Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Types of IndustriesTypes of Industries

We distinguish between four types of industries:We distinguish between four types of industries:

1.1. Pure (Perfect) CompetitionPure (Perfect) Competition

2.2. Monopolistic CompetitionMonopolistic Competition

3.3. OligopolyOligopoly

4.4. MonopolyMonopoly

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Pure CompetitionPure Competition

A purely competitive A purely competitive industry has the following industry has the following characteristics:characteristics:

1.1. Many sellersMany sellers

2.2. Low barriers to enterLow barriers to enter

3.3. Competitors’ products are identicalCompetitors’ products are identical

4.4. Buyers have perfect informationBuyers have perfect informationMicroeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Profit MaximizationProfit Maximization

Profit = Total Revenue (TR) - Total Cost (TC)Profit = Total Revenue (TR) - Total Cost (TC)

Example 1Example 1A firm sells 100 products at $2.00 each. Its total A firm sells 100 products at $2.00 each. Its total cost is $160. What is its profit?cost is $160. What is its profit?

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Profit MaximizationProfit Maximization

Example 1 answerExample 1 answerProfit = TR – TCProfit = TR – TCTR = P x Q = $2 x 100 = $200TR = P x Q = $2 x 100 = $200

Profit = $200 - $160 = $40Profit = $200 - $160 = $40

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Marginal and Average RevenueMarginal and Average Revenue

Because one firm in pure competition is a small Because one firm in pure competition is a small part of the entire market, it can supply more part of the entire market, it can supply more products to the market without significantly products to the market without significantly affecting the supply and the price. affecting the supply and the price.

For example, if the market price is $2, then a For example, if the market price is $2, then a purely competitive firm can sell 100 products at purely competitive firm can sell 100 products at $2, 110 products at $2, or 120 products at $2.$2, 110 products at $2, or 120 products at $2.

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Marginal and Average RevenueMarginal and Average Revenue

Marginal revenue is the additional revenue per Marginal revenue is the additional revenue per product. For example, if at Q = 100, TR = product. For example, if at Q = 100, TR = $200, and at Q = 110, TR = $220, then MR = $200, and at Q = 110, TR = $220, then MR = $20 / 10, or $2.$20 / 10, or $2.

Average revenue is the revenue per product. If Average revenue is the revenue per product. If at Q = 100, TR = $200, then AR = $200 / 100, at Q = 100, TR = $200, then AR = $200 / 100, or $2.or $2.

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Marginal and Average RevenueMarginal and Average Revenue

Demand and revenue for a purely competitive firm, which Demand and revenue for a purely competitive firm, which sells a product at $2 is as follows:sells a product at $2 is as follows:

Microeconomics

Q Price TR MR AR

0 $2 $0 - -

100 $2 $200 $2 $2

110 $2 $220 $2 $2

120 $2 $240 $2 $2

130 $2 $260 $2 $2

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

A Purely Competitive Firm’s Total Revenue CurveA Purely Competitive Firm’s Total Revenue Curve

MicroeconomicsQuantity

Price,Revenue Total Revenue

100 110 120

200

220240

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

A Purely Competitive Firm’s Demand, Marginal, A Purely Competitive Firm’s Demand, Marginal, and Average Revenue Curvesand Average Revenue Curves

Microeconomics

Demand, AR, MR

Quantity

2.00 D = MR = AR

100 110 120

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

A Purely Competitive Firm’s Cost and Revenue A Purely Competitive Firm’s Cost and Revenue CurvesCurves

Microeconomics

AR, MR, Price, Costs

Quantity

2.00 D = MR = AR

MC ATC

AVC

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Profit-maximizing QuantityThe Profit-maximizing Quantity

Microeconomics

AR, MR, Price, Costs

Quantity

2.00 D = MR = AR

MC ATC

AVC

MR=MC

Qpm

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Profit AreaThe Profit Area

Microeconomics

AR, MR, Price, Costs

Quantity

2.00 D = MR = AR

MC ATC

AVC

MR=MC

100

1.80

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Case of a LossThe Case of a Loss

Microeconomics

AR, MR, Price, Costs

Quantity

D = MR = AR

MC ATC

AVC

Qlm

1.60

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Case of a Loss and a Shut-downThe Case of a Loss and a Shut-down

Microeconomics

AR, MR, Price, Costs

Quantity

1.20 D = MR = AR

MC ATC

AVC

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Long-run Equilibrium Price and QuantityThe Long-run Equilibrium Price and Quantity

Microeconomics

AR, MR, Price, Costs

Quantity

1.75 D = MR = AR

MC ATC

AVC

Qlr

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Farming IndustryThe Farming Industry

Characteristics of farming industries in Characteristics of farming industries in industrialized countries include:industrialized countries include:1.1. There are many farmers.There are many farmers.2.2. There are relatively low barriers to There are relatively low barriers to

enter the farming industry.enter the farming industry.3.3. Farmers competing in the same market Farmers competing in the same market

sell identical or nearly identical products.sell identical or nearly identical products.4.4. Buyers of agricultural products have significant Buyers of agricultural products have significant

information about the product. information about the product.

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Farming Industry and ElasticityThe Farming Industry and Elasticity

Supply of agricultural products has increased Supply of agricultural products has increased considerably during the past century.considerably during the past century.

Demand for agricultural products has increased as Demand for agricultural products has increased as well, but not as much supply, because:well, but not as much supply, because:Income inelasticity of demand for food is low.Income inelasticity of demand for food is low.Price elasticity of demand for food is low.Price elasticity of demand for food is low.

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Farming IndustryThe Farming Industry

Revenue (TR) of many farmers has decreased, Revenue (TR) of many farmers has decreased, because real prices (P) have decreased. because real prices (P) have decreased.

TR = P x QTR = P x QP has decreased considerably. Q (quantity sold) P has decreased considerably. Q (quantity sold) has increased, but less than proportionately.has increased, but less than proportionately.

Microeconomics

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

The Farming IndustryThe Farming Industry

In industrialized countries, the following programs In industrialized countries, the following programs have been implemented:have been implemented:1. Price Supports1. Price Supports2. Acreage Restrictions2. Acreage Restrictions3. Target Prices3. Target Prices4. Direct Subsidies and Loan Programs4. Direct Subsidies and Loan Programs5. Foreign Import Restrictions 5. Foreign Import Restrictions

Microeconomics

PricePer Bushel

Quantity Demanded of Wheat in Hundreds

$3.00

12

$5.00

10

SD

15

surplus

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Price Supports

PricePer Bushel

Quantity Demanded of Wheat in Hundreds

S1

$3.00

12

$6.00

10

S2

D

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Acreage Restrictions

PricePer Bushel

Quantity Demanded of Wheat in Hundreds

$3.00

12

$4.50S

D

15

DeficiencyPayment of

$4.50 - $1.50 = $3.00

$1.50

Target Prices

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Unit 6 - Profit Maximization of a Unit 6 - Profit Maximization of a Purely Competitive FirmPurely Competitive Firm

Other Farm Subsidy ProgramsOther Farm Subsidy Programs

Direct subsidies and soft loans to farmers increase Direct subsidies and soft loans to farmers increase farmers’ incomes and raise taxes.farmers’ incomes and raise taxes.

Import restrictions support domestic farmers by Import restrictions support domestic farmers by restricting competition and supply. Consumers restricting competition and supply. Consumers pay higher prices.pay higher prices.

Yearly cost of U.S. farm programs is Yearly cost of U.S. farm programs is approximately $20 billion.approximately $20 billion.

Microeconomics