Transcript DEMAND CURVE OF THE FIRM IN A COMPETITIVE MARKET

PROFIT MAXIMISATION BY
A FIRM IN A COMPETITIVE
MARKET
MAIN TOPICS
• DEFINITION OF A COMPETITIVE MARKET
• MARKET DEMAND AND FIRM DEMAND
• TOTAL REVENUE OF THE FIRM
• MARGINAL REVENUE OF THE FIRM
• TOTAL REVENUE LESS TOTAL COSTS
• MARGINAL COST AND PROFIT
MAXIMISATION
COMPETITIVE MARKETS
• Large number of buyers: None can control the price
• Large number of sellers: None can control the price
• Uniform commodity: All sellers are selling identical
commodities, so they are perfect substitutes
• Entry to the industry is easy.
• Established firms do not have an advantage over
new firms
MARKET DEMAND
QUANTITY PRICE
0
40
10
35
20
30
30
25
40
20
50
15
60
10
70
5
80
0
MARKET DEMAND AND
SUPPLY
MARKET SUPPLY AND DEMAND
PRICE
45
40
35
30
25
20
15
10
5
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
QUANTITY
DEMAND FOR ONE FIRM’S
OUTPUT
• The firm is a small part of the market
• Other firm’s products are perfect
substitutes
• The firm can charge no more than the
market price
A FIRM’S DEMAND SCHEDULE
QUANTITY PRICE
0
20
10
20
20
20
30
20
40
20
50
20
60
20
70
20
80
20
A FIRM’S DEMAND CURVE
FIRM'S DEMAND
40
PRICE
30
20
10
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
QUANTITY
TOTAL REVENUE OF A FIRM
• The quantity a firm sells multiplied by the
price of the product.
TOTAL REVENUE OF A FIRM45
40
Q
P
0
10
20
30
40
50
60
70
80
35
TR
20
20
20
20
20
20
20
20
20
0
200
400
600
800
1000
1200
1400
1600
30
25
20
15
10
5
0
0 5 10 1
TOTAL REVENUE OF A FIRM
A FIRM'S TOTAL REVENUE
REVENUE
1800
1600
1400
1200
1000
800
600
400
200
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
QUANTITY
MARGINAL REVENUE
• The change in total revenue given the change in
quantity
• In a competitive industry marginal revenue always
equals price.
• That is, the firm adds the price of one more unit to
its total revenue whenever it sells one more unit.
• This is not true for firms in industries that are not
competitive.
A FIRM’S MARGINAL
REVENUE SCHEDULE
QUANTITY PRICE
0
10
20
30
40
50
60
70
80
TR
20
20
20
20
20
20
20
20
20
MR
0
200
400
600
800
1000
1200
1400
1600
20
20
20
20
20
20
20
20
A FIRM’S MARGINAL
REVENUE CURVE
FIRM'S MARGINAL REVENUE
PRICE
40
35
30
25
20
15
10
5
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
QUANTITY
COMPETITIVE FIRM’S
PROFIT MAXIMISING
DECISION
• The firm is a price taker, so it cannot decide
what price to charge.
• Assume that the firm is producing each output
at the minimum possible cost.
• The firm can only decide how much to
produce
• The firm’s goal is to maximise profits
PROFITS OF A COMPETITIVE
FIRM
Q
TR
0
10
20
30
40
50
60
70
80
TC
0
200
400
600
800
1000
1200
1400
1600
100
150
250
400
600
900
1300
1800
2400
profits
-100
50
150
200
200
100
-100
-400
-800
TOTAL REVENUE AND COST
CURVES
COSTS AND REVENUES
TOTAL COSTS AND REVENUES
OF A FIRM
1600
1400
1200
1000
800
600
400
200
0
TR
TC
0 10 20 30 40 50 60 70 80 90
QUANTITY
PROFITS
PROFITS OFA FIRM
COSTS AND REVENUES
250
200
150
100
50
0
-50 0
10
20
30
40
50
-100
-150
-200
QUANTITY
60
70
80
90
PROFIT MAXIMISATION
• Profit is maximised when the difference between
the total revenues and total costs is greatest
• At outputs where revenues increase by more than
costs if output increases, output is too low.
Increasing output will increase profit.
• At outputs where revenues increase by less than
costs if output increases, output is too high.
Decreasing output will decrease profit
PROFIT MAXIMISATION
• If marginal revenue equals marginal cost, then
profit is maximised.
• The increase in revenue equals the increase in cost
when one more unit is produced.
• The decrease in revenue equals the decrease in
costs when one less unit is produced
• Maximum profits may occur when average costs are
not at a minimum.
PROFIT MAXIMISATION
Q
MR
0
10
20
30
40
50
60
70
80
MC
20
20
20
20
20
20
20
20
20
AVC
5
10
15
20
30
40
50
60
5.00
7.50
10.00
12.50
16.00
20.00
24.29
28.75
ATC
15.00
12.50
13.33
15.00
18.00
21.67
25.71
30.00
profits
-100
50
150
200
200
100
-100
-400
-800
PROFIT MAXIMISATION
PROFIT MAXIMISATION
70
DOLLARS
60
50
MR
40
30
MC
20
ATC
AVC
10
0
0
50
QUANTITY
100