Today
Perfect competition Profit-maximization in the SR The firm’s SR supply curve The industry’s SR supply curve
Market Structure
Market Structure: the key features of a market, including:– # of firms– type of product– nature of firm’s cost– # of buyers
Market structure is usually defined in terms of sellers.
Perfect
Competition =
Manyfirms
Oligopoly = A
few firms
Four Basic Models
Monopoly = One
firm
Monopolistic
Competition =
Some firms
Perfect Competition:Five Assumptions Homogeneous Product: Goods
produced by different sellers are perceived to be identical by consumers.
Perfect Information about Prices Given the first two assumptions, will a
seller be able to sell his product for a price higher than his competitors?
Assumptions 3-5
The market is large enough to support many sellers.
The firms are price takers: they acts as if their own output has no effect on price.
No barriers to entry: firms can enter and exit the market freely.
Revenue (assuming fixed price per unit) Total Revenue (TR) = price x quantity
sold (PQ) Average Revenue (AR) = (TR/Q) =
(PQ/Q) = P Marginal Revenue (MR) = TR/Q the
change in TR when output rises by one unit.
Profits = TR - TC (or TR - TFC - TVC)
Note on Marginal Revenue
The above definition is a general definition of MR that works for all industry structures. In perfect competition, since firms are price takers, MR = P = AR.
For any other market structure, MR < P.
Demand for a Particular Firm’s Output
q Q
D
SPP Typical Firm Industry or Market
The price-taking firm faces a perfectly elastic demand for its product at the market price.
Q*
P*P*d = AR = MR
Decision 1
Should the firm produce anything? Produce if: profit producing > profit not producing TR - TFC - TVC > 0 - 0 -TFC TR > TVC TR/Q > TVC/Q Produce in SR ifProduce in SR if P > AVCP > AVC
Decision 2
If the firm does produce in the SR, then: Decision 2: How much should it produce
in the SR? max profits = max (TR - TFC - TVC) Given TFC do not vary with output, we
can ignore them when choosing output. If we choose q to maximize TR- TVC, we will also be maximizing profits.
Total Revenue Minus Total Variable Cost on Graph
q
P MC
If we maximize TR - TVC then we will maximize profits. TR - TVC is maximized when MR = MC.
Profit over operating costs.
MR = P = AR
q*
The Firm’s Profit-Maximizing Rule Choose quantity where MR = MC (given
MC is sloping upward and AVC are covered).
Price-Taking and Profit-Maximization For price-taking firms, MR = P. Maximize profits by choosing q where
MC = P.
The Firm’s Supply Curve
The firm’s supply curve tells how much the firm will produce in the short run at every possible price, given a fixed plant size.
Firm’s SR Supply Curve
The firm’s supply curve is equal to its MC curve above AVC.
P1 is sometimes called the “shutdown point” because if price falls below P1, the firm shuts down in the short run.
Industry Short Run Supply Curve
Industry SR Supply Curve: tells us how much the industry will produce at every possible price, given fixed plant sizes and a fixed number of firms.
Deriving Industry SupplyP P P
10 q Q
IndustryFirm 2Firm 1mc1
1522 25 32 4220
SRS
1
2
3 mc2
1715
The industry supply curve is the horizontal summation of the firms’ marginal cost curves (above their AVC curves).
The Price-Taking Firm’s SR Supply Curve Look at the graph (next slide) to answer these
questions: In the short run, if the market price is $3, what
quantity will the firm produce? _____ In the short run, if the market price is $5.25,
what quantity will the firm produce? _____ In the short run, if the market price is $7.50,
what quantity will the firm produce? _____ Trace out the firm's short-run supply curve.
Short Run Industry Supply
Suppose that there are 100 price-taking firms in this industry and all have identical cost curves to the firm depicted in the graph.
Draw the short-run industry supply curve in the right-hand panel of the next slide. Be sure to use the scale provided.