1 / 41

Chapter 11 Managerial Decisions in Competitive Markets

Chapter 11 Managerial Decisions in Competitive Markets. Learning Objectives. Discuss 3 characteristics of perfectly competitive markets Explain why the demand curve facing a perfectly competitive firm is perfectly elastic and serves as the firm’s marginal revenue curve

Download Presentation

Chapter 11 Managerial Decisions in Competitive Markets

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Chapter 11Managerial Decisions in Competitive Markets

  2. Learning Objectives • Discuss 3 characteristics of perfectly competitive markets • Explain why the demand curve facing a perfectly competitive firm is perfectly elastic and serves as the firm’s marginal revenue curve • Find short‐run profit‐maximizing output, derive firm and industry supply curves, and identify producer surplus • Explain characteristics of long‐run competitive equilibrium for a firm, derive long‐run industry supply, and identify economic rent and producer surplus • Find the profit‐maximizing level of a variable input • Employ empirically estimated values of market price, average variable cost, and marginal cost to calculate profit‐maximizing output and profit

  3. Perfect Competition • Firms are price-takers • Each produces only a very small portion of total market or industry output • All firms produce a homogeneous product • Entry into & exit from the market is unrestricted

  4. Demand for a Competitive Price-Taker • Demand curve is horizontal at price determined by intersection of market demand & supply • Perfectly elastic • Marginal revenue equals price • Demand curve is also marginal revenue curve (D = MR) • Can sell all they want at the market price • Each additional unit of sales adds to total revenue an amount equal to price

  5. S P0 P0 D = MR D Q0 Demand for a Competitive Price-Taking Firm (Figure 11.2) Price (dollars) Price (dollars) 0 0 Quantity Quantity Panel B – Demand curve facing a price-taker Panel A – Market

  6. Profit-Maximization in the Short Run • In the short run, managers must make two decisions: • Produce or shut down? • If shut down, produce no output and hires no variable inputs • If shut down, firm loses amount equal to TFC • If produce, what is the optimal output level? • If firm does produce, then how much? • Produce amount that maximizes economic profit Profit = π = TR - TC

  7. Profit-Maximization in the Short Run • In the short run, the firm incurs costs that are: • Unavoidable and must be paid even if output is zero • Variable costs that are avoidable if the firm chooses to shut down • In making the decision to produce or shut down, the firm considers only the (avoidable) variable costs & ignores fixed costs

  8. Profit Margin (or Average Profit) • Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) • Managers should ignore profit margin (average profit) when making optimal decisions

  9. Short-Run Output Decision • Firm will produce output where P = SMCas long as: • Total revenue ≥ total avoidable cost or total variable cost (TR  TVC) • Equivalently, the firm should produce if P  AVC

  10. Short-Run Output Decision • The firm will shut down if: • Total revenue cannot cover total avoidable cost (TR < TVC) or, equivalently, P  AVC • Produce zero output • Lose only total fixed costs • Shutdown price is minimum AVC

  11. Fixed, Sunk,& Average Costs • Fixed, sunk, & average costs are irrelevant in the production decision • Fixed costs have no effect on marginal cost or minimum average variable cost—thus optimal level of output is unaffected • Sunk costs are forever unrecoverable and cannot affect current or future decisions • Only marginal costs, not average costs, matter for the optimal level of output

  12. Profit Maximization: P = $36 (Figure 11.3)

  13. Profit Maximization: P = $36 (Figure 11.3)

  14. Profit Maximization: P = $36 (Figure 11.4) Break-even point Panel A: Total revenue & total cost Break-even point Panel B: Profit curve when P = $36

  15. Total cost = $17 x 300 = $5,100 Short-Run Loss Minimization: P = $10.50 (Figure 11.5) Profit = $3,150 - $5,100 = -$1,950 Total revenue = $10.50 x 300 = $3,150

  16. Summary of Short-Run Output Decision • AVCtells whether to produce • Shut down if price falls below minimum AVC • SMC tells how much to produce • If P  minimum AVC, produce output at which P = SMC • ATC tells how much profit/loss if produce π = (P – ATC)Q

  17. Short-Run Supply Curves • For an individual price-taking firm • Portion of firm’s marginal cost curve above minimum AVC • For prices below minimum AVC, quantity supplied is zero • For a competitive industry • Horizontal sum of supply curves of all individual firms; always upward sloping • Supply prices give marginal costs of production for every firm

  18. Short-Run Producer Surplus • Short-run producer surplus is the amount by which TR exceeds TVC • The area above the short-run supply curve that is below market price over the range of output supplied • Exceeds economic profit by the amount of TFC

  19. Computing Short-Run Producer Surplus (Figure 11.6)

  20. Short-Run Firm & Industry Supply (Figure 11.6)

  21. Long-Run Profit-Maximizing Equilibrium (Figure 11.7) Profit = ($17 - $12) x 240 = $1,200

  22. Long-Run Competitive Equilibrium • All firms are in profit-maximizing equilibrium (P = LMC) • Occurs because of entry/exit of firms in/out of industry • Market adjusts so P = LMC = LAC

  23. Long-Run Competitive Equilibrium (Figure 11.8)

  24. Long-Run Industry Supply • Long-run industry supply curve can be flat (perfectly elastic) or upward sloping • Depends on whether constant cost industry or increasing cost industry • Economic profit is zero for all points on the long-run industry supply curve for both types of industries

  25. Long-Run Industry Supply • Constant cost industry • As industry output expands, input prices remain constant, & minimum LAC is unchanged • P = minimum LAC, so curve is horizontal (perfectly elastic) • Increasing cost industry • As industry output expands, input prices rise, & minimum LAC rises • Long-run supply price rises & curve is upward sloping

  26. Long-Run Industry Supply for a Constant Cost Industry (Figure 11.9)

  27. Long-Run Industry Supply for an Increasing Cost Industry (Figure 11.10) Firm’s output

  28. Economic Rent • Payment to the owner of a scarce, superior resource in excess of the resource’s opportunity cost • In long-run competitive equilibrium firms that employ such resources earn zero economic profit • Potential economic profit is paid to the resource as economic rent • In increasing cost industries, all long-run producer surplus is paid to resource suppliers as economic rent

  29. Economic Rent in Long-Run Competitive Equilibrium (Figure 11.11)

  30. Profit-Maximizing Input Usage • Profit-maximizing level of input usage produces exactly that level of output that maximizes profit

  31. Profit-Maximizing Input Usage • Marginal revenue product (MRP) • MRP of an additional unit of a variable input is the additional revenue from hiring one more unit of the input • If choose to produce: • If the MRPof an additional unit of input is greater than the price of input, that unit should be hired • Employ amount of input where MRP= input price

  32. Profit-Maximizing Input Usage • Average revenue product (ARP) • Average revenue per worker • Shut down in short run if ARP < MRP • WhenARP < MRP, TR < TVC

  33. Profit-Maximizing Labor Usage (Figure 11.12)

  34. Implementing the Profit-Maximizing Output Decision • Step 1: Forecast product price • Use statistical techniques from Chapter 7 • Step 2: Estimate AVC& SMC • AVC = a + bQ + cQ2 • SMC = a + 2bQ + 3cQ2

  35. Implementing the Profit-Maximizing Output Decision • Step 3: Check shutdown rule • If P AVCmin then produce • If P < AVCmin then shut down • To find AVCmin substitute Qmin into AVC equation

  36. Implementing the Profit-Maximizing Output Decision • Step 4: If P  AVCmin, find output where P = SMC • Set forecasted price equal to estimated marginal cost & solve for Q* P = a + 2bQ* + 3cQ*2

  37. Implementing the Profit-Maximizing Output Decision • Step 5: Compute profit or loss • Profit = TR – TC = P x Q* - AVC x Q* - TFC = (P – AVC)Q* - TFC • IfP < AVCmin, firm shuts down & profit is -TFC

  38. Profit & Loss at Beau Apparel (Figure 11.13)

  39. Profit & Loss at Beau Apparel (Figure 11.13)

  40. Summary • Perfect competitors are price-takers, produce homogenous output, and have no barriers to entry • The demand curve for a perfectly competitive firm is perfectly elastic (or horizontal) at the market determined equilibrium price, and marginal revenue equals price • Managers make two decisions in the short run: (1) produce or shut down, and (2) if produce, how much to produce • When positive profit is possible, profit is maximized at the output where P = SMC • When market price falls below minimum AVCthe firm shuts down and produces nothing, losing only TFC

  41. Summary • In long-run competitive equilibrium, all firms are in profit-maximizing equilibrium (P = LMC) • No incentive for firms to enter or exit the industry because economic profit is zero (P = LAC) • Choosing either output or input usage leads to the same optimal output decision and profit level • Five steps to find the profit-maximizing rate of production and the level of profit for a competitive firm: • Forecast the price of the product • Estimate average variable cost and marginal cost • Check the shutdown rule • If P ≥min AVC find the output level where P = SMC • Compute profit or loss

More Related