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Perfectly Competitive Markets:Choosing Output in Short Run

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Microeconomics ­ECO402
VU
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)
113
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Microeconomics ­ECO402
VU
Profit Maximization in the Short Run
Cost,
R(q)
Revenue,
Total Revenue
Profit
($s per
year)
Slope of R(q) = MR
0
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?
0
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)
A
($s per
year)
B
q*
q0
0
Output (units per year) š (q)
114
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Microeconomics ­ECO402
VU
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
Δq
Profits  are maximized
when  :
MR - MC = 0 so that
Δš
ΔR
ΔC
=
-
= 0 or
MR(q) = MC(q)
Δq
Δq
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
115
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Microeconomics ­ECO402
VU
Demand & Marginal Revenue Faced by a Competitive Firm
Price
Price
$ per
$ per
Firm
Industry
bushel
bushel
$
$
d
D
Output
Output
100
200
100
(millions
(bushels)
of bushels)
­ The
competitive firm's demand
· Individual producer sells all units for $4 regardless of the producer's level of output.
· If the producer tries to raise price, sales are zero.
· If the producers tries to lower price he cannot increase sales
· P = D = MR = AR
­
Profit Maximization
· MC(q) = MR = P
Choosing Output in Short Run
We will combine production and cost analysis with demand to determine output and
profitability.
A Competitive Firm Making a Positive Profit
M
Price 60
($ per
unit)
50
Lost profit for
Lost profit for
qq < q*
q2 > q*
A
D
AR=MR=
40
ATC
C
B
AVC
30
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
10
0
1
2
3
4
5
6
7
8
9
10
11
Output
q
q
q q
*
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Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor