Transcript Document

and
Unit 3 – Theory of the Firm
This lecture is interactive.
Before beginning make sure students
are paired with a partner with a
whiteboard, marker & eraser.
Move your seat together beside your
partner’s to where you can
comfortably take your own notes &
write on the white board together.
You don’t need to take notes
until you see this sign.
4 market structures in
which firms compete:
#1 – perfect competition
#2 – monopoly
#3 – monopolistic competition
#4 - oligopoly
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1.
2.
3.
4.
Many buyers and sellers
All the products are homogeneous.
All buyers & sellers are price takers.
There are NO barriers to entry.
5. There is perfect information.
6. There is no chance of long-run
profits.
In Unit 2 we
learned about
this graph.
What does this
graph tell us?
P
Hello Kitty Purses
S
P
D
Q
Q
The industry/market graph is simple supply
and demand.
The price charged in the market
and the quantity produced are where
supply and demand meet.
In this unit on costs we’re adding to our
analysis the individual firm.
cost
firm
On your whiteboard
draw the graph for an
individual firm
correctly labeling the 2
axes & title of graph.
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quantity
On your graph correctly diagram & label
the ATC & AVC curves.
cost
firm
ATC
AVC
quantity
On your graph correctly diagram & label
the MC curve.
cost
firm
MC
ATC
AVC
ensure that MC
intersects ATC
& AVC at lowest
points.
quantity
Indicate where the law of diminishing
returns sets in.
cost
firm
MC
ATC
AVC
diminishing returns
sets in here
b/c…explain
quantity
cost
firm
MC
ATC
AVC
In this segment as more
inputs were added, the cost of
each next unit was rising.
In this segment as more inputs were
added to production, the cost of each
next unit (marginal) was decreasing.
quantity
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P
firm
P
industry S
P
D
Q
Q
Q
The industry/market P and Q are printed with
capital letters “P” and “Q”
The individual firm’s graph is going to be a little
more difficult.
dollars
firm
P
MC
p
mr
A
ATC
d
industry S
P
(P = MR)
B
C
D
mc
MR>MC
q1
q
q2 Rate of
Q
Q
output
It’s a bit involved, no?
You are a farmer in this market. How many units
or bushels of corn should you produce?
Small q1?
Small q?
Don’t copy notes yet!
or Small q2?
dollars
P
MC
p
mr
A
ATC
d
S
P
(P = MR)
B
C
D
mc
MR>MC
q1
q
q2 Rate of
Q
Q
output
And the answer is-Small “q”
Why?
Because that’s the “q” where
MR = MC
Draw the firm & market graphs below.
cost
firm
P
market
S
MC
MR=D=AR=P
p
D
q
quantity
Q
Q
cost
P
S
MC
d
p
P
(P = MR)
D
q
output
Q
Q
Let’s look at each line individually so that
you understand more about how individual
firms make decisions.
Individual firms are price takers and will take
the market price.
dollars
P
S
MC
P
d
(P = MR)
p
D
q
Rate of
output
Q
Q
Notice that P = MR = D and they are also equal
to AR.
The questions is—
P -- Price
MR – Marginal Revenue Why are they all
D -- Demand
equal to each
AR – Average Revenue
other? 15 of 34
dollars
$2
p
P
d
S
$2P
(P = MR)
D
Q
Q
Since the firm is a price taker, it must take the
market price. Say that the market price for a
bushel of corn is $2 per bushel.
Rate of
output
dollars
P
$2P
d
$2
p
S
(P = MR)
D
1234
Rate of
output
q x P = TR
1 x $2
2
2 x $2
4
3 x $2
6
4 x $2
8
Who do we appreciate?
Q
Q
For how much does
each firm sell each
unit (bushel)? $2
What do you get when
you multiply P x q?
The Farmer!!
TR
dollars
P
S
P = MR
$2P
$2
p
D
Rate of
output
q x P = TR
1 x $2
2>
2 x $2
4
>
3 x $2
6
>
4 x $2
8
P
=
MR
$2
$2
$2
MR
Q
Q
What MR?
MR is the additional
revenue earned from
selling 1 more of the
good
cost
D = P = MR
P
S
$2P
$2
p
D
1
Q
At a price of $2 the demand is infinitely elastic.
Buyers can buy one unit (bushel) to an infinite
amount of units (bushels) for $2 per bushel.
So, now D = P = MR.
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Q
dollars
D = P = MR = AR
P
S
$2P
$2
p
D
Q
Q
q x P = TR AR MR How would you figure
out average revenue?
1 x $2
2
2
2 AR = TR / q
2 x $2
4
2
2
3 x $2
6
2
2
4 x $2
8
2
P
= AR = MR
Rate of
output
dollars
MR DARP
MR = D = AR = P
D = P = MR = AR
$2
p
P
S
$2P
D
Q
Q
Are there any questions on why D = P = MR = AR?
When I grew up on the farm, we just so happened
to live next to another farmer who everyone called,
“Mr. Darp.”
I never realized until I started teaching economics
that people in the community called him that
because he knew so much about perfect competition.
Rate of
output
dollars
P
S
MC
MR=D=AR=P
p
P
D
q
Rate of
output
Q
Q
When labeling the demand curve for the individual
firm, make sure it is labeled—MR=D=AR=P
All firms maximize profits by producing where
MR = MC.
dollars
P
S
MC
MR=D=AR=P
p
P
D
q
Rate of
output
Q
Q
All firms maximize profits by producing where MR = MC.
How do we know this from our previous discussion
where we said firms and individuals make decisions “on
the margin?”
because a firm would say to itself, “Can I get more for the
next unit, than I would have to pay to produce it?”
cost
P
firm
MC
p
market
S
ATC
MR=D=AR=P
D
q
Note: MC touches ATC
at its lowest point.
quantity
Q
Q
Now we add the ATC curve to the graph to
determine if this firm is earning an economic profit,
an economic loss, or breaking even.
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cost
P
MC
p
S
ATC
MR=D=AR=P
ATC
D
q
Rate of
output
Q
Q
Whenever the P is above ATC at the profitmaximizing quantity (q), then the firm is earning
an economic profit.
In this situation the P is above ATC at profitmaximizing quantity (q).
cost
P
Economic
profit
pp
B
MC
A
A
S
ATC
MR=D=AR=P
C
D
Rate of
Q
Q
qq
output
Since the P is above ATC at the profit-maximizing
output q, the firm is earning an economic profit.
What is the formula for total revenue? P x q
Then P x q will give you the total revenue of:
TR = 0, P, A, q
x00
dollars
P
Economic
profit
p
BB
MC
A
S
ATC
MR=D=AR=P
C
C
D
Rate of
Q
Q
q
x00
output
What is the formula for total costs? ATC x q
Then P x ATC will give you the total costs of:
TC = 0, B, C, q
The TR (0, P, A, q) is larger than the TC (0, B, C, q).
Since TR > TC, the firm is earning economic profit.
Economic Profit = B, P, A, C
Practice on a white board
Write both team members’ names on
the whiteboard.
Draw a correctly labeled diagram
showing both the industry and the
individual firm where the firm is
suffering an economic loss.
Draw as large as possible still being
easily legible.
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Let’s check the
market graph
first.
P
market
S
P & Q axes labeled? 1 P
point each
market labeled? 1
point
S & D labeled? 1
point each
D
Q
Q
dotted lines drawn
from equilibrium to
axes? 1 point each
equilibrium P & Q
labeled? 1 point each
cost
firm
P
MC
market
ATC
S
MR=D=AR=P
p
P
D
q
quantity
Q
Q
2 axes labeled?
firm labeled?
MC curve Nike
ATC curve smiley face & swoosh & labeled?
labeled?
cost
firm
P
MC
market
ATC
S
MR=D=AR=P
p
P
D
q
quantity
MC intersect ATC lowest
point?
firm’s price line drawn
from market, solid line &
labeled?
firm’s price labeled on
axis with small p?
Q
Q
firm’s quantity correctly
determined from MR = MC,
drawn dotted line & labeled
small q?
was firm’s Mr. DARP line
drawn below ATC?
Erase your white board.
Write both team members’ names on
the whiteboard.
Draw a correctly labeled diagram
showing both the industry and the
individual firm where the firm is at
zero economic profit.
Draw as large as possible still being
easily legible.
cost
firm
P
MC
market
ATC
S
MR=D=AR=P
p
P
D
q
quantity
Q
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Q