many small firms standardized product no need to advertise “price takers” free entry and...
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PURE COMPETITION
PURE COMPETITION Many small firms Standardized product
No need to advertise “Price takers” Free entry and exit Perfectly elastic demand
Average revenue Marginal revenue Price
9-2
Demand for Perfectly Competitive Firms
Why are they Price Takers?•If a firm charges above the market price, NO ONE will buy. They will go to other firms•There is no reason to price low because consumers will buy just as much at the market price.
Since the price is the same at all quantities demanded, the demand curve for each firm is…
Perfectly Elastic (A Horizontal straight line)
3Copyright ACDC Leadership 2015
P
Q
Demand
P
Q5000
D
S
Industry(all firms)
$10 $10
The Competitive Firm is a Price TakerPrice is set by the Industry
4
Firm
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5
What is the additional revenue for selling an
additional unit? 1st unit earns $102nd unit earns $10Marginal revenue is constant at $10Notice:
• Total revenue increases at a constant rate
• MR equal Average Revenue
5
MR=D=AR=P
The Competitive Firm is a Price TakerPrice is set by the Industry
P
Q
Demand
Firm
$10
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6
What is the additional revenue for selling an
additional unit? 1st unit earns $102nd unit earns $10Marginal revenue is constant at $10Notice:
• Total revenue increases at a constant rate
• MR equal Average Revenue
6
MR=D=AR=P
The Competitive Firm is a Price TakerPrice is set by the Industry
P
Q
Demand
Firm
$10
For Perfect Competition:Demand = MR
(Marginal Revenue)
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Short-Run Profit MaximizationWhat is the goal of every business?
To Maximize Profit!!!!!!•To maximum profit firms must make the right output •Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10) • Should you produce…
…if the additional cost of another unit is $5…if the additional cost of another unit is $9…if the additional cost of another unit is $11
7Copyright ACDC Leadership 2015
Short-Run Profit MaximizationWhat is the goal of every business?
To Maximize Profit!!!!!!•To maximum profit firms must make the right output •Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10) • Should you produce…
…if the additional cost of another unit is $5…if the additional cost of another unit is $9…if the additional cost of another unit is $11
8
Profit Maximizing Rule
MR=MC
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P
Q
Demand
P
Q10,000
D
S
Industry Firm(price taker)
$7 $7
9
ATC
MC
Lets put costs and revenue together to calculate profit.
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Total Revenue =$63
$9
8
7
6
5
4
3
2
1
1 2 3 4 5 6 7 8 9 10
MC
ATC
•How much output should be produced?•How much is Total Revenue? How much is Total Cost? •Is there profit or loss? How much?
MR=D=AR=P
Total Cost=$45
Profit = $18
10
Q
P
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Suppose the market demand falls. What would happen if the price is lowered from
$7 to $5? The MR=MC rule still applies but now the firm will make an economic loss.
The profit maximizing rule is also the loss minimizing rule!!!
11Copyright ACDC Leadership 2015
Total Revenue=$35
Co
st a
nd
Rev
enu
e
1 2 3 4 5 6 7 8 9 10
MC
ATC
•How much output should be produced?•How much is Total Revenue? How much is Total Cost? •Is there profit or loss? How much?
MR=D=AR=P
Total Cost = $42
Loss =$7
$9
8
7
6
5
4
3
2
1
12
Q
Assume the market demand falls even more. If the price is lowered from $5 to $4
the firm should stop producing.
Shut Down Rule:•A firm should continue to produce as long as the price is above the AVC •When the price falls below AVC then the firm should minimize its losses by shutting down •Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.
13Copyright ACDC Leadership 2015
TC=$35
TR=$20
1 2 3 4 5 6 7 8 9 10
MC
AVC
ATC
P<AVC. They should shut down Producing nothing is cheaper than staying open.
MR=D=AR=P
Fixed Costs=$10
$9
8
7
6
5
4
3
2
1
14
Q
Price
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SHORT-RUN SUPPLY CURVE
Firms produce where MR=MC
P1
0
Co
st a
nd
Rev
enu
es (
Do
llars
)
Quantity Supplied
MR1
P2 MR2
P3 MR3
P4 MR4
P5 MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
This Price is Below AVCAnd Will Not Be Produced
ab
c
d
e
9-15
SHORT-RUN SUPPLY CURVE
P1
0
Co
st a
nd
Rev
enu
es (
Do
llars
)
Quantity Supplied
MR1
P2 MR2
P3 MR3
P4 MR4
P5 MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
ab
c
d
e
MC Above AVC Becomesthe Short-Run Supply Curve S
Examine the MC for the Competitive Firm
Break-even(Normal Profit) Point
Shut-Down Point (If P is Below)
Firms produce where MR=MC
9-16
Three Characteristics of MR=MC Rule:1. Rule applies to ALL markets
structures (PC, Monopolies, etc.)2. The rule applies only if price is
above AVC 3. Rule can be restated P = MC for
perfectly competitive firms (because MR = P)
Profit Maximizing RuleMR = MC
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PRACTICE
18Copyright ACDC Leadership 2015
$1615
109
5
0
MC
ATC14
1. Should the firm produce?2. What output should the firm produce?3. What is the TR and TC at that output?4. How much profit or loss?
MR=D=AR= P
Yes10TR=$140
Profit=$40TC=$100
#1
19Quantity 3 7 10 12
Price
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20
12
0 3 6 8 10
MC
MR=D=AR=P
AVC
ATC
15
18
What output should the firm produce?What is TR at that output?What is TC?How much profit or loss?
6$90
$120Loss= $30
#2
20
Price
QuantityCopyright ACDC Leadership 2015
$12
10
05 6 7 8
MC
MR=D=AR=P
AVCATC
11
1. What output should the firm produce?2. What is TR at MR=MC point?3. What is TC at MR=MC point?4. How much profit or loss?
9
Loss=Only Fixed Cost $5
Zero Shutdown (Price below AVC)$45
$55#3
21
Price
QuantityCopyright ACDC Leadership 2015
$1211
65
3
0
MC
ATC10
1. Should the firm produce?2. What output should the firm produce?3. What is the TR and TC at that output?4. How much profit or loss?
MR=D=AR= P
Yes10TR=$100
Profit=$40TC=$60
#4
22Quantity 3 7 10 12
Price
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MAXIMIZING PROFIT
OutputVariable
CostFixedCost
TotalCost
MarginalCost
0 $0 $20 -
1 $12
2 $22
3 $27
4 $40
5 $60
6 $100
Assume the firm can sell each unit at a
price of $301. How many units
should the firm produce to maximize profit?
2. What is the total revenue at that quantity?
3. How much is the profit?
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Notice that at 6 units the firm is still making profit. It’s just not maximizing profit
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MAXIMIZING PROFIT
OutputVariable
CostFixedCost
TotalCost
MarginalCost
0 $0 $20 -
1 $12
2 $22
3 $27
4 $40
5 $60
6 $100
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Notice that at 6 units the firm is still making profit. It’s just not maximizing profit
TR MR Profit
- - -
$30 $30 -$2
$60 $30 $18
$90 $30 $43
$120 $30 $60
$150 $30 $70
$180 $30 $60
SHORT-RUN SUPPLY CURVE
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$50
4540353025 2015 10
5 0
Cos
t an
d R
even
ue
1 2 3 4 5 6 7 9
AVC
ATC
26
MR1
Marginal Cost and Individual Supply
MR2
MR3
MR4
MR5
MC
Q
Notice: As price increases, the quantity increases
Notice: The firm will not produce when MC is below AVC
$50
4540353025 2015 10
5 0
Cos
t an
d R
even
ue
1 2 3 4 5 6 7 9
AVC
ATC
27
Marginal Cost and Supply
MC
Q
= Supply
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Short-run Supply Curve: MC above AVC
If variable costs increase (ex: per unit tax)
$50
4540353025 2015 10
5 0
Cos
t an
d R
even
ue
1 2 3 4 5 6 7 9
AVC
28
Marginal Cost and Supply
Q
MC1=Supply1
AVC
MC2=Supply2
When MC increases, SUPPLY decrease
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What if variable costs decrease (ex: subsidy)?
$50
4540353025 2015 10
5 0
Cos
t an
d R
even
ue
1 2 3 4 5 6 7 9
AVC
29
Marginal Cost and Supply
Q
MC1=Supply1
AVC
MC2=Supply2
When MC decreases, SUPPLY increases
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Marginal Cost and Supply
MC
ATC
PFMR=D=AR= P
30QuantityQF
Price
What happens to quantity if fixed costs increase?
Quantity stays the same because
MC/Supply doesn’t change
ATC1
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Per Unit vs. Lump SumA PER UNIT tax or subsidy affects the VARIABLE COSTS so MC, AVC, and ATC will shift.
This WILL affect the quantity produced
A LUMP SUM tax or subsidy only affects FIXED COSTS so only AFC and ATC will shift. MC stays the same.
This WILL NOT affect the quantity produced
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2008 Audit Exam