1 / 18

Ch 8: Profit Max Under Perfect Competition

Ch 8: Profit Max Under Perfect Competition. Three assumptions in p.c. model: 1) Price-taking : many small firms, none can affect mkt P by ing Q  no mkt power; 2 ) Product homogeneity : each firm produces nearly identical product

bruno
Download Presentation

Ch 8: Profit Max Under Perfect Competition

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Ch 8: Profit Max Under Perfect Competition • Three assumptions in p.c. model: • 1) Price-taking: many small firms, none can affect mkt P by ing Q  no mkt power; • 2) Product homogeneity: each firm produces nearly identical product • 3) Free entry and exit: assures big number of firms in industry.

  2. More on Perfect Competition • Real-life examples: • Agricultural products • Oil. • P.C. is an ideal; useful starting point. • Also assume:

  3. Profit Maximization • Profit-max extends beyond just p.c. mkt structure. • Define profit = TR – TC • (q) = R(q) – C(q), or •  = R – C. • So firm picks q* where difference between TR and TC is greatest. • With graphs of TR and TC:

  4. Three Curves in Figure 8.1 • TR: slope is MR • TC: slope is MC. •  function: see inverse U-shape: • Max  where: • 1) • 2) • 3) Rule: • pick -max q* where MR = MC.

  5. Review Implications of Perfect Competition • First: keep terms straight: • Q = • D = • q = • d = • Market D is downward sloping but demand curve faced by individual firm is perfectly elastic (horizontal). • So: firm demand curve is same is its MR curve.

  6. Further Implications • Recall: firm’s demand curve is its MR curve. • This means that P = MR. • So profit-max rule: pick -max q* where MC = MR = P. • Also, since P = MR for each q, then P = MR = AR.

  7. FURTHER Details • Revise rule: pick -max q* where MR = MC AND MC is rising. • Note: • Short Run profit for p.c. firm: • P - ATC at q* = avg profit per unit of q. • Explain: • Total  at q* = q*  avg. .

  8. Firm’s SR Shutdown Decision • Situation: What if the SR -max q* results in losses? • Firm must choose (1) vs (2): • 1) Continue producing at q*: • 2) Shutdown in SR:

  9. SR Shutdown Rule • Firm must know: at q*, what is: • P, • ATC, and • AVC. • Rule: If   0 in SR: • continuing producing q* as long as P  AVC. • In LR:

  10. Competitive Firm’s SR Supply Curve • Supply Curve: shows q produced at each possible price. • SR supply curve: the firm’s MC curve for all points where MC  AVC • I.e., -max q* is where P  AVC. • Remember “trigger” for shutdown in SR  implies that MC curve has an irrelevant part (where MC  P).

  11. Firm’s Response to  Price of Input • Consider:  price input  causes  MC at each q  shift up to left of MC curve. • See Figure 8.7: • Start at P = $5 with MC1; so q* = q1. • Now: price input causes  MC: • Shifts MC up to left. • Causes  q*.

  12. SR Market Supply Curve • Shows: amount of Q the industry will produce in SR at each possible price. • Sum SR supply curves for firms using horizontal summation. • That is: at each possible price, sum up total quantity supplied by each firm. • See Figure 8.9. • (Note: for each firm: as q es, individual MC curves no .).

  13. Price Elasticity of Market Supply • ES = %Qs/1%P = • (Q/Q) / (P/P). • ES  0 always because SMC slopes upward. • If MC  a lot in response to Q, then ES is low. • Extreme cases: • Perfectly inelastic S: • Perfect elastic S:

  14. Producer Surplus in SR • Concept analogous to CS. • For rising MC: P  MC for every unit of q except last one produced. • For a firm (see Figure 8.11): • For all units produced (up to q*): • Measures area above MC schedule (S curve) and below mkt price.

  15. LR Competitive Equilibrium • If each firm earns zero economic , each firm is in LR equilibrium. • Three conditions: • 1. All firms in industry are profit-maximizing. • 2. No firm has incentive to enter or leave industry (due to  = 0). • 3. P is that which equates QS = QD in market.

  16. Adjustment from SR to LR Equilibrium • Firm starts in SR equilibrium. • Positive profits induce new firms to entire industry. • This causes market P to fall. • This causes firm’s MR line to fall, until profits = 0 again. • Key: firms enter as long as P  AVC • Note: in this case, MC no shift due to constant cost assumption. • LR choice of q*: • where LMC = P = MR = LAC. • Key is LMC=LAC.

  17. Economic Rent • Economic Rent: • For an industry: economic rent same as LR producer surplus. • For a fairly fixed factor (like land): • In LR in a competitive mkt:

  18. Industry’s LR Supply Curve • Cannot just sum horizontally because as price es, # firms in industry es. Must connect the zero-profit points. • Shape of LR supply curve: depends on whether (and in what direction) the es in each firm’s q causes es in input prices. • Constant cost industry: As q and Q , input prices no  so firm’s MC, AVC, and ATC NO shift as q changes. • SO: LR industry supply curve is flat (perfectly horizontal).

More Related