8perfect competition w voice-over

Chapter 8 Perfect (pure) Competition:

1 Chapter 8 Perfect (pure) Competition Monopoly – chapter 9 Monopolistic Competition – chapter 10 Oligopoly – chapter 10

Perfect Competition:

2 Perfect Competition Explaining how competitive markets determine prices, output, and profits

Characteristics of Perfect Competition:

3 Characteristics of Perfect Competition many small firms 2. homogeneous product 3. very easy entry and exit 4. price taker

What determines price?:

4 What determines price? Market Supply and Market Demand

Market Demand Curves vs. Firm Demand Curves:

5 Market Demand Curves vs. Firm Demand Curves Market demand Market supply Equilibrium price p e PRICE (per shirt) QUANTITY (thousand shirts per day) The T-shirt market p e QUANTITY (shirts per day) Demand facing single firm Demand facing one shop

Short-Run Profit Maximization for Perfectly Competitive:

6 Short-Run Profit Maximization for Perfectly Competitive The only thing it can control is how many units it produces Then produce where it will maximize profits, or at least minimize losses

Two methods to determine how many units to produce?:

7 Two methods to determine how many units to produce? TR minus TC MR equals MC

Marginal Analysis:

8 Marginal Analysis Economic reasoning is making decisions on the basis of costs and benefits . The relevant costs and relevant benefits are the expected incremental or additional costs and/or benefits. Marginal is the term we use to describe this.

Producing Exactly at the Output Level Where MC = MR Enables Us to Maximize Total Profits (or Minimize Total Losses):

9 Producing Exactly at the Output Level Where MC = MR Enables Us to Maximize Total Profits (or Minimize Total Losses) MR = additional revenue from selling one more unit MC = additional cost of producing one more unit We keep adding to output as long as MR exceeds MC If we stop short of this point, we would not maximize profit We stop adding to output when MR = MC If we continued to add output, MC would exceed MR and this would diminish our profits

Marginal Revenue = Price:

10 Marginal Revenue = Price The contribution to total revenue of an additional unit of output is called marginal revenue. Marginal Revenue ( MR ) - The change in total revenue that results from a one-unit increase in the quantity sold. Thus, Marginal Revenue = Price

Marginal Revenue equals Marginal Cost:

11 Marginal Revenue equals Marginal Cost As long as MR is > than MC, money is being made on that last unit At the output where MR < MC, money is being lost on that last unit

Slide 12:

12 Profit Maximization and Loss Minimization Output Price TR MR TC ATC MC Total Profits 1 1 $200 $200 $200 $500 $500 $100 1 2 200 400 200 550 275 50 1 3 200 600 200 610 203 60 1 4 200 800 200 700 175 90 1 5 200 1000 200 830 166 130 1 6 200 1200 200 1000 167 170 1 7 200 1400 200 1205 172 205 Profit Maximization Point: MC = MR This occurs somewhere between 6 and 7 units. We are assuming output can be produced in tenths of a unit

Slide 13:

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Profit-Maximizing Rate of Output:

14 Profit-Maximizing Rate of Output Profits are maximized at the rate of output where price equals marginal cost. Profit-maximization rule – produce at that rate of output where marginal revenue equals marginal cost.

Short-Run Loss Minimization for a Perfectly Competitive Firm:

15 Short-Run Loss Minimization for a Perfectly Competitive Firm A Perfectly Competitive Firm Facing a Short-Run Loss Market conditions can change the prevailing price

The Decision to Shut Down:

16 The Decision to Shut Down A firm has two basic options in the short run The firm can operate If it operates, it will produce the output that will yield the highest possible profits If it is losing money, it will operate at that output at which losses are minimized The firm can shut down If the firm shuts down, the output is zero Shutting down does not mean zero total costs The firm must still meet its fixed costs Remember, at an output of zero total cost equals fixed cost The firm can not go-out-of-business until all fixed cost obligations are eliminated

Slide 17:

17 Problem 1 Problem 2 Problem 3 (All dollar figures in millions) Fixed costs $ 5 $10 $ 8 Variable costs 6 9 12 Prospective Sales 7 8 10 Decision Problem # 1 Decision - Operate or shut Down? Short Run Choices Operate TC = FC + VC ($5 + $6) = $11 Sales = . . . . . . . . . . . . . . . . 7 Loss = . . . . . . . . . . . . . . . . $ 4 Shut Down TC = (FC) = $5 Sales = . . . . . . 0 Loss = . . . . . . $5 Operate

Slide 18:

18 Problem 1 Problem 2 Problem 3 (All dollar figures in millions) Average Fixed costs $ 5 $10 $ 8 Average Variable costs 6 9 12 Price 7 8 10 Decision Problem # 2 Decision - Operate or shut Down? Short Run Choices Operate TC = FC + VC ($10 + $9) = $19 Sales = . . . . . . . . . . . . . . . . . . 8 Loss = . . . . . . . . . . . . . . . . . . $11 Shut Down TC = (FC) = $10 Sales = . . . . . . 0 Loss = . . . . . . $10 Operate Shut down

Slide 19:

19 Problem 1 Problem 2 Problem 3 (All dollar figures in millions) Average Fixed costs $ 5 $10 $ 8 Average Variable costs 6 9 12 Price 7 8 10 Decision Problem # 3 Decision - Operate or shut Down? Short Run Choices Operate TC = FC + VC ($8 + $12) = $20 Sales = . . . . . . . . . . . . . . . . . . 10 Loss = . . . . . . . . . . . . . . . . . . $10 Shut Down TC = (FC) = $8 Sales = . . . . . . 0 Loss = . . . . . . $8 Operate Shut down Shut down

Slide 20:

20 Problem 1 Problem 2 Problem 3 (All dollar figures in millions) Average Fixed costs $ 5 $10 $ 8 Average Variable costs 6 9 12 Price 7 8 10 Decision Operate Shut down Shut down In the short run . . . A firm has two options The firm operates when sales exceed average variable cost The firm shuts down when average variable cost are greater than sales Note: Fixed costs are not relevant in the operate/shut down decision!

Slide 21:

21 Price (MR) is below minimum average variable cost Firm will shut down

The Long Run:

22 The Long Run The time at which all cost become variable cost The long run never exist except in theory You will never have a situation in which all your cost are variable This would mean no rent, no insurance, no guaranteed salaries, no depreciation, etc You never really reach the long run As you proceed through the short run, you are forced to make decisions that will push the long run farther into the future

Slide 23:

23 The Most Efficient Output How much is the firm’s most efficient output? This occurs at an output of 10, which is the minimum point on the ATC (which is the break-even point) How much is the most profitable output? This occurs at an output of 11 which is where MC=MR

Short-Run / Long-Run Supply:

24 Short-Run / Long-Run Supply In the short run If the price is below the shut-down point (min AVC), the firm will shut down If the price is above the shut-down point (min AVC), the firm will operate In the long run If the price is below the break-even point (min ATC), the firm will go out of business If the price is above the break-even point (min ATC), the firm will stay in business

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