Transcript 4-3 - Perfect Competition

PERFECT (OR PURE) COMPETITION
PERFECT COMPETITION
 Many
small firms
 Standardized product
 No
need to advertise
 “Price
takers”
 Free entry and exit
 Perfectly elastic demand
 Average
revenue
 Marginal revenue
 Price
9-2
Demand for Perfectly Competitive
Firms
Why are they Price Takers?
•If a firm charges above the market price, NO
ONE will buy. They will go to other firms
•There is no reason to price low because
consumers will buy just as much at the market
price.
Since the price is the same at all quantities
demanded, the demand curve for each firm is…
Perfectly Elastic
(A Horizontal straight line)
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The Competitive Firm is a Price Taker
Price is set by the Industry
Industry
(all firms)
P
Firm
S
P
$10
$10
Demand
D
5000
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Q
Q
4
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional
revenue for selling an
additional unit?
1st unit earns $10
2nd unit earns $10
Marginal revenue is
constant at $10
Notice:
Firm
P
$10
• Total revenue increases
at a constant rate
• MR equal Average
Revenue
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Demand
MR=D=AR=P
Q
5
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional
revenue for selling an
Firm
additional unit?
P
For
Perfect
Competition:
st
1 unit earns $10
2nd unit earnsDemand
$10
= MR
Marginal revenue is
Revenue) Demand
constant (Marginal
at $10
$10
Notice:
MR=D=AR=P
• Total revenue increases
at a constant rate
• MR equal Average
Revenue
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Q
6
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
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Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
•To maximum profit firms must make the right
output
•Firms should continue to produce until the
additional revenue from each new output
equals the additional cost.
Example (Assume the price is $10)
• Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
Profit Maximizing Rule
MR=MC
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Lets put costs and revenue together
to calculate profit.
Firm
Industry
P
S
P
(price taker)
MC
$7
$7
Demand
ATC
D
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10,000
Q
Q
9
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
P
$9
MC
8
7
6
5
4
3
2
1
MR=D=AR=P
Profit = $18
ATC
Total Cost=$45
Total Revenue =$63
1 2 3 4 5 6 7 8 9 10 Q
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Suppose the market demand falls. What
would happen if the price is lowered from
$7 to $5?
The MR=MC rule still applies but now the
firm will make an economic loss.
The profit maximizing rule is also the
loss minimizing rule!!!
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Cost and Revenue
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
MC
$9
8
ATC
7
6
Loss =$7
5
MR=D=AR=P
4
3
2 Total Cost = $42
Total Revenue=$35
1
1 2 3 4 5 6 7 8 9 10 Q
12
Assume the market demand falls even
more. If the price is lowered from $5 to $4
the firm should stop producing.
Shut Down Rule:
•A firm should continue to produce as long
as the price is above the AVC
•When the price falls below AVC then the
firm should minimize its losses by shutting
down
•Why? If the price is below AVC the firm is
losing more money by producing than they
would have to pay to shut down.
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P<AVC. They should shut down
Producing nothing is cheaper than staying open.
Price
$9
8
7
6
5
4
3
2
1
MC
ATC
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20
1 2 3 4 5 6 7 8 9 10 Q
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SHORT-RUN SUPPLY CURVE
Cost and Revenues (Dollars)
Firms produce where MR=MC
e
P5
P3
P2
P1
MR5
d
P4
MC
ATC
c
AVC
b
a
MR4
MR3
MR2
MR1
This Price is Below AVC
And Will Not Be Produced
0
Q2
Q3
Q4
Quantity Supplied
Q5
9-15
SHORT-RUN SUPPLY CURVE
Firms produce where MR=MC
Cost and Revenues (Dollars)
Examine the MC for the Competitive Firm
MC Above AVC Becomes
the Short-Run Supply Curve
Break-even
(Normal Profit) Point
e
P5
P3
P2
P1
MC
MR5
d
P4
S
ATC
c
AVC
b
a
MR4
MR3
MR2
MR1
Shut-Down Point
(If P is Below)
0
Q2
Q3
Q4
Quantity Supplied
Q5
9-16
Profit Maximizing Rule
MR = MC
Three Characteristics of MR=MC Rule:
1. Rule applies to ALL markets
structures (PC, Monopolies, etc.)
2. The rule applies only if price is
above AVC
3. Rule can be restated P = MC for
perfectly competitive firms (because
MR = P)
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PRACTICE
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#1
1. Should the firm produce? Yes
2. What output should the firm produce? 10
3. What is the TR and TC at that output? TR=$140
4. How much profit or loss?
TC=$100
Profit=$40
Price
MC
$16
15
14
MR=D=AR= P
ATC
10
9
5
0
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7
10
12
Quantity
19
What output should the firm produce? 6
What is TR at that output? $90
What is TC? $120
How much profit or loss? Loss= $30
#2
Price
MC
24
ATC
20
18
AVC
15
MR=D=AR=P
12
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0
3
6
8
10
Quantity
20
#3
1. What output should the firm produce? Zero Shutdown
2. What is TR at MR=MC point? $45
(Price below AVC)
3. What is TC at MR=MC point? $55
4. How much profit or loss? Loss=Only Fixed Cost $5
MC
Price
ATC
AVC
$12
11
10
MR=D=AR=P
9
0
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6
7
8
Quantity
21
#4
1. Should the firm produce? Yes
2. What output should the firm produce? 10
3. What is the TR and TC at that output? TR=$100
4. How much profit or loss?
TC=$60
Profit=$40
Price
MC
$12
11
10
MR=D=AR= P
ATC
6
5
3
0
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7
10
12
Quantity
22
MAXIMIZING PROFIT
Output
Variable Fixed
Cost
Cost
0
1
2
3
4
5
6
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$0
$12
$22
$27
$40
$60
$100
$20
Total
Cost
Marginal
Cost
-
Assume the firm can
sell each unit at a
price of $30
1. How many units
should the firm
produce to
maximize profit?
2. What is the total
revenue at that
quantity?
3. How much is the
profit?
23
MAXIMIZING PROFIT
Output
Variable Fixed
Cost
Cost
0
1
2
3
4
5
6
$0
$12
$22
$27
$40
$60
$100
$20
Total
Cost
Marginal
Cost
-
TR MR Profit
$30
$60
$90
$120
$150
$180
$30
$30
$30
$30
$30
$30
-$2
$18
$43
$60
$70
$60
Notice that at 6 units the firm is still making
profit. It’s just not maximizing profit
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SHORT-RUN
SUPPLY CURVE
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Marginal Cost and Individual Supply
Cost and Revenue
Notice: As price increases, the
quantity increases
$5
0
45
40
35
30
25
20
15
10
5
0
MC
ATC
MR5
AVC
MR4
MR3
MR2
MR1
1
2
3
4
5
6
7
9
Q
26
Marginal Cost and Supply
Cost and Revenue
Notice: The firm will not produce when
MC is below AVC
$5
0
45
40
35
30
25
20
15
10
5
0
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MC = Supply
ATC
Short-run
Supply Curve:
AVC
MC above AVC
1
2
3
4
5
6
7
9
Q
27
Marginal Cost and Supply
Cost and Revenue
If variable costs increase (ex: per unit tax)
$5
0
45
40
35
30
25
20
15
10
5
0
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MC2=Supply2
MC1=Supply1
AVC
AVC
When MC increases, SUPPLY decrease
1
2
3
4
5
6
7
9
Q
28
Marginal Cost and Supply
Cost and Revenue
What if variable costs decrease (ex: subsidy)?
$5
0
45
40
35
30
25
20
15
10
5
0
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MC1=Supply1
MC2=Supply2
AVC
AVC
When MC decreases, SUPPLY increases
1
2
3
4
5
6
7
9
Q
29
Marginal Cost and Supply
What happens to quantity if fixed costs
increase?
Price
MC
MR=D=AR= P
ATC1
ATC
PF
Quantity stays
the same because
MC/Supply
doesn’t change
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QF
Quantity
30
Per Unit vs. Lump Sum
A PER UNIT tax or subsidy affects the
VARIABLE COSTS so MC, AVC, and
ATC will shift.
This WILL affect the quantity produced
A LUMP SUM tax or subsidy only
affects FIXED COSTS so only AFC and
ATC will shift. MC stays the same.
This WILL NOT affect the quantity produced
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2008 Audit Exam