Micro L14 Perfect Competition

8/8/2019 Micro L14 Perfect Competition

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Profit, Loss & Perfect Competition

Market Types

Maximizing Profit/Minimizing Loss The Marginal Revenue Curve

Perfect Competition

Short-Run vs Long-Run

Questions for Next Time


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Market Types

Perfect Competition

Monopoly

Monopolistic Competition

Oligopoly


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Maximizing Profit/Minimizing Loss

Total Revenue = Price x Total Revenue Marginal Revenue = the increase in total revenue when output

increases by one unit, or

MR = Change in Total RevenueChange in Output

As long as MR > MC, the addition to Total Profit is increasingand production should be increased

As soon as MR < MC, the addition to Total Profit is decreasedand production should be decreased

Therefore Profit is Maximized (Losses Minimized) whereMR = MC


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Graphing Demand & Marginal Revenue

Output Price Total Revenue Marginal Revenue

1 $5 $ 5 $5

2 5 10 5

3 5 15 5

4 5 20 5

5 5 25 5

6 5 30 5

21-3Copyright2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Marginal revenue is the increase in total revenue when

output sold goes up by one unit


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Graphing Demand & Marginal Revenue

Output

6

5

4

3

2

1

0

D,MR

0 1 2 3 4 5 6

Output Price Total Revenue Marginal Revenue

1 $5 $ 5 $5

2 5 10 5

3 5 15 5

4 5 20 5

5 5 25 5

6 5 30 5



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Profit Maximization and Loss Minimization

Output Price TR MR TC ATC MC Total Profits1 1 $200 $200 $200 $500 $500 $100 - $300

1 2 200 400 200 550 275 50 - 150

1 3 200 600 200 610 203 60 - 10

1 4 200 800 200 700 175 90 100

1 5 200 1000 200 830 166 130 1701 6 200 1200 200 1000 167 170 200

7 200 1400 200 1205 172 205 195


Profit Maximization Point: MC = MR

This occurs somewhere between 6 and 7 units.

We are assuming output can be produced in tenths of a unit


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0 1 2 3 4 5 6 7

0

100

200

300

400

500

Output

D,MR

ATC

MC


Profit Maximization and Loss Minimization

Output MR MC

1 $200 $100

2 200 50

3 200 60

4 200 90

5 200 130

6 200 170

7 200 205Profit Maximization Point: MC = MR

Most efficient Production Point: MC = ATC

The most profitable output is where the MC curve crosses the D, MR curve. This

occurs at an output of 6.7 units


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Market Types

Perfect Competition

-- many firms sell an identical product to many

buyers-- no restrictions on entry to or exit from the market

-- established firms have no advantage over newfirms

-- sellers and buyers are well informed about prices

Example: commodities, especially farming


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Perfect Competition The firm has no control over its price set by forces

of market demand and supply

The firm can sell all of its production at the goingprice

The primary decision the firm must make is howmuch to produce

It makes no sense to produce a single unit where

what you receive (revenue/price) is less than theunits cost (ATC/MC)

So, problem is to determine the profit maximizinglevel of output (TR-TC = Max Profit)


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Short Run Production Decisions

How much the firm chooses to produce is becomes aquestion of production cost vs revenue

The firm will logically choose to produce at a levelthat maximizes profit

Two methods of computing that level of production

1. The point where Total Revenue Total Cost =

Max Profit, or where TR-TC = Max P2. The point where Marginal Cost = MarginalRevenue, or where MC=MR


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The Perfect Competitors Demand Curve

Out ut

Firm

Out ut (in millions)

Industry

,

S

9

8

The intersection of the industry supply and demand curve set the

price that is taken by the individual firm, in this case $6


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Output

20

1

16

14

12

10

6

4

2

0

D,MR

ATC

MC

0 2 4 6 10 12 14 16 1 20

The Perfect Competitor in the Short Run

In the short run the perfect competitor may make a profit or lose

money


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The Perfect Competitor in the Short Run

Out ut

8

8

,

T

8 8

Is this firm making a profit or losing money?

Answer: Making a profit because the D,MR curve is above the ATC curve


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Exit & Temporary Shutdown Decisions

When Total Costs exceed Total Revenue, what does the firmdo?

In the long run, the firm may choose to exit the market if it

feels the imbalance is permanent

In the short run, the firm must analyze its revenue & costs

-- If Revenue exceeds Variable Cost, then some revenue iscontributing toward covering part of fixed cost and the firmshould continue to operate

-- If Revenue is less than Variable Cost, then the firm is incurringall its fixed costs plus some of the Variable Cost and the

firm should consider a temporary shutdown


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Long Run- Output, Price & Profit

In the long run the firm in perfect competition earnszero economic profit. Means firm earns the normal

profit only Economic Profit brings in other firms which increases

competition Industry Supply Curve shifts to theright = more product and lower prices

Economic Loss induces higher cost firms to exit theindustry Industry Supply Curve shifts to the left =less product and higher prices for firms that are left


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Long Run Permanent Change in

Demand

A permanent increase in demand creates short term

economic profits, but encourage new firms to enterthe market

A permanent decrease in demand triggers a similar

response except in the opposite direction incurringeconomic losses encourages firms to exit the industry


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Out ut

,

ir

Out ut (i illi )

arket

,

Going from Taking a Loss in the Short Run to

Breaking Even in the Long Run

This pushes the industry price up to $8. At this price the firm breaks even.


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Going from Making a Profit in the Short Run to

Breaking Even in the Long Run

Output

D2,MR2

ATC

MC

ir

Output (i illi s)

D

2

M r t

D1,MR1

1

20

1

16

14

12

10

6

4

2

0

20

1

16

14

12

10

6

4

2

00 2 10 2 34 6 10 12 14 16 1 20

New firms are attracted into the industry. This increases supply moving the

supply curve from S1 to S2


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The Perfect Competitor in the Long Run

Out ut

,

In the long run the firm breaks even

The ATC curve is tangent to the demand curve at the point where MC = MR.

ATC will equal price at the break-even point (the minimum point on the ATC

curve)

Price = ATC

The most profitable level of

output is 11.1


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External Economies & Diseconomies

External Economies Factors beyond a firms controlthat will lower its costs as the market output

increases-- improvement in farm inputs (seed, fertilizer)

-- technological change

External Diseconomies Factors beyond a firmscontrol that will increase its costs as market outputincreases

-- Congestion (Airline Industry)


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Market Types

Monopoly

-- one firm sells a good or service with no closesubstitutes

-- a barrier blocks the entry of new firms

Example: Utility companies/DeBeers in diamonds


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Market Types

Monopolistic Competition

-- Large number of firms making similar but slightly

different products-- Each producer is a sole producer of a particular

version of the product (Branding)

-- Although each firm has a monopoly on its brand,

they still compete with one another

Example: Nike/Reebok


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Micro L14 Perfect Competition

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