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Competition
Chapter 8
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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
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Market Structures
Perfect competition Imperfect competition
ImperfectImperfect
Monopolistic competition
Oligopoly
Monopoly
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Goal: Maximize Profit
= TR – TCRecall:
–TC = TFC + TVC = wL + rK
–ATC = TC / Q
–MC = Δ(TC)/ΔQ
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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 )
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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.
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under perfect competition
ΔP=0 MR =P
Decision rule:
is maximized when P=MC
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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.
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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
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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
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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).
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Costs and Production in the Short-Run
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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)
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Summary (P. 220, Table 9-4)
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Profitability and Market Price
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Profitability and Market Price
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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.