Industrial Supply Curve in Perfectly Competitive Markets, Appunti di Microeconomia

Scarica Industrial Supply Curve in Perfectly Competitive Markets e più Appunti in PDF di Microeconomia solo su Docsity! Chapter 8 – Profit Maximization and Competitive Supply - Once we know its cost curve, the question becomes: How much should be produced? - In this chapter we are seeing: . How a firm chooses its output level that maximizes its profit . How the output choices of individual firms lead to a supply curve for an entire industry . Perfectly Competitive Markets . How a competitive firm chooses its output in the short and long run . How the firm’s output choice changes as the cost of production increases . Deriving the firm’s supply curve . Aggregating the supply curves to obtain the Industrial Supply curve 8.1 Perfectly Competitive Market - In chapter 2 we used supply-demand analysis to explain how changing market conditions affect the market price - We saw equilibrium price and quantity of a good was determined by the intersection of the market demand and supply - From this analysis we derive the model of a Perfectly Competitive Market - There are three main basic assumption on this model: 1) Price Taking - Each firm (many) compete in the market, each firm faces a direct competitor for its product - Because each firm sells a sufficiently proportion of total market output, its decision have no impact on market price - Thus each firm takes the market price as given Firms are price takers - The assumption of price takers applies to consumers too; takes the price as given and has no impact on market price - There are many ind. Firms and consumers in the market, all of whom believe that their decisions will not affect prices 2) Product Homogeneity - Price-taking behavior occurs in markets where firms produce identical or nearly products - When the products of all of the firms in a market are perfectly substitutable with one another – homogeneous - No firm can rise the price without losing (business) - Economists refer to these tipology of product as Commodities - This assumption important because it ensures that there is a single market price, consistent with supply-demand analysis 3) Free Entry and Exit - No special costs that make it difficult for a new firm either to enter an industry and produce, or to exit if it cannot make a profit - As a result, buyers can easily switch from one supplier to another, and suppliers can easily enter or exit a market - Special cases such as the pharmaceutical industries: Merck and Pfizer hold patents that give them unique rights to produce drugs. New firm will have to work hard. - This assumption is fundamental for competition to be effective If this three assumptions of perfect competition hold, market demand and supply curves can be used to analyze the bahvior of market prices. In most markets, these assumptions are unlikely to hold exactly. When is a Market Highly Competitive? - Few real-world markets are perfectly competitive in the sense that each firm faces a perfect horizontal demand curve for a homogeneous product in an industry that it can freely enter or exit - Many markets are highly competitive in the sense that firms face highly elastic deman curves and relatively easy entry and exit - There is no simple indicator to tell us when a market is highly competitive. Often it is necessary to analyze both the firms theirselves and their strategic interactions 8.2 Profit Maximization Do firms Maximize Profit? - The assumption of Profit Maximization is frequently used because it predicts business behavior avoiding unnecessary analytical complications - For smaller firms managed by owners, profit dominates all decision (almost). Bigger firms have no communication between managers and owners (stockholders). Owners cannot monitor managers’ behavior on a regular basis and managers can deviate from profit-maximization behavior. They may be concerned in certain goals as revenue maximization, revenue growth. They may be concerned with short-run profit (promotion) at the expense of its long-run profit which better serves the interes of holder - Manager’s freedom to pursue goals other than long-run profit maximization is limited; there can be replacement of new management - Firms that do survive in competitive industries make longrun profit maximization one of their highest priorities - Thus our working assumption of profit maximization is reasonable NB: Maximizing the market value of the firm is amore appropriate goal than profit maximization because market value inclued the stream of profits that the firm earns over time. It is the stream of current and future profits that is of direct interest to the stockholders Alternative Forms of Organization - Some forms of organization have objectives that are quite different from profit maximization. - An important occasion is the cooperative – an association of businesses or people jointly owned and operated by members for mutual benefit - Each participating member is an autonomus economic unit, each firm will act to maximize its own profits taking the common marketing and distribution agreement as given. They are common in agricultural markets. - Housing cooperatives or co-ops are an other example of organization. A co-op might be an apartment building for which the title to the land and the building is owned by a corporation. The members residents of the co-op own shares in the corporation, accompanied by a right to occupy a unit - The members can participate in the management of the building in a ariety of ways such as organizing social events, handling finances and deciding neighborhood. - The objective is not profit maximization but rather to provide members with high-quality housing at the lowest possible cost Condominium is an housing unit that is individually owned but provides access to common facilities that are paid for and controlled jointly by an association of owners 8.3 Marginal Revenue, Marginal Cost and Profit Maximization - We are beginning by looking at the profit-maximization output decision for any firm (whether competive or a firm influencing cost) - Profit difference between Total Revenue and Total Cost. Finding the firm’s profit maximizing output level means analyzing its revenue - Firm’s output is Q, the revenue R. This Revenue is equal to the Price P times the number of units sold: R = PQ - The cost of production C also depends on the level of output. The firm’s profit PIG is the difference between R and C - To maximize profit, the firm selects the output for which the difference between Revenue and Cost it’s the greatest - The Average and Marginal Revenue curves are drawn as a horizontal line at a price equal to $40 - We have drawn the Averahe Total Cost curves (ATC), the Average Variable Cost curve (AVC) and the Marginal Cost curve (MC) so that we can see the profit easily - Profit is maximized at A, where outpt q* is 8 and the price is $40 because Marginal Revenue is equl to Marginal Cost at this point - To see that A is the profit maximization point let’s consider q1 = 7 .Marginal Revenue > Marginal Cost - Therefore, Profit coul be maximized by increasing the output - The shaded area between Q* and Q1 shows the lost profit associated with the reduction of output - When Output is Q*=8 profit is given by the area of rectangle ABCD NB. Marginal Cost and Marginal Revenue are equals at a point in which the Marginal Cost is rising Competitive Firm’s Short-Run Profit - the distance AB is the difference between price and average cost at the output level Q*, which is the average profit per unit of output. - Segment BC meaures the total number of units produced. - At Q* the price P is less then Average Cost. Line AB therefore measures the average loss from production - Rectangle ABCD is the firm’s profit. When should the Firm Shut Down? - Suppose a firm is losing money; should it shut down and leave the industry? The answer depends in part on the firm’s expectations about its future business conditions - Note that the firm is losing money when its Price is less than Average Total Cost at the profit-maximization output q* - Will shutting down always be the sensible strategy? Not necessarily. The firm might operate at a loss in the short-run because it expects to become profitable again the future. Operating at a loss might be painful, but will keep open the prospect of future with a possible flexibility to change the amount of total cost and reducing the average total cost. 8.5 The Competitive Firm’s Short-Run Supply Curve - A supply curve for a firm tells us how much output it will produce at every possible price - We have see that competitive firms will increase output to the point at which price is equal to marginal cost, but will shut down if price is below average variable cost - Therefore, the firm’s supply curve is the portion of the marginal cost curve for which marginal cost is greater than average variable cost - Note that for any P greater than minimun AVC, the profit-maximization output can be read directly from the graph - P1 to Q1 and P2 to Q2 - For P less than or equal to AVC the profit maximization is 0 - The entire short-run supply curve consists of the crosshatched portion of the vertical axis plus the marginal cost curve above the point of minimum average variable cost. - It slopes upward for the same reason that Marginal Cost Increases - Therefore an increase in the market price will induce those firms already in the market to increase the quantity they produce The firm’s response to an Input Price Change -When the price of its product change, the firm changes its output level to ensure that the Marginal Cost remains equal to the price - Often the product price changes as the input price changes - Suppose the price of one input increases. Because now it costs more to produce each unit of output, this increase causes the Marginal Cost MC to shift upward from MC to MC 1 - The new profit-maximization output is Q2 at which P = MC2 Production Q2 8.6 The Short-Run Market Supply Curve - The short-run market supply curve shows the amount of output that the industry will produce in the short run for every possible price - Therefore, the market supply curve can be obtained by adding the supply curve curves of each of these firms - Each MC is drawn above the Average Variable Cost Curve - At any price below P1, the industry will produce no output because P1 is the minimum average variable cost of the lowest-cost firm - From P1 and P2 only Firm 3 will produce - In P2 the Industry supply will be the sum of the quantity supplied by all the three firms (2+5+8 = 15 units) - The same goes later for P3 - Draw supply as smooth and upward sloping curve Elasticity of Market Supply - As price rises, all firms in the industry expand their output. The additional output increases the demand for inputs to production and may lead to higher input prices - Increasing inputs shifts a firm’s marginal cost curve upward - In turn, higher input prices will cause firms’ Margincal Cost Curves to shift upward Accounting Profit and Economic Profit - It is important to distinuish between them. - Accounting Profit is measured by the difference between the firms’ Revenues and its cash flows for labor, raw materials and interest plus depreciation expenses - Economic Profit takes into account Opportunity Cost Accounting Profit: R – wL(labor cost) Positive Economic Profit (PIG) = R – wL – rK(capital cost) Capital Cost the correct measure is the User Cost of Capital, which is the annual return that the firm could earn by investing its money elsewhere instead of purchasing capital, plus the annual depreciation of the capital Zero Economic Profit - When a firm enters into business, it does so in the expectation of a return on its investement. - A zero economic profit means that the firm is earning a normal – competitive – return on that investement. - This nomal return, which is part of the User Cost of Capital, is the firm’s Opportunity Cost to buy capital rather than other Thus a firm earning zero economic profit is doing as well by investing its money in capital as it could by investing elsewhere. It is performing adequately and should stay in business. In competitive markets economic profit becomes zero in the long run (not poorly, but rather the industry is competitive) Entry and Exit - An high return causes investors to direct resources away from other industries and into this one – there will be entry into the market - The increased production associated with new entry causes the Market Supply Curve to shift to the right. As a result, market output increases and the marke price of the product falls Figure B: - The supply curve shifts from S1 to S2 Figure A: - Suppose the firm’s minimum Long-Run Average Cost remains $30 but the price has fallen to $20 - Absent expectation of price change, the firm will leave the indsutry when it can’t cover all the costs P < AVC - The exit of firms form the market will decrease production, which will cause the Market Supply curve to shift to the left - Marketo Output will decrease and the price of the product will rise until an equilibrium is reached In a market with entry and exit, a firm enters when it can earn a positive long-run profit and exits when it faces the prospect of a long-run loss When a firm earns zero economic profit, has no incentive to exit the industry. A Long-Run Competitive Equilibrium occurs with three conditions: 1. All firms in the indsutry are profit maximizing 2. No firms has incentive either to enter or exit in the industry because all the firms are earning zero economic profit 3. The price of the product is such that the quantity supplied by the industry is equal to the quantity demanded by consumers - The Dynamic process that leads to this equilibrium may seem puzzling: Firms enter the market hoping to gain a profit, and exit because of economic losses. But why does a firm enter the market knowing that will earn zero economic profit? The answer is that zero economic profit represents a competitive return for the firm investement of financial capital (it can’t do better financially) - The concept of long-run equilibrium tells us the direction that a firm’s behavior is likely to take. Firms having Identical Costs - To see why all the conditions for a long-equilibrium must hold let’s suppose that all the firms have identical costs - If too many firms enter the industry in response to an opportunity for profit the Industry Supply Curve shift to the right and the price wil fall like the imge above. - At that price, however, firms will lose money. As a result some firms will exit until the Market Supply curve shift back to S2 (Equilibrium) Firms having Different Costs - Let’s suppose the firms have all different cost curves. Perhaps, one firm has a patent that lets it produce at a lower Average Cost than all others greater accounting profit and enjoys a higher producer surplus than other firms - Other investors, not having the patent, have no incentive to enter and the fortunate firm has no incentive exiting the market - The distinction between Accounting Profit and Economic Profit is important here. If the patent is useful, other firms will pay to use it. The increased value of the patent thus represents an opportunity cost to the firm that hold it (it can sell it too) - If all firms are equally efficient, the Economic Profit falls to 0 - If the firmwith the patent is more efficient, it will have a positive Economic Profit - If the firmer holder is less efficient, it exits the industry and sells the patent The Opportunity Cost of Land - There are cases in which firms earning a positive accounting profit may be earning zero economic profit - Suppose of a clothing store near a large shopping center (the additional flow of customers can increase the accounting profit) - This happens because the cost of the land is based on its historical cost. As far as economic profit is concerned, this happens to be an Opportunity Cost - By definition, Positive Economic Profit represents an Opportunity for investors and incentive to enter the industry. Positive Accounting Profit, however may signal that firms already in the industry possess valuable assets, skills or ideas which do not neccesarily encourage entry Economic Rent - Some firms earn higher accounting profit than others because they have access to factors of production that are in limited supply - In these situations, what makes Economic Profit zero in the long-run is the willingness of other firms to use the factors of production that are limited supplied. - The Positive Accounting Profit translates into Economic Rent: amount that firms are willing to pay for an input less the minimum amount necessary to obtain it - In competitive markets, in both short and long run, economic rent is often positive even though profit is zero - The presence of economic rent explains why in certain markets firms cannot enter in response to profit opportunities - In those markets, the supply of one or more inputs is fixed (economic rent) and all firms enjoy zero economic profit Producer Surplus in the Long-Run - How does rent relate to producer surplus? Note that while Economic rent applies to factors of inputs, Producer Surplus applies to Output - Note that Producer Surplus measures the difference between the Market Price that a producer receives and the Marginal Cost of Production - Thus in the Long-Run, the producer surplus that a firm earns on the output that it sells consists of the Economic Rent that it enjoys from all its scarce resources The Surplus wil reflect all Economic Rents - They sell it at a higher price thereby earning an accounting profit of 2,80$ above its average cost of 7.20$ on each ticket - The rent associated with the more desirable location represents a cost to the firm – an opportunity cost Economic Profit is 0 8.8 The Industy’s Long-Run Supply Curve - In our analysis of Short Run Supply curve we first derived the firm’s supply curve and then showed how the summation of individual firms’ supply curves generated a Market Supply Curve - For the Long Run is different Firms enter and exit as the price changes Impossible to sum up supply curves - The shape of the long-run supply curve depends on the extent to which increases and decrease in industry output affect the prices that firms must pay for inputs into the production process - In case of economices of scale production, input prices declines as output increases. In diseconomies of scale, input prices may increase with the output- The third possibility is that input may not change with output. - In our analysis of long-run supply, it will be useful to distinguish between: 1. Constant-Cost Industry