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Oligopoly
Monopolistic competition
Imperfect
Monopoly
Goal: Maximize Profit

= TR – TC
Recall:
–TC = TFC + TVC = wL + rK
–ATC = TC / Q
–MC = Δ(TC)/ΔQ
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 )
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Profit-Maximizing Output
Decision
rule:
is maximized when MR =
MC
profit is maximized at the quantity of
output where the marginal revenue of the
last unit produced is equal to its marginal
cost.
under perfect competition
ΔP=0  MR =P
Decision rule:
is maximized when P=MC
Perfect Competition
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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
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
Short-Run optimal output level
Goal: maximize profit
 Demand facing the industry: downward
sloping
 Demand facing the firm: horizontal
(all are price takers, and no one is large
enough to affect market price)
 Optimal output level determined by
D=P=MC
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Short-Run optimal output level: various
profit situations
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Rule: produce at P=MC.
Positive Economic Profit: when
D=MR=P>ATC at P=MC
Operating at a loss: when
AVC<D=MR=P<ATC at P=MC
Shut Down: when D=MR=P<AVC at P=MC
The break-even price: the market price at
which the firm earns zero profits (P=ATC).
Costs and Production in the Short-Run
Principles:
MC tells how much to produce (produce
up to the amount where 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)
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Summary (P. 220, Table 9-4)
Profitability and Market Price
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.