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Unit 6 - Profit Maximization of a Purely Competitive Firm. Types of Industries We distinguish between four types of industries: Pure (Perfect) Competition Monopolistic Competition Oligopoly Monopoly. Microeconomics. Unit 6 - Profit Maximization of a Purely Competitive Firm.

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unit 6 profit maximization of a purely competitive firm
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Types of Industries

We distinguish between four types of industries:

    • Pure (Perfect) Competition
    • Monopolistic Competition
    • Oligopoly
    • Monopoly

Microeconomics

unit 6 profit maximization of a purely competitive firm2
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Pure Competition

A purely competitive industry has the following characteristics:

    • Many sellers
    • Low barriers to enter
    • Competitors’ products are identical
    • Buyers have perfect information

Microeconomics

unit 6 profit maximization of a purely competitive firm3
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Profit Maximization

Profit = Total Revenue (TR) - Total Cost (TC)

Example 1A firm sells 100 products at $2.00 each. Its total cost is $160. What is its profit?

Microeconomics

unit 6 profit maximization of a purely competitive firm4
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Profit Maximization

Example 1 answerProfit = TR – TCTR = P x Q = $2 x 100 = $200

Profit = $200 - $160 = $40

Microeconomics

unit 6 profit maximization of a purely competitive firm5
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Marginal and Average Revenue

Because one firm in pure competition is a small part of the entire market, it can supply more products to the market without significantly affecting the supply and the price.

For example, if the market price is $2, then a purely competitive firm can sell 100 products at $2, 110 products at $2, or 120 products at $2.

Microeconomics

unit 6 profit maximization of a purely competitive firm6
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Marginal and Average Revenue

Marginal revenue is the additional revenue per product. For example, if at Q = 100, TR = $200, and at Q = 110, TR = $220, then MR = $20 / 10, or $2.

Average revenue is the revenue per product. If at Q = 100, TR = $200, then AR = $200 / 100, or $2.

Microeconomics

unit 6 profit maximization of a purely competitive firm7
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Marginal and Average Revenue

Demand and revenue for a purely competitive firm, which sells a product at $2 is as follows:

Microeconomics

unit 6 profit maximization of a purely competitive firm8
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • A Purely Competitive Firm’s Total Revenue Curve

Price,

Revenue

Total Revenue

240

220

200

100

110

120

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm9
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • A Purely Competitive Firm’s Demand, Marginal, and Average Revenue Curves

Demand, AR, MR

2.00

D = MR = AR

Quantity

100

110

120

Microeconomics

unit 6 profit maximization of a purely competitive firm10
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • A Purely Competitive Firm’s Cost and Revenue Curves

AR, MR,

Price, Costs

MC

ATC

2.00

D = MR = AR

AVC

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm11
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Profit-maximizing Quantity

AR, MR,

Price, Costs

MC

ATC

MR=MC

2.00

D = MR = AR

AVC

Quantity

Qpm

Microeconomics

unit 6 profit maximization of a purely competitive firm12
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Profit Area

AR, MR,

Price, Costs

MC

ATC

MR=MC

2.00

D = MR = AR

1.80

AVC

100

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm13
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Case of a Loss

AR, MR,

Price, Costs

MC

ATC

1.60

D = MR = AR

AVC

Qlm

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm14
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Case of a Loss and a Shut-down

AR, MR,

Price, Costs

MC

ATC

AVC

1.20

D = MR = AR

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm15
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Long-run Equilibrium Price and Quantity

AR, MR,

Price, Costs

MC

ATC

AVC

1.75

D = MR = AR

Qlr

Quantity

Microeconomics

unit 6 profit maximization of a purely competitive firm16
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Farming Industry

Characteristics of farming industries in industrialized countries include:

    • There are many farmers.
    • There are relatively low barriers to enter the farming industry.
    • Farmers competing in the same market sell identical or nearly identical products.
    • Buyers of agricultural products have significant information about the product.

Microeconomics

unit 6 profit maximization of a purely competitive firm17
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Farming Industry and Elasticity

Supply of agricultural products has increased considerably during the past century.

Demand for agricultural products has increased as well, but not as much supply, because:

    • Income inelasticity of demand for food is low.
    • Price elasticity of demand for food is low.

Microeconomics

unit 6 profit maximization of a purely competitive firm18
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Farming Industry
  • Revenue (TR) of many farmers has decreased, because real prices (P) have decreased.

TR = P x QP has decreased considerably. Q (quantity sold) has increased, but less than proportionately.

Microeconomics

unit 6 profit maximization of a purely competitive firm19
Unit 6 - Profit Maximization of a Purely Competitive Firm
  • The Farming Industry

In industrialized countries, the following programs have been implemented:1. Price Supports2. Acreage Restrictions3. Target Prices4. Direct Subsidies and Loan Programs5. Foreign Import Restrictions

Microeconomics

unit 6 profit maximization of a purely competitive firm20
Unit 6 - Profit Maximization of a Purely Competitive Firm

PricePer Bushel

D

surplus

S

$5.00

$3.00

Quantity Demanded of Wheat in Hundreds

10

12

15

Price Supports

unit 6 profit maximization of a purely competitive firm21
Unit 6 - Profit Maximization of a Purely Competitive Firm

PricePer Bushel

S2

S1

$6.00

$3.00

D

Quantity Demanded of Wheat in Hundreds

10

12

Acreage Restrictions

unit 6 profit maximization of a purely competitive firm22
Unit 6 - Profit Maximization of a Purely Competitive Firm

PricePer Bushel

D

S

$4.50

DeficiencyPayment of$4.50 - $1.50 = $3.00

$3.00

$1.50

Quantity Demanded of Wheat in Hundreds

12

15

Target Prices

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Unit 6 - Profit Maximization of a Purely Competitive Firm
  • Other Farm Subsidy Programs

Direct subsidies and soft loans to farmers increase farmers’ incomes and raise taxes.

Import restrictions support domestic farmers by restricting competition and supply. Consumers pay higher prices.

Yearly cost of U.S. farm programs is approximately $20 billion.

Microeconomics

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