many small firms standardized product no need to advertise “price takers” free entry and...

PURE COMPETITION

PURE 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)

3Copyright ACDC Leadership 2015

P

Q

Demand

P

Q5000

D

S

Industry(all firms)

$10 $10

The Competitive Firm is a Price TakerPrice is set by the Industry

4

Firm

Copyright ACDC Leadership 2015

5

What is the additional revenue for selling an

additional unit? 1st unit earns $102nd unit earns $10Marginal revenue is constant at $10Notice:

• Total revenue increases at a constant rate

• MR equal Average Revenue

5

MR=D=AR=P


P

Q

Demand

Firm

$10


6

What is the additional revenue for selling an

additional unit? 1st unit earns $102nd unit earns $10Marginal revenue is constant at $10Notice:

• Total revenue increases at a constant rate

• MR equal Average Revenue

6

MR=D=AR=P


P

Q

Demand

Firm

$10

For Perfect Competition:Demand = MR

(Marginal Revenue)


Short-Run Profit MaximizationWhat 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


Short-Run Profit MaximizationWhat 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

8

Profit Maximizing Rule

MR=MC


P

Q

Demand

P

Q10,000

D

S

Industry Firm(price taker)

$7 $7

9

ATC

MC

Lets put costs and revenue together to calculate profit.


Total Revenue =$63

$9

8

7

6

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

MC

ATC

•How much output should be produced?•How much is Total Revenue? How much is Total Cost? •Is there profit or loss? How much?

MR=D=AR=P

Total Cost=$45

Profit = $18

10

Q

P


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!!!


Total Revenue=$35

Co

st a

nd

Rev

enu

e

1 2 3 4 5 6 7 8 9 10

MC

ATC

•How much output should be produced?•How much is Total Revenue? How much is Total Cost? •Is there profit or loss? How much?

MR=D=AR=P

Total Cost = $42

Loss =$7

$9

8

7

6

5

4

3

2

1

12

Q

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.


TC=$35

TR=$20

1 2 3 4 5 6 7 8 9 10

MC

AVC

ATC

P<AVC. They should shut down Producing nothing is cheaper than staying open.

MR=D=AR=P

Fixed Costs=$10

$9

8

7

6

5

4

3

2

1

14

Q

Price


SHORT-RUN SUPPLY CURVE

Firms produce where MR=MC

P1

0

Co

st a

nd

Rev

enu

es (

Do

llars

)

Quantity Supplied

MR1

P2 MR2

P3 MR3

P4 MR4

P5 MR5

MC

AVC

ATC

Q2 Q3 Q4 Q5

This Price is Below AVCAnd Will Not Be Produced

ab

c

d

e

9-15


P1

0

Co

st a

nd

Rev

enu

es (

Do

llars

)

Quantity Supplied

MR1

P2 MR2

P3 MR3

P4 MR4

P5 MR5

MC

AVC

ATC

Q2 Q3 Q4 Q5

ab

c

d

e

MC Above AVC Becomesthe Short-Run Supply Curve S

Examine the MC for the Competitive Firm

Break-even(Normal Profit) Point

Shut-Down Point (If P is Below)

Firms produce where MR=MC

9-16

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)

Profit Maximizing RuleMR = MC


PRACTICE


$1615

109

5

0

MC

ATC14

1. Should the firm produce?2. What output should the firm produce?3. What is the TR and TC at that output?4. How much profit or loss?

MR=D=AR= P

Yes10TR=$140

Profit=$40TC=$100

#1

19Quantity 3 7 10 12

Price


24

20

12

0 3 6 8 10

MC

MR=D=AR=P

AVC

ATC

15

18

What output should the firm produce?What is TR at that output?What is TC?How much profit or loss?

6$90

$120Loss= $30

#2

20

Price

QuantityCopyright ACDC Leadership 2015

$12

10

05 6 7 8

MC

MR=D=AR=P

AVCATC

11

1. What output should the firm produce?2. What is TR at MR=MC point?3. What is TC at MR=MC point?4. How much profit or loss?

9

Loss=Only Fixed Cost $5

Zero Shutdown (Price below AVC)$45

$55#3

21

Price

QuantityCopyright ACDC Leadership 2015

$1211

65

3

0

MC

ATC10

1. Should the firm produce?2. What output should the firm produce?3. What is the TR and TC at that output?4. How much profit or loss?

MR=D=AR= P

Yes10TR=$100

Profit=$40TC=$60

#4

22Quantity 3 7 10 12

Price


23

MAXIMIZING PROFIT

OutputVariable

CostFixedCost

TotalCost

MarginalCost

0 $0 $20 -

1 $12

2 $22

3 $27

4 $40

5 $60

6 $100

Assume the firm can sell each unit at a

price of $301. 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?


Notice that at 6 units the firm is still making profit. It’s just not maximizing profit

24

MAXIMIZING PROFIT

OutputVariable

CostFixedCost

TotalCost

MarginalCost

0 $0 $20 -

1 $12

2 $22

3 $27

4 $40

5 $60

6 $100


Notice that at 6 units the firm is still making profit. It’s just not maximizing profit

TR MR Profit

- - -

$30 $30 -$2

$60 $30 $18

$90 $30 $43

$120 $30 $60

$150 $30 $70

$180 $30 $60

$50

4540353025 2015 10

5 0

Cos

t an

d R

even

ue

1 2 3 4 5 6 7 9

AVC

ATC

26

MR1

Marginal Cost and Individual Supply

MR2

MR3

MR4

MR5

MC

Q

Notice: As price increases, the quantity increases

Notice: The firm will not produce when MC is below AVC

$50

4540353025 2015 10

5 0

Cos

t an

d R

even

ue

1 2 3 4 5 6 7 9

AVC

ATC

27

Marginal Cost and Supply

MC

Q

= Supply


Short-run Supply Curve: MC above AVC

If variable costs increase (ex: per unit tax)

$50

4540353025 2015 10

5 0

Cos

t an

d R

even

ue

1 2 3 4 5 6 7 9

AVC

28


Q

MC1=Supply1

AVC

MC2=Supply2

When MC increases, SUPPLY decrease


What if variable costs decrease (ex: subsidy)?

$50

4540353025 2015 10

5 0

Cos

t an

d R

even

ue

1 2 3 4 5 6 7 9

AVC

29


Q

MC1=Supply1

AVC

MC2=Supply2

When MC decreases, SUPPLY increases



MC

ATC

PFMR=D=AR= P

30QuantityQF

Price

What happens to quantity if fixed costs increase?

Quantity stays the same because

MC/Supply doesn’t change

ATC1


31

Per Unit vs. Lump SumA 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


2008 Audit Exam

many small firms standardized product no need to advertise “price takers” free entry and...

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