Econ Dept, UMR Presents Perfect Competition-- --A A Perfect Competition Model of Markets Model of Markets
Starring Starring The Perfectly Competitive N The Perfectly Competitive N Firm Firm Profit Maximizing Decisions N Profit Maximizing Decisions N In the Short Run 7 In the Short Run 7 In the Long Run 7 In the Long Run 7
Featuring Featuring An Overview of Market Structures N An Overview of Market Structures N The Assumptions of the Perfectly N The Assumptions of the Perfectly N Competitive Model Competitive Model N The Marginal Cost = Marginal Revenue The Marginal Cost = Marginal Revenue N Rule Rule N Marginal Cost and Short Run Supply Marginal Cost and Short Run Supply N Social Surplus N Social Surplus N
Part II: Profit Maximization in the Part II: Profit Maximization in the Short Run Short Run N First, we define some terms First, we define some terms N N Second, we explore the MR = MC rule Second, we explore the MR = MC rule N N Third, we look at the Third, we look at the N O The Break The Break- -even point, and even point, and O O The Shut down point The Shut down point O
Reminders... Reminders... N Firms operate in perfectly Firms operate in perfectly N competitive output and input competitive output and input markets markets N In perfectly competitive industries, In perfectly competitive industries, N prices are determined in the market prices are determined in the market and firms are price takers and firms are price takers N The demand curve for the firm The demand curve for the firm ’ s ’ s N product is perceived to be perfectly product is perceived to be perfectly elastic elastic
Total and Marginal Revenue Total and Marginal Revenue N Total revenue is the amount of Total revenue is the amount of N revenue the firm takes in from the revenue the firm takes in from the sale of its product. sale of its product. TR = price x quantity sold TR = price x quantity sold N Marginal revenue is the change in Marginal revenue is the change in N revenue to a firm when it changes revenue to a firm when it changes output by one unit output by one unit MR = ) TR/ ) q MR = ) TR/ ) q
Marginal Revenue Marginal Revenue N Marginal Revenue is the change in Marginal Revenue is the change in N revenue from selling one more, or one revenue from selling one more, or one less unit less unit N If the firm gets price p* for every unit it If the firm gets price p* for every unit it N sells, as it does in perfect competition as it does in perfect competition , , sells, then p* is the marginal revenue at all then p* is the marginal revenue at all quantities quantities MR = ∆ ∆ in TR / in TR / ∆ ∆ in Q O MR = in Q O N Horizontal Demand Curve means, Horizontal Demand Curve means, N O MR = P MR = P O
Demand Curve, d, as seen by the Demand Curve, d, as seen by the price taking firm price taking firm $ d p* d q/t 0
Firm ' s Horizontal Demand Firm ' s Horizontal Demand Curve Curve N At P > p*, Sales = 0 At P > p*, Sales = 0 N N At P < p*, Less Profits then if Sell at p* At P < p*, Less Profits then if Sell at p* N N p* found from Market Equilibrium p* found from Market Equilibrium N Price Price
Profit Maximization Profit Maximization N We assume that the firm is profit We assume that the firm is profit N maximizing maximizing N Profit = Total Revenue Profit = Total Revenue - - Total Cost Total Cost N N Total Revenue is P x q Total Revenue is P x q N N Profit maximization means cost of Profit maximization means cost of N producing any output is minimized producing any output is minimized O The input mix is such that MP The input mix is such that MP i /P i = MP j /P j i /P i = MP j /P O j for all variable inputs i and j used for all variable inputs i and j used O The cost curves drawn are the lowest The cost curves drawn are the lowest O possible possible
Consider the following data for a firm q TFC TVC MC P=MR TR TC TR-TC 0 $55 $ 0 $-- $ 40 1 55 45 40 2 55 65 40 3 55 70 40 4 55 80 40 5 55 95 40 6 55 120 40 7 55 155 40 8 55 200 40 255 40 9 55 10 55 320 40 Can you fill in the missing columns?
What is the firm 's 's profit maximizing profit maximizing What is the firm level of output? level of output? q TFC TVC MC P=MR TR TC TR-TC 0 $55 $ 0 $-- $40 $-- $ 55 $ -55 1 55 45 45 40 40 100 -60 2 55 65 20 40 80 120 -40 3 55 70 5 40 120 125 - 5 4 55 80 10 40 160 135 25 5 55 95 15 40 200 150 30 6 55 120 25 40 240 175 65 7 55 155 35 40 280 210 70 8 55 200 45 40 320 255 65 9 55 255 55 40 360 310 50 10 55 320 65 40 400 375 25
Profit Maximizing Profit Maximizing N Since the perfectly competitive firm Since the perfectly competitive firm N cannot choose the price, the only choice cannot choose the price, the only choice left for the firm is to choose how much left for the firm is to choose how much to produce. to produce. N The firm will choose the quantity where The firm will choose the quantity where N TR- -TC is the largest, in other words TC is the largest, in other words - - TR where the difference between the TR where the difference between the TR and TC curves is the biggest and TC curves is the biggest
Profit Maximized when TR Profit Maximized when TR and TC are furthest apart and TC are furthest apart TR TC $ 280 280 210 210 55 55 q* = 7 = 7 q/t
Profit Maximizing Profit Maximizing N Note that the slope of the TR and TC Note that the slope of the TR and TC N curves are the same at this quantity curves are the same at this quantity N This means the the derivative of TR is This means the the derivative of TR is N the same as the derivative of TC at q* the same as the derivative of TC at q* N There is a way we can find q* without There is a way we can find q* without N calculus, though calculus, though N We will need to graph the MR and MC We will need to graph the MR and MC N curves curves
Profit Max without Calculus Profit Max without Calculus $ MC MR q 1 q 2 q 3 q 4 q/t
Profit Maximizing Profit Maximizing N Consider the quantity q Consider the quantity q 1 N 1 $ MC N At q At q 1 MR>MC. This 1 MR>MC. This N means that the means that the MR additional revenue from additional revenue from selling one more is selling one more is greater than the cost of greater than the cost of making one more. making one more. N This means the firm will This means the firm will q 1 q 2 q 3 q 4 q/t N make more profit by make more profit by making one more, so making one more, so they will they will N The same is true at q The same is true at q 2 N 2
Profit Maximizing Profit Maximizing N At q At q 3 , MR=MC. 3 , MR=MC. N This means that This means that $ MC the firm will get the firm will get exactly as much exactly as much MR money from money from selling one more selling one more as it cost them to as it cost them to make one more make one more q 1 q 2 q 3 q 4 q/t N So the firm has no So the firm has no N interest in interest in making one more making one more
Profit Maximizing Profit Maximizing N And at q And at q 4 , MR<MC. 4 , MR<MC. N $ This means that it This means that it MC costs more to make costs more to make one more than it will one more than it will MR bring in when it is bring in when it is sold sold N This means the firm This means the firm N will lose money will lose money q 1 q 2 q 3 q 4 q/t N So the firm would So the firm would N want to decrease want to decrease production to bring production to bring MC down MC down
The Golden Rule The Golden Rule N A profit maximizing firm will always A profit maximizing firm will always N produce where MC=MR produce where MC=MR N In the case of Perfect Competition, we In the case of Perfect Competition, we N know MR=P, so we could also say that know MR=P, so we could also say that a profit maximizing firm produces a profit maximizing firm produces where P=MC where P=MC
In a perfectly competitive market, the In a perfectly competitive market, the firm ’ s demand curve is the firm’s marginal firm ’ s demand curve is the firm’s marginal revenue curve. revenue curve. Market Firm S $5 $5 P=MR D Q/t/t q/t/t
Comparing Marginal Cost and Comparing Marginal Cost and Marginal Revenue to Maximize Profit Marginal Revenue to Maximize Profit Market Firm MC P P S $5 $5 P=MR D Q/t q/t
The firm maximizes profits by producing where MR = MC. Market Firm P P MC S P=MR $5 $5 D q Q/t q/t
Why is q=300 the profit- -maximizing maximizing Why is q=300 the profit level of output for the firm? level of output for the firm? Firm MC P ATC $5 P=MR 0 100 250 300 340 q/t
What will be the firm ’ s profit level at the profit-maximizing level of output? Firm MC P ATC $5.00 P=MR $3.50 0 100 250 300 340 q/t
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