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B1 The firms and industry operating in a PC structure The long and the short of it.

B1 The firms and industry operating in a PC structure The long and the short of it. B & D pp. 102-8. Sub-topics. Assumptions of the model Revenue curves Profit maximization in the SR Profit maximization in the LR Shut-down price and break-even price. Learning Objectives.

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B1 The firms and industry operating in a PC structure The long and the short of it.

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  1. B1 The firms and industry operating in a PC structureThe long and the short of it. B & D pp. 102-8

  2. Sub-topics • Assumptions of the model • Revenue curves • Profit maximization in the SR • Profit maximization in the LR • Shut-down price and break-even price

  3. Learning Objectives • Describe, using examples, the assumed characteristics of perfect competition: a large number of firms; a homogeneous product; freedom of entry and exit; perfect information; perfect resource mobility. • Explain, using a diagram, why, in the long run, a perfectly competitive firm will make normal profit. • Explain, using a diagram, how a perfectly competitive market will move from short- run equilibrium to long-run equilibrium. • Explain, using a diagram, when a loss-making firm would shut down and exit the market in the long run.

  4. 1. characteristics of perfect competition • a large number of firms • a homogeneous product • freedom of entry and exit • perfect information • perfect resource mobility Identify 2-3 examples and justify that they are perfectly competitive:

  5. Recall: how to calculate profit Recall: TR – TC = Profit Thus: AR*Q – AC*Q = Profit Remember this is economic profit – more than mere accounting profit. Thus we call “zero” economic profit = normal (5%?) More than that is “supernormal”; Less than that is “subnormal”

  6. Marginal Analysis Recall STEP ONE: Use the Marginal Cost and Marginal Revenue curves to determine the output where profit is maximised Recall STEP TWO: Use the Average Cost and Average Revenue curves to determine what the profit (loss) will be.

  7. MC AC MR AC Max profit output Determine the profit situation 1. Mark the max profit output with a vertical marker 2a. mark the AC at this output with a horizontal line 2b. label the AR at this output AR Supernormal profit 2c. If AR>AC shade in rectangle formed and label it Supernormal Profit

  8. MC AC AC MR Max profit output Determine the profit situation 1. Mark the max profit output with a vertical marker 2a. mark the AC at this output with a horizontal line Subnormal profit 2b. label the AR at this output AR 2c. If AR<AC shade in rectangle formed and label it Subnormal Profit

  9. MC AC AC MR Max profit output Determine the profit situation 1. Mark the max profit output with a vertical marker Normal profit 2a. mark the AC at this output with a horizontal line 2b. label the AR at this output AR= 2c. If AR=AC label it Normal Profit

  10. 3 short run Profit situations for all firms • When AC=AR the firm is breaking even and earning normal profit • When AR>AC the firm is earning profits in excess of normal. We call this supernormal profits • When AR<AC the firm is making less than normal profits(not necessarily a loss). We call this subnormal profits In all cases the short run supply is the MC curve

  11. LO 2-4: The long run profit for PC • Explain, using a diagram, why, in the long run, a perfectly competitive firm will make normal profit. • Explain, using a diagram, how a perfectly competitive market will move from short- run equilibrium to long-run equilibrium. • Explain, using a diagram, when a loss-making firm would shut down and exit the market in the long run.

  12. Key Point about moving to the LR situation • If firms are making supernormal profit, this will attract other firms to enter the market. • If firms are making subnormal profit (either having shut down or operating in the SR) some will leave the industry. • What will that do to the market price, and subsequently the profit level?

  13. Individual producer MC S1 AC MR Market price AR Supernormal profit AC Max profit output Short-run supernormal profits… Total market S D Firms enter the industry, increasing market supply, decreasing the price…

  14. MC S1 AC MR Market Price decreases until… MR2 Max profit output actually decreases for each firm Firms will enter the industry if profit is to be made; this drives the price down to break-even point! Individual producer Total market S Market price AR AC D AC=MR2 where there is normal profits

  15. Individual producer Total market MC S1 AC S MR2 Price 2 AC MR Subnormal profit AR Market price D Max profit output When subnormal profits are being made, some firms will leave the industry, thus… AC=AR2 normal profits Max profit output

  16. Diagram Task: Label all the curves and axisFind the maximum profit output, and show the profit situationShow what impact will this have on the total market in the long run.Show the individual firm at long run equilibrium

  17. Part 2: Label all the curves and axisShow the equilibrium price and from it the revenue curvesFind the maximum profit output, and show the profit situationWhat impact will this have on the total market in the long run? Show this.Show the individual firm at long run equilibrium

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