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CompetitionCompetition
Perfect CompetitionFirms Choices in Perfect CompetitionThe Firm’s Short-Run DecisionThe Firm’s Supply CurveThe Industry Supply Curve
Perfect CompetitionPerfect CompetitionPerfect competition occurs in a market
where: There are many firms, each selling an identical
product There are many buyers Firms in the industry have no advantage over
potential new entrants (no barriers to entry) Firms and buyers are well informed about the
prices of the products of each firm in the industry
Perfect CompetitionPerfect Competition
In perfect competition, each firm is a price taker
Examples of firms in perfect competition: Wheat farms Fisheries Paper
Firms Choices in Perfect Firms Choices in Perfect CompetitionCompetition
In a perfectly competitive market, a firm must make four key decisions: Whether to enter the industry If enter, whether to stay in the industry or
leave it If stay, whether to produce or to temporarily
shut down If produce, how much to produce (and how
to produce it)
Firms Choices in Perfect Firms Choices in Perfect CompetitionCompetition
In the short run we can only choose: whether to produce or to temporarily shut
down If we do produce, how much to produce
The Firm’s Short-Run The Firm’s Short-Run DecisionDecision
All decisions are about profit--which action makes the maximum profit
Economic profit =
total revenue - total costTotal revenue = Price x Quantity [Remember, total cost includes normal
profit, an opportunity cost]
Normal profitNormal profit
The entrepreneurial ability and time of the entrepreneur needs to be rewarded by the normal profit in an industry
Risky industries, or industries which demand high entrepreneurial skills are probably paying off higher profits
Also remember that any money you invest has a opportunity cost because you could have invested it in your next best option instead
The revenue curves in perfect competition are: Average revenue Marginal revenue Total revenue
The following figure shows the revenue curves of a firm in perfect competition
Revenue in Perfect CompetitionRevenue in Perfect Competition
First, market’s or industry’s demand and market supply determine the price that the firm takes as given
Revenue in Perfect CompetitionRevenue in Perfect Competition
The firm can sell any quantity it chooses at this price
Revenue in Perfect CompetitionRevenue in Perfect Competition
The demand curve the firm faces is perfectly elastic
Average revenue (AR) = marginal revenue (MR)
Revenue in Perfect CompetitionRevenue in Perfect Competition
The firm’s total revenue curve is linear
An increase in the quantity sold brings a proportional increase in total revenue (TR)
Revenue in Perfect CompetitionRevenue in Perfect Competition
The firm’s short-run problem is to choose the output that maximizes profit.
We can solve this problem by looking at either: total cost and total revenue, or marginal cost and marginal revenue
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
This figure shows the firm’s profit maximizing output by using total cost and total revenue
At low output rates, the firm incurs an economic loss
The reason is that it has some fixed costs, remember?
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
At an output rate of 4 sweaters a day, the firm breaks even
At output rates above 12 sweaters a day, the firm again incurs an economic loss
This time, the reason is now diminishing returns, remember?
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
At 12 sweaters a day, the firm breaks even
Between 4 and 12 sweaters a day, the firm makes an economic profit
The maximum profit occurs at 9 sweaters a day
Here, total revenue is $225, total cost is $183, and economic profit is $42
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Here we derive the firm’s profit maximizing output by using the profit curve
The profit curve reaches its maximum at 9 sweaters a day
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Now we show profit maximizing output by using marginal analysis
Marginal revenue equals marginal cost
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Profit maximization does not guarantee a profit
When price equals marginal cost, average total cost, ATC, can be greater than, equal to, or less than price
Profit maximization can mean loss minimization
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
The following figures show the three possible outcomes: economic profit break even economic loss
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Here, the firm breaks even
The price is $20 and the profit-maximizing quantity is 8
ATC equals AR
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Here, the firm incurs an economic loss
The price is $17 and the profit-maximizing quantity is 7
ATC exceeds AR
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
The shutdown point is the point at which the firm's maximized profit is the same regardless of whether the firm produces or temporarily shuts down
The shutdown point is the point of minimum average variable cost
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
If price equals minimum AVC, the profit is the same from producing as from shutting down temporarily and paying the fixed costs
Either way, the firm incurs a loss equal to total fixed cost
If the firm produced with AVC greater than price, its loss would exceed total fixed cost
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
Let us show the shutdown decision and the shutdown point
The Firm’s Short-Run DecisionThe Firm’s Short-Run Decision
The Firm’s Supply CurveThe Firm’s Supply Curve
A perfectly competitive firm's supply curve shows how the firm's profit maximizing output varies as the market price varies
A perfectly competitive firm's supply curve is the firm's marginal cost curve above the point of minimum average variable cost
This shows the firm’s supply curve
We begin with the firm’s cost curves in part (a)
The Firm’s Supply CurveThe Firm’s Supply Curve
For prices above minimum AVC, a change in price brings a change in the quantity supplied along the MC curve
The Firm’s Supply CurveThe Firm’s Supply Curve
At minimum AVC, the firm is indifferent between supplying 7 and supplying zero
Both are points on the firm’s supply curve
The Firm’s Supply CurveThe Firm’s Supply Curve
But nothing in between 7 and zero is on the supply curve
The firm will never supply 1,…,6 sweaters a day
At prices below minimum AVC, the quantity supplied is zero
Let’s look at the supply curve
The Firm’s Supply CurveThe Firm’s Supply Curve
At prices below minimum AVC, the quantity supplied is zero along the price axis.
Then there is a jump from zero to the shutdown point
The Firm’s Supply CurveThe Firm’s Supply Curve
And at prices above minimum AVC, the quantity supplied is traced by the MC curve
The Firm’s Supply CurveThe Firm’s Supply Curve
The Industry Supply CurveThe Industry Supply Curve
The short-run industry supply curveThe horizontal sum of the firm’s supply
curves
This figure shows the industry supply curve
It is like the firm’s curve except it has no break at the shutdown price
The Industry Supply CurveThe Industry Supply Curve
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