Understanding Perfectly Competitive Markets: Firm Behavior and Profit Maximization - Prof., Study notes of Microeconomics

Download Understanding Perfectly Competitive Markets: Firm Behavior and Profit Maximization - Prof. and more Study notes Microeconomics in PDF only on Docsity! 1 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts 2 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts CHAPTER 11 Firms in Perfectly Competitive Markets Fernando Quijano Prepared by: The market for organically grown food has expanded rapidly in the United States. 5 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Which of the following conditions must exist in order to have a perfectly competitive market? a. There must be many buyers and many firms, all of whom are small relative to the market. b. The products sold by firms in the market must be different from each other. c. There must be some barriers to entry in order to protect perfect competition. d. All of the above. 6 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Which of the following conditions must exist in order to have a perfectly competitive market? a. There must be many buyers and many firms, all of whom are small relative to the market. b. The products sold by firms in the market must be different from each other. c. There must be some barriers to entry in order to protect perfect competition. d. All of the above. 7 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Perfectly competitive market A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market. Price taker A buyer or seller that is unable to affect the market price. A Perfectly Competitive Firm Cannot Affect the Market Price Perfectly Competitive Markets Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve. 11.1 LEARNING OBJECTIVE 10 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts How a Firm Maximizes Profit in a Perfectly Competitive Market Profit Total revenue minus total cost. Profit = TR – TC Revenue for a Firm in a Perfectly Competitive Market Average revenue (AR) Total revenue divided by the quantity of the product sold. Marginal revenue (MR) The change in total revenue from selling one more unit of a product. or , quantityin Change revenue in total Change Revenue Marginal Q TR MR    Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE 11 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts How a Firm Maximizes Profit in a Perfectly Competitive Market NUMBER OF BUSHELS (Q) MARKET PRICE (PER BUSHEL) (P) TOTAL REVENUE (TR) AVERAGE REVENUE (AR) MARGINAL REVENUE (MR) 0 1 2 3 4 5 6 7 8 9 10 $4 4 4 4 4 4 4 4 4 4 4 $0 4 8 12 16 20 24 28 32 36 40 - $4 4 4 4 4 4 4 4 4 4 - $4 4 4 4 4 4 4 4 4 4 Table 11-2 Farmer Parker’s Revenue from Wheat Farming Revenue for a Firm in a Perfectly Competitive Market Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE 12 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts How a Firm Maximizes Profit in a Perfectly Competitive Market QUANTITY (BUSHELS) (Q) TOTAL REVENUE (TR) TOTAL COST (TC) PROFIT (TR-TC) MARGINAL REVENUE (MR) MARGINAL COST (MC) 0 1 2 3 4 5 6 7 8 9 10 $0.00 4.00 8.00 12.00 16.00 20.00 24.00 28.00 32.00 36.00 40.00 $2.00 5.00 7.00 8.50 10.50 13.00 16.50 21.50 28.50 38.00 50.50 -$2.00 -1.00 1.00 3.50 5.50 7.00 7.50 6.50 3.50 -2.00 -10.50 — $4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 — $3.00 2.00 1.50 2.00 2.50 3.50 5.00 7.00 9.50 12.50 Determining the Profit-Maximizing Level of Output Table 11-3 Farmer Parker’s Profits from Wheat Farming Explain how a firm maximizes profit in a perfectly competitive market. 11.2 LEARNING OBJECTIVE 15 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Illustrating Profit or Loss on the Cost Curve Graph Profit = (P x Q)  TC   Q QP )(  Q Profit Q TC P ATC Q   Profit Profit = (P  ATC) x Q or Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE 16 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Showing a Profit on the Graph FIGURE 11-4 The Area of Maximum Profit Illustrating Profit or Loss on the Cost Curve Graph A firm maximizes profit at the level of output at which marginal revenue equals marginal cost. The difference between price and average total cost equals profit per unit of output. Total profit equals profit per unit multiplied by the number of units produced. Total profit is represented by the area of the green-shaded rectangle, which has a height equal to (P - ATC) and a width equal to Q. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE 17 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Solved Problem 11-3 Determining Profit-Maximizing Price and Quantity OUTPUT PER DAY TOTAL COST 0 $10.00 1 20.50 2 24.50 3 28.50 4 34.00 5 43.00 6 55.50 7 72.00 8 93.00 9 119.00 YOUR TURN: For more practice, do related problems 3.3 and 3.4 at the end of this chapter. Use graphs to show a firm’s profit or loss. 11.3 LEARNING OBJECTIVE 20 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Deciding Whether to Produce or to Shut Down in the Short Run 1. Continue to produce 2. Stop production by shutting down temporarily Sunk cost A cost that has already been paid and that cannot be recovered. In the short run, a firm experiencing losses has two choices: Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE 21 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts When to Close a Laundry Making the Connection Keeping a business open even when suffering losses can sometimes be the best decision for an entrepreneur in the short run. YOUR TURN: Test your understanding by doing related problems 4.5 and 4.6 at the end of this chapter. Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE 22 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Deciding Whether to Produce or to Shut Down in the Short Run Shutdown point The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run. The Supply Curve of a Firm in the Short Run Total revenue < Variable cost, (P × Q) < VC P < AVC or, in symbols: If we divide both sides by Q, we have the result that the firm will shut down if: Explain why firms may shut down temporarily. 11.4 LEARNING OBJECTIVE 25 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run EXPLICIT COSTS Water Wages Organic fertilizer Electricity Payment on bank loan $10,000 $15,000 $10,000 $5,000 $45,000 IMPLICIT COSTS Foregone salary Opportunity cost of the $100,000 she has invested in her farm $30,000 $10,000 Total cost $125,000 Economic Profit and the Entry or Exit Decision Table 11- 4 Farmer Moreno’s Costs per Year Economic profit A firm’s revenues minus all its costs, implicit and explicit. Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE 26 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Economic Profit Leads to Entry of New Firms FIGURE 11-8 The Effect of Entry on Economic Profits Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE 27 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts FIGURE 11-9 The Effect of Exit on Economic Losses Economic Losses Lead to Exit of Firms Economic Profit and the Entry or Exit Decision “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run 30 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts FIGURE 11-10 The Long-Run Supply Curve in a Perfectly Competitive Industry The Long-Run Supply Curve in a Perfectly Competitive Market “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE 31 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Long-run supply curve A curve that shows the relationship in the long run between market price and the quantity supplied. Increasing-Cost and Decreasing-Cost Industries Industries with upward-sloping long- run supply curves are called increasing-cost industries. Industries with downward-sloping long- run supply curves are called decreasing-cost industries. The Long-Run Supply Curve in a Perfectly Competitive Market “If Everyone Can Do It, You Can’t Make Money at It”: The Entry and Exit of Firms in the Long Run Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run. 11.5 LEARNING OBJECTIVE 32 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Perfect Competition and Efficiency Productive efficiency The situation in which a good or service is produced at the lowest possible cost. Productive Efficiency Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE 35 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Perfect Competition and Efficiency Allocative efficiency A state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. Allocative Efficiency Explain how perfect competition leads to economic efficiency. 11.6 LEARNING OBJECTIVE 36 of 79 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. C h a p te r 1 1 : F ir m s i n P e rf e c tl y C o m p e ti ti v e M a rk e ts Allocative efficiency Average revenue (AR) Economic loss Economic profit Long-run competitive equilibrium Long-run supply curve Marginal revenue (MR) Perfectly competitive market Price taker Productive efficiency Profit Shutdown point Sunk cost KEY TERMS