Competition

Chapter 8

Recall: Producer Decision-making

Optimal behavior: choose the right input combination or right production level

Goal: – Max production at given cost– Min cost for given output levelMax profit

profit = TR – TC

TR = P Q

P: determined by market

Market Structures

Perfect competition Imperfect competition

ImperfectImperfect

Monopolistic competition

Oligopoly

Monopoly

Goal: Maximize Profit

= TR – TCRecall:

–TC = TFC + TVC = wL + rK

–ATC = TC / Q

–MC = Δ(TC)/ΔQ

Total Revenue: TR

TR = PQ AR = PQ/Q = P MR = Δ(PQ)/ΔQ

= (ΔP*Q)/ΔQ + (P*ΔQ)/ΔQ

= (ΔP /ΔQ ) Q + P(ΔQ/ΔQ )

Profit-Maximizing Output

Decision rule:

is maximized when MR = MC

profit is maximized at the quantity of output where the marginal revenue of the last unit produced is equal to its marginal cost.

under perfect competition

ΔP=0 MR =P

Decision rule:

is maximized when P=MC

Perfect Competition

Perfectly competitive market: all participants are price takers

Perfectly competitive industry: all producers are price-takers

Price taker: whose action has no effect on market price

Price-taking producer: market price does not change because of the quantity he sells.

Price-taking consumer: market price does not change because of the amount he buys.

Perfect Competition: Characteristics

Many buyers and sellersand each is so small that no one can affect price individually (for sellers, no one has large market share)

All firms produce a homogeneous product (identical / standardized)at least consumers think so

Free entry and exiteach firm has complete knowledge about production and cost

Short-Run optimal output level

Goal: maximize profit Demand facing the industry: downward

sloping Demand facing the firm: horizontal

(all are price takers, and no one is large enough to affect market price)

Optimal output level determined by

D=P=MC

Short-Run optimal output level: various profit situations

Rule: produce at P=MC. Positive Economic Profit: when

D=MR=P>ATC at P=MC Operating at a loss: when

AVC<D=MR=P<ATC at P=MC Shut Down: when D=MR=P<AVC at P=MC The break-even price: the market price at

which the firm earns zero profits (P=ATC).

Costs and Production in the Short-Run

Principles:

MC tells how much to produce (produce up to the amount where P=MC)

ATC tells how much profit or loss is made if the firm decides to produce (profit = (P - ATC) * Q).

AVC tells whether to keep producing (keep producing only when P>AVC at P=MC)

Summary (P. 220, Table 9-4)

Profitability and Market Price

Profitability and Market Price

The Short-Run Production Decision

A firm will cease production in the short-run if the market price falls below the shut-down price, which is equal to minimum average variable cost.