Perfectly Competitive Markets:Choosing Output in Short Run

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Microeconomics ECO402

Lesson 22

Perfectly Competitive Markets

Characteristics of Perfectly Competitive Markets

1) Price taking

2) Product homogeneity

3) Free entry and exit

Price Taking

The individual firm sells a very small share of the total market output and, therefore,

cannot influence market price.

The individual consumer buys too small a share of industry output to have any impact on

market price.

Product Homogeneity

The products of all firms are perfect substitutes.

Examples

· Agricultural products, oil, copper, iron, lumber

Free Entry and Exit

Buyers can easily switch from one supplier to another.

Suppliers can easily enter or exit a market.

Discussion Questions

What are some barriers to entry and exit?

Are all markets competitive?

When is a market highly competitive?

Do firms maximize profits?

Possibility of other objectives

· Revenue maximization

· Dividend maximization

· Short-run profit maximization

Implications of non-profit objective

· Over the long-run investors would not support the company

· Without profits, survival unlikely

Long-run profit maximization is valid and does not exclude the possibility of altruistic

behavior.

Marginal Revenue, Marginal Cost & Profit Maximization

Determining the profit maximizing level of output

Profit (š ) = Total Revenue - Total Cost

Total Revenue (R) = Pq

Total Cost (C) = Cq

Therefore:

š (q) = R (q) - C (q)

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Microeconomics ECO402

Profit Maximization in the Short Run

Cost,

R(q)

Revenue,

Total Revenue

Profit

($s per

year)

Slope of R(q) = MR

Output (units per year)

C(q)

Cost,

Revenue,

Total Cost

Profit

$ (per

year)

Slope of C(q) = MC

Why is cost positive when q is zero?

Output (units per year)

Marginal Revenue, Marginal Cost & Profit Maximization

Marginal revenue is the additional revenue from producing one more unit of output.

Marginal cost is the additional cost from producing one more unit of output.

C(q)

Cost,

Revenue,

Profit

R(q)

($s per

year)

Output (units per year) š (q)

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Microeconomics ECO402

Comparing R(q) and C(q)

Output levels: 0- q0:

· C(q)> R(q)

Negative profit

· FC + VC > R(q)

· MR > MC

Indicates higher profit at higher output

Question: Why is profit negative when output is zero?

Output levels: q0 - q*

· R(q)> C(q)

· MR > MC

Indicates higher profit at higher output while Profit is increasing

Output level: q*

· R(q)= C(q)

· MR = MC

· Profit is maximized

· Question

Why is profit reduced when producing more or less than q*?

Output levels beyond q*:

· R(q)> C(q)

· MC > MR

· Profit is decreasing

Therefore, it can be said:

Profits are maximized when MC = MR.

ΔR

ΔC

MR =

š = R-C

MC =

Δq

Profits are maximized

when :

MR - MC = 0 so that

Δš

ΔR

ΔC

= 0 or

MR(q) = MC(q)

Δq

The Competitive Firm

Price taker

Market output (Q) and firm output (q)

Market demand (D) and firm demand (d)

R(q) is a straight line

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Microeconomics ECO402

Demand & Marginal Revenue Faced by a Competitive Firm

Price

$ per

Firm

Industry

bushel

Output

100

200

100

(millions

(bushels)

of bushels)

The

competitive firm's demand

· Individual producer sells all units for $4 regardless of the producer's level of output.

· If the producer tries to raise price, sales are zero.

· If the producers tries to lower price he cannot increase sales

· P = D = MR = AR

Profit Maximization

· MC(q) = MR = P

Choosing Output in Short Run

We will combine production and cost analysis with demand to determine output and

profitability.

A Competitive Firm Making a Positive Profit

Price 60

($ per

unit)

Lost profit for

qq < q*

q2 > q*

AR=MR=

ATC

AVC

At q*: MR = MC

q1 : MR > MC and

and P > ATC

q2: MC > MR and

q0: MC = MR but

š = (P - AC) x q*

MC falling

or ABCD

Output

q q

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