chapter 8
Download
Skip this Video
Download Presentation
Chapter 8

Loading in 2 Seconds...

play fullscreen
1 / 83

Chapter 8 - PowerPoint PPT Presentation


  • 489 Views
  • Uploaded on

Chapter 8 Profit Maximization and Competitive Supply Topics Perfectly Competitive Markets Profit Maximization Marginal Revenue, Marginal Cost, and Profit Maximization Choosing Output in the Short-Run Topics Short-Run Market Supply Output in the Long-Run Industry’s Long-Run Supply Curve

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Chapter 8' - paul


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.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
chapter 8

Chapter 8

Profit Maximization and Competitive Supply

topics
Topics
  • Perfectly Competitive Markets
  • Profit Maximization
  • Marginal Revenue, Marginal Cost, and Profit Maximization
  • Choosing Output in the Short-Run

Chapter 8

topics3
Topics
  • Short-Run Market Supply
  • Output in the Long-Run
  • Industry’s Long-Run Supply Curve

Chapter 8

perfectly competitive markets
Perfectly Competitive Markets
  • Characteristics

1) Price taking

2) Product homogeneity

3) Free entry and exit

Chapter 8

perfectly competitive markets5
Perfectly Competitive Markets
  • Price Taking
    • Individual firm sells a very small share of the total market output and, therefore, cannot influence market price.
    • Individual consumer buys too small a share of industry output to have any impact on market price.

Chapter 8

perfectly competitive markets6
Perfectly Competitive Markets
  • Product Homogeneity
    • The products of all firms are perfect substitutes.

Chapter 8

perfectly competitive markets7
Perfectly Competitive Markets
  • Free Entry and Exit
    • Buyers can easily switch from one supplier to another.
    • Suppliers can easily enter or exit a market.

Chapter 8

profit maximization
Profit Maximization
  • Do firms maximize profits?
    • Possibility of other objectives
      • Revenue maximization
      • Dividend maximization
      • Short-run profit maximization

Chapter 8

profit maximization9
Profit Maximization
  • Do firms maximize profits?
    • Implications of non-profit objective
      • Over the long-run investors would not support the company
      • Without profits, survival unlikely

Chapter 8

profit maximization10
Profit Maximization
  • Do firms maximize profits?
    • Long-run profit maximization is valid and does not exclude the possibility of altruistic behavior.

Chapter 8

marginal revenue marginal cost and profit maximization
Marginal Revenue, Marginal Cost,and Profit Maximization
  • The profit maximizing level of output
    • Profit = Total Revenue - Total Cost
    • Total Revenue (R) = Pq
    • Total Cost (C) = C(q)
    • Therefore:

Chapter 8

profit maximization in the short run
Total Revenue

R(q)

Slope of R(q) = MR

Profit Maximization in the Short Run

Cost,

Revenue,

Profit

($s per year)

0

Output (units per year)

Chapter 8

profit maximization in the short run13
C(q)

Total Cost

Slope of C(q) = MC

Why is cost positive when q is zero?

Profit Maximization in the Short Run

Cost,

Revenue,

Profit

$ (per year)

0

Output (units per year)

Chapter 8

marginal revenue marginal cost and profit maximization14
Marginal Revenue, Marginal Cost,and 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.

Chapter 8

marginal revenue marginal cost and profit maximization15
C(q)

R(q)

A

B

q0

q*

Marginal Revenue, Marginal Cost,and Profit Maximization
  • 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

Cost,

Revenue,

Profit

($s per year)

0

Output (units per year)

Chapter 8

marginal revenue marginal cost and profit maximization16
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Comparing R(q) and C(q)
    • Question: Why is profit negative when output is zero?

Chapter 8

marginal revenue marginal cost and profit maximization17
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Comparing R(q) and C(q)
    • Output levels: q0 - q*
      • R(q)> C(q)
      • MR > MC
        • Indicates higher profit at higher output
        • Profit is increasing

Chapter 8

marginal revenue marginal cost and profit maximization18
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Comparing R(q) and C(q)
    • Output level: q*
      • R(q)= C(q)
      • MR = MC
      • Profit is maximized

Chapter 8

marginal revenue marginal cost and profit maximization19
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Question
    • Why is profit reduced when producing more or less than q*?

Chapter 8

marginal revenue marginal cost and profit maximization20
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Comparing R(q) and C(q)
    • Output levels beyond q*:
      • R(q)> C(q)
      • MC > MR
      • Profit is decreasing

Chapter 8

marginal revenue marginal cost and profit maximization21
Cost,

Revenue,

Profit

$ (per year)

C(q)

R(q)

A

B

q0

q*

0

Output (units per year)

Marginal Revenue, Marginal Cost,and Profit Maximization
  • Therefore:
    • Profits are maximized when MC = MR.

Chapter 8

marginal revenue marginal cost and profit maximization24
Marginal Revenue, Marginal Cost,and Profit Maximization
  • 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

Chapter 8

demand and marginal revenue faced by a competitive firm
$4

d

$4

D

Demand and Marginal Revenue Facedby a Competitive Firm

Price

$ per

bushel

Price

$ per

bushel

Firm

Industry

Output

(millions

of bushels)

Output

(bushels)

100

200

100

marginal revenue marginal cost and profit maximization26
Marginal Revenue, Marginal Cost,and Profit Maximization
  • The Competitive Firm
    • 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.

Chapter 8

marginal revenue marginal cost and profit maximization27
Marginal Revenue, Marginal Cost,and Profit Maximization
  • The Competitive Firm
    • The competitive firm’s demand
      • If the producers tries to lower price he cannot increase sales
      • P = D = MR = AR

Chapter 8

marginal revenue marginal cost and profit maximization28
Marginal Revenue, Marginal Cost,and Profit Maximization
  • The Competitive Firm
    • Profit Maximization
      • MC(q) = MR = P

Chapter 8

choosing output in the short run
Choosing Output in the Short Run
  • Combine production and cost analysis with demand to determine output and profitability.

Chapter 8

a competitive firm making a positive profit
MC

Lost profit for

qq < q*

Lost profit for

q2 > q*

A

D

AR=MR=P

ATC

C

B

AVC

At q*: MR = MC

and P > ATC

q1 : MR > MC and

q2: MC > MR and

q0: MC = MR but

MC falling

q0

q1

q*

q2

A Competitive FirmMaking a Positive Profit

Price

($ per

unit)

60

50

40

30

20

10

0

1

2

3

4

5

6

7

8

9

10

11

Output

Chapter 8

a competitive firm incurring losses
MC

ATC

B

C

D

P = MR

A

At q*: MR = MC

and P < ATC

Losses = P- AC) x q* or ABCD

AVC

F

E

q*

A Competitive FirmIncurring Losses

Price

($ per

unit)

Would this producer

continue to produce with a loss?

Output

Chapter 8

choosing output in the short run32
Choosing Output in the Short Run
  • Summary of Production Decisions
    • Profit is maximized when MC = MR
    • If P > ATC the firm is making profits.
    • If AVC < P < ATC the firm should produce at a loss.
    • If P < AVC < ATC the firm should shut-down.

Chapter 8

a competitive firm s short run supply curve
The firm chooses the

output level where MR = MC,

as long as the firm is able to

cover its variable cost of

production.

MC

ATC

P2

AVC

P1

What happens

if P < AVC?

P = AVC

q1

q2

A Competitive Firm’sShort-Run Supply Curve

Price

($ per

unit)

Output

Chapter 8

a competitive firm s short run supply curve34
A Competitive Firm’sShort-Run Supply Curve
  • Observations:
    • P = MR
    • MR = MC
    • P = MC
  • Supply is the amount of output for every possible price. Therefore:
    • If P = P1, then q = q1
    • If P = P2, then q = q2

Chapter 8

a competitive firm s short run supply curve35
A Competitive Firm’sShort-Run Supply Curve

S = MC above AVC

Price

($ per

unit)

MC

ATC

P2

AVC

P1

P = AVC

Shut-down

Output

q1

q2

Chapter 8

a competitive firm s short run supply curve36
A Competitive Firm’sShort-Run Supply Curve
  • Observations:
    • Supply is upward sloping due to diminishing returns.
    • Higher price compensates the firm for higher cost of additional output and increases total profit because it applies to all units.

Chapter 8

a competitive firm s short run supply curve37
A Competitive Firm’sShort-Run Supply Curve
  • Firm’s Response to an Input Price Change
    • When the price of a firm’s product changes, the firm changes its output level, so that the marginal cost of production remains equal to the price.

Chapter 8

the response of a firm to a change in input price
Input cost increases

and MC shifts to MC2

and q falls to q2.

MC2

Savings to the firm

from reducing output

MC1

$5

q2

q1

The Response of a Firm toa Change in Input Price

Price

($ per

unit)

Output

Chapter 8

industry supply in the short run
S

The short-run

industry supply curve

is the horizontal

summation of the supply

curves of the firms.

MC1

MC2

MC3

P3

P2

P1

Industry Supply in the Short Run

$ per

unit

Question: If increasing

output raises input

costs, what impact

would it have on

market supply?

Quantity

0

2

4

5

7

8

10

15

21

Chapter 8

the short run market supply curve
The Short-Run Market Supply Curve
  • Elasticity of Market Supply

Chapter 8

the short run market supply curve41
The Short-Run Market Supply Curve
  • Perfectly inelastic short-run supply arises when the industry’s plant and equipment are so fully utilized that new plants must be built to achieve greater output.
  • Perfectly elastic short-run supply arises when marginal costs are constant.

Chapter 8

the short run market supply curve42
The Short-Run Market Supply Curve
  • Producer Surplus in the Short Run
    • Firms earn a surplus on all but the last unit of output.
    • The producer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.

Chapter 8

producer surplus for a firm
At q* MC = MR.

Between 0 and q ,

MR > MC for all units.

Producer

Surplus

MC

AVC

B

A

P

Alternatively, VC is the

sum of MC or ODCq* .

R is P x q*or OABq*.

Producer surplus =

R - VC or ABCD.

D

C

q*

Producer Surplus for a Firm

Price

($ per

unit of

output)

0

Output

Chapter 8

the short run market supply curve44
The Short-Run Market Supply Curve
  • Producer Surplus in the Short-Run

Chapter 8

the short run market supply curve45
The Short-Run Market Supply Curve
  • Observation
    • Short-run with positive fixed cost

Chapter 8

producer surplus for a market
S

Market producer surplus is

the difference between P*

and S from 0 to Q*.

P*

Producer

Surplus

D

Q*

Producer Surplus for a Market

Price

($ per

unit of

output)

Output

Chapter 8

choosing output in the long run
Choosing Output in the Long Run
  • In the long run, a firm can alter all its inputs, including the size of the plant.
  • We assume free entry and free exit.

Chapter 8

output choice in the long run
In the long run, the plant size will be

increased and output increased to q3.

Long-run profit, EFGD > short run

profit ABCD.

LMC

LAC

SMC

SAC

D

A

E

$40

P = MR

C

B

G

F

$30

In the short run, the

firm is faced with fixed

inputs. P = $40 > ATC.

Profit is equal to ABCD.

q1

q2

q3

Output Choice in the Long Run

Price

($ per

unit of

output)

Output

Chapter 8

output choice in the long run49
LMC

LAC

SMC

SAC

E

$40

P = MR

$30

Output Choice in the Long Run

Price

($ per

unit of

output)

Question: Is the producer making

a profit after increased output

lowers the price to $30?

D

A

C

B

G

F

q1

q2

q3

Output

Chapter 8

choosing output in the long run50
Choosing Output in the Long Run
  • Accounting Profit & Economic Profit
    • Accounting profit = R - wL
    • Economic profit = R = wL - rK
      • wl = labor cost
      • rk= opportunity cost of capital

Chapter 8

choosing output in the long run51
Choosing Output in the Long Run

Long-Run Competitive Equilibrium

  • Zero-Profit
    • If R > wL + rk, economic profits are positive
    • If R = wL + rk, zero economic profits, but the firms is earning a normal rate of return; indicating the industry is competitive
    • If R < wl + rk, consider going out of business

Chapter 8

choosing output in the long run52
Choosing Output in the Long Run

Long-Run Competitive Equilibrium

  • Entry and Exit
    • The long-run response to short-run profits is to increase output and profits.
    • Profits will attract other producers.
    • More producers increase industry supply which lowers the market price.

Chapter 8

long run competitive equilibrium
Profit attracts firms
  • Supply increases until profit = 0

S1

LMC

P1

LAC

S2

$30

P2

D

Q1

Q2

Long-Run Competitive Equilibrium

$ per

unit of

output

$ per

unit of

output

Firm

Industry

$40

q2

Output

Output

choosing output in the long run54
Choosing Output in the Long Run
  • Long-Run Competitive Equilibrium

1) MC = MR

2) P = LAC

      • No incentive to leave or enter
      • Profit = 0

3) Equilibrium Market Price

Chapter 8

choosing output in the long run55
Choosing Output in the Long Run
  • Questions

1) Explain the market adjustment when P < LAC and firms have identical costs.

2) Explain the market adjustment when firms have different costs.

3) What is the opportunity cost of land?

Chapter 8

choosing output in the long run56
Choosing Output in the Long Run
  • Economic Rent
    • Economic rent is the difference between what firms are willing to pay for an input less the minimum amount necessary to obtain it.

Chapter 8

choosing output in the long run57
Choosing Output in the Long Run
  • An Example
    • Two firms A & B
    • Both own their land
    • A is located on a river which lowers A’s shipping cost by $10,000 compared to B.
    • The demand for A’s river location will increase the price of A’s land to $10,000

Chapter 8

choosing output in the long run58
Choosing Output in the Long Run
  • An Example
    • Economic rent = $10,000
      • $10,000 - zero cost for the land
    • Economic rent increases
    • Economic profit of A = 0

Chapter 8

firms earn zero profit in long run equilibrium
A baseball team

in a moderate-sized city

sells enough

tickets so that price

is equal to marginal

and average cost

(profit = 0).

LMC

LAC

$7

1.0

Firms Earn Zero Profit inLong-Run Equilibrium

Ticket

Price

Season Tickets

Sales (millions)

Chapter 8

firms earn zero profit in long run equilibrium60
LMC

LAC

Economic Rent

$10

$7

1.3

Firms Earn Zero Profit inLong-Run Equilibrium

Ticket

Price

A team with the same

cost in a larger city

sells tickets for $10.

Season Tickets

Sales (millions)

Chapter 8

firms earn zero profit in long run equilibrium61
Firms Earn Zero Profit inLong-Run Equilibrium
  • With a fixed input such as a unique location, the difference between the cost of production (LAC = 7) and price ($10) is the value or opportunity cost of the input (location) and represents the economic rent from the input.

Chapter 8

firms earn zero profit in long run equilibrium62
Firms Earn Zero Profit inLong-Run Equilibrium
  • If the opportunity cost of the input (rent) is not taken into consideration it may appear that economic profits exist in the long-run.

Chapter 8

the industry s long run supply curve
The Industry’s Long-Run Supply Curve
  • The shape of the long-run supply curve depends on the extent to which changes in industry output affect the prices the firms must pay for inputs.

Chapter 8

the industry s long run supply curve64
The Industry’s Long-Run Supply Curve
  • To determine long-run supply, we assume:
    • All firms have access to the available production technology.
    • Output is increased by using more inputs, not by invention.

Chapter 8

the industry s long run supply curve65
The Industry’s Long-Run Supply Curve
  • To determine long-run supply, we assume:
    • The market for inputs does not change with expansions and contractions of the industry.

Chapter 8

long run supply in a constant cost industry
Economic profits attract new

firms. Supply increases to S2 and

the market returns to long-run

equilibrium.

Q1 increase to Q2.

Long-run supply = SL = LRAC.

Change in output has no impact on

input cost.

S1

S2

MC

AC

C

P2

P2

A

B

SL

P1

P1

D1

D2

q1

q2

Q1

Q2

Long-Run Supply in aConstant-Cost Industry

$ per

unit of

output

$ per

unit of

output

Output

Output

long run supply in a constant cost industry67
Long-Run Supply in aConstant-Cost Industry
  • In a constant-cost industry, long-run supply is a horizontal line at a price that is equal to the minimum average cost of production.

Chapter 8

long run supply in an increasing cost industry
Due to the increase

in input prices, long-run

equilibrium occurs at

a higher price.

S1

S2

LAC2

SMC2

SL

SMC1

P2

LAC1

P2

P3

P3

B

A

P1

P1

D1

D1

q1

q2

Q1

Q2

Q3

Long-Run Supply in anIncreasing-Cost Industry

$ per

unit of

output

$ per

unit of

output

Output

Output

long run supply in a increasing cost industry
Long-Run Supply in aIncreasing-Cost Industry
  • In a increasing-cost industry, long-run supply curve is upward sloping.

Chapter 8

the industry s long run supply curve70
The Industry’sLong-Run Supply Curve
  • Questions

1) Explain how decreasing-cost is possible.

2) Illustrate a decreasing cost industry.

3) What is the slope of the SL in a decreasing-cost industry?

Chapter 8

long run supply in an decreasing cost industry
Due to the decrease

in input prices, long-run

equilibrium occurs at

a lower price.

S1

S2

SMC1

LAC1

SMC2

P2

P2

LAC2

P1

A

P1

B

P3

P3

SL

D1

D2

q1

q2

Q1

Q2

Q3

Long-Run Supply in anDecreasing-Cost Industry

$ per

unit of

output

$ per

unit of

output

Output

Output

long run supply in a increasing cost industry72
Long-Run Supply in aIncreasing-Cost Industry
  • In a decreasing-cost industry, long-run supply curve is downward sloping.

Chapter 8

the industry s long run supply curve73
The Industry’sLong-Run Supply Curve
  • The Effects of a Tax
    • In an earlier chapter we studied how firms respond to taxes on an input.
    • Now, we will consider how a firm responds to a tax on its output.

Chapter 8

effect of an output tax on a competitive firm s output
MC2 = MC1 + tax

The firm will

reduce output to

the point at which

the marginal cost

plus the tax equals

the price.

MC1

An output tax

raises the firm’s

marginal cost by the

amount of the tax.

t

P1

AVC2

AVC1

q2

q1

Effect of an Output Tax on a Competitive Firm’s Output

Price

($ per

unit of

output)

Output

Chapter 8

effect of an output tax on industry output
S2 = S1 + t

S1

t

P2

Tax shifts S1to S2and

output falls to Q2. Price

increases to P2.

P1

D

Q2

Q1

Effect of an OutputTax on Industry Output

Price

($ per

unit of

output)

Output

Chapter 8

the industry s long run supply curve76
The Industry’sLong-Run Supply Curve
  • Long-Run Elasticity of Supply

1) Constant-cost industry

      • Long-run supply is horizontal
      • Small increase in price will induce an extremely large output increase

Chapter 8

the industry s long run supply curve77
The Industry’sLong-Run Supply Curve
  • Long-Run Elasticity of Supply

1) Constant-cost industry

      • Long-run supply elasticity is infinitely large
      • Inputs would be readily available

Chapter 8

the industry s long run supply curve78
The Industry’sLong-Run Supply Curve
  • Long-Run Elasticity of Supply

2) Increasing-cost industry

      • Long-run supply is upward-sloping and elasticity is positive
      • The slope (elasticity) will depend on the rate of increase in input cost
      • Long-run elasticity will generally be greater than short-run elasticity of supply

Chapter 8

the industry s long run supply curve79
The Industry’sLong-Run Supply Curve
  • Question:
    • Describe the long-run elasticity of supply in a decreasing -cost industry.

Chapter 8

summary
Summary
  • In the short run, a competitive firm maximizes its profit by choosing an output at which price is equal to (short-run) marginal cost.
  • The short-run market supply curve is the horizontal summation of the supply curves of the firms in an industry.

Chapter 8

summary81
Summary
  • The producer surplus for a firm is the difference between revenue of a firm and the minimum cost that would be necessary to produce the profit-maximizing output.

Chapter 8

summary82
Summary
  • In the long-run, profit-maximizing competitive firms choose the output at which price is equal to long-run marginal cost.
  • The long-run supply curve for a firm can be horizontal, upward sloping, or downward sloping.

Chapter 8

end of chapter 8

End of Chapter 8

Profit Maximization and Competitive Supply

ad