Mic 9

941 views
658 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
941
On SlideShare
0
From Embeds
0
Number of Embeds
4
Actions
Shares
0
Downloads
49
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Mic 9

  1. 1. Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 1
  2. 2. CHAPTER 9 Perfect CompetitionMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 MICROECONOMICS 2 2 9–
  3. 3. DEFINITION AND CHARACTERISTICS OF A PERFECTLY COMPETITIVE MARKET Definition A market in which there are many buyers and sellers, the products are homogeneous and sellers can easily enter and exit from the market. Characteristics • Large number of buyers and sellers – firms are price takers.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 MICROECONOMICS 3 3 9–
  4. 4. DEFINITION AND CHARACTERISTICS OF A PERFECTLY COMPETITIVE MARKET (CON’T) Homogenous or standardized product – the buyers do not differentiate the products of one seller to another seller. Free of entry and exit into the market. Role of non-price competition is insignificant. Perfect knowledge of the market – all the sellers and buyers in perfect competition market will have perfect knowledge of that market. Rights ReservedMicroeconomics All© Oxford University Press Malaysia, 2008 9– 4
  5. 5. PRICE DETERMINATION IN A PERFECTLY COMPETITIVE FIRM The price is determined by the Since firms are price takers, they intersection of the market supply face a horizontal demand curve. curve and the market demand Demand curve in perfect Price curve. competition is horizontal or Price perfectly elastic. Therefore, Price = MR = AR. SSRM10 RM10 P = MR = AR DD Quantity Quantity Q* Market Firm Microeconomics All Rights Reserved © Oxford University Press Malaysia, 2008 9– 5
  6. 6. PROFIT MAXIMIZATION IN A PERFECTLY COMPETITIVE FIRM 1. Using Total approach TOTAL REVENUE – TOTAL COST APPROACH (1) (2) (3) (4) 5) Using Table: Quantity Price Total Total Cost Profit/ Profit maximization is (per kg per (per kg per Revenue (TC) Lloss determined by scanning dAy) dAy) (TR) through the profit at each 0 10 0 60 -60 level, and the level which 10 10 100 140 -40 gives the highest profit is 20 10 200 210 -10 the profit maximizing 30 10 300 output. 290 10 40 10 400 390 10 50 10 500 500 0 60 10 600 630 -30 70 10 700 800 -100Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 6
  7. 7. PROFIT MAXIMIZATION IN A PERFECTLY COMPETITIVE FIRM TR, TC TC Using Graph: TR TR curve is a straight line through the origin. The maximum profit is where the vertical Highest vertical difference is the highest. difference Quantity 40Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 7
  8. 8. PROFIT MAXIMIZATION IN A PERFECTLY COMPETITIVE FIRM 2. Using Marginal approach MARGINAL REVENUE – MARGINAL COST APPROACH (1) (2) (3) (4) (5) (6) (7) Quantity Price Total Marginal Total Marginal Profit/ (per kg per (per kg Revenue Revenue Cost Cost Lloss day) per day) (TR) (MR) (TC) (TC) Using Table: 0 10 0 - 60 - -60 The profit 10 8 -40 maximizing 10 100 10 140 output level is 20 10 200 10 210 7 -10 obtained 30 10 300 10 290 8 10 following the 40 10 400 10 390 10 10 MR = MC rule. 50 10 500 10 500 11 0 60 10 600 10 630 13 -30 70 10 700 10 800 17 -100Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 8
  9. 9. PROFIT MAXIMIZATION IN A PERFECTLY COMPETITIVE FIRM MR, MC MC Using Graph: TR curve is a straight line through the origin. The maximum profit is RM10 MR where the vertical difference is the highest. Quantity 40Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 9
  10. 10. PROFIT MAXIMIZATION USING THE EQUATION METHOD The demand function for a product sold by a perfect competitor is given as QD = 20 – P and the marginal cost is MC = −10 + 3Q. Calculate profit maximizing price and quantity.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 10
  11. 11. PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T) Solution For profit maximization to take place, we use the MR = MC rule. Firstly, we need to derive the demand curve. Given Q = 20 − P P = 20 − Q MR = 20 − Q (since in perfect competitive firm, P = MR = AR)Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 11
  12. 12. PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T) MR = MC 20 − Q = −10 + 3Q 4Q = 30 Q = 7.5 Substitute Q = 7.5 into P = 20 − Q P = 20 − 7.5 P = 12.5Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 12
  13. 13. SHORT-RUN SUPPLY CURVE Price The figure shows the AC, AVC (RM) and MC. There are five different MC market prices. The horizontal demand curve at each price is shown. e AC Point a is not considered a supply20 P1 = MR1 = AR1 curve since at any point below the AVC minimum of AVC, the firm would shut down its operation and the quantity supplied would be zero. d10 P = MR = AR The portion of marginal cost curve c P2 = MR2 = AR2 which lies above the average b variable cost curve is the firm’s P3 = MR3 = AR3 supply curve.5 a P4 = MR4 = AR4 Supply curve of a competitive firm is the upward portion of MC above minimum of AVC as shown by 40 60 Quantity points b, c, d and e. Microeconomics All Rights Reserved © Oxford University Press Malaysia, 2008 9– 13
  14. 14. PROFIT MAXIMIZATION IN THE SHORT RUN A competitive firm earns economic profitPrice (RM) MC The firm’s demand curve is ATC horizontal at the price of RM20 where AR = MR. The marginal cost curve intersects the demand curve at point B. A competitive firm maximizes its profit when MR = MC. PROFIT B The profit maximizing price and P* P = MR = AR output is P* and Q*. 20 At output Q* respectively the firm earns economic profit or supernormal profit equal to the area shaded. Economic profit or supernormal profit is the profit earned by a competitive Q* firm when TR>TC. Quantity Microeconomics All Rights Reserved © Oxford University Press Malaysia, 2008 9– 14
  15. 15. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) A competitive firm at breakevenPrice (RM) MC Normal profit or breakeven profit is necessary for a firm to stay in business (TR =TC). ATC At output Q*, the firm is at breakeven and earns normal profit. The profit maximizing price and output is P* B and Q*, respectively. P* P = MR = AR 20 The firm’s demand curve is horizontal at the price of RM20 where AR = MR. The marginal cost curve intersects the demand curve at point B. A competitive firm maximizes its profit when MR = MC. Q* QuantityMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 15
  16. 16. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T)A competitive firm suffers economic losses The firm’s demand curve is horizontal at the price of RM20 MC where AR = MR.Price (RM) The marginal cost curve intersects the demand curve at point B. A competitive firm maximizes its profit when MR = MC. ATC The profit maximizing price and B output is P* and Q* respectively. P* P = MR = AR 20 At output Q*, the firm suffers LOSSES economic losses or subnormal profit equal to the area shaded. Economic losses or subnormal Quantity profit is the losses incurred by a Q* competitive firm when TR<TC.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 16
  17. 17. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) SHUT DOWN PRICE A firm will continue its operations even if it suffers losses. MC A firm can continue production untilPrice (RM) the price is equal to minimum average variable cost (AVC). At the price of RM5, the losses incurred by the firm is equal to the ATC fixed cost. B P = MR = AR If price falls below RM5, the firm 20 TOTAL FIXED AVC LOSSES COST would incur more operating losses than fixed cost and the firm must shut down. 5 Shut down point is at the point where the price equals to minimum Q* Quantity AVC.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 17
  18. 18. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) EFFECT OF ENTRYPrice is determined by the intersection of the market Firms that earn supernormal profits in short run will only be able to earn normalsupply curve and the market demand curve. or zero profits in long run due to entry of newcomers. Price (RM)Price (RM) The economic profit MC attracts newcomers AC SS to the industry. As a SS1 result, many firms20 will enter the market 20 P = MR = AR and this will lead to15 an increase in PROFIT 15 P1 = MR1 = AR1 supply. DD Quantity Quantity Q* 60 Supply curve will shift to the The competitive firm sells 60 kg of right and equilibrium market chicken and earns an economic Market price will fall to RM15. Firm profit shown by the shaded area.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 18
  19. 19. PROFIT MAXIMIZATION IN THE LONG RUN EFFECT OF EXITThe losses in short run forces those sellers who Firms that suffer losses in short runcannot cover their AVC or TVC to leave the market. Supply curve will shift to left and equilibrium market can still continueAs many firms exit the market, RM15 price will rise to this will lead to a their operation. As in The competitivedecrease in the market supply. long run they are firm sells 60 kg of able to earn normal chicken and or zero profits due toPrice (RM) Price (RM) suffers losses exit of the firms. MC shown by the SS shaded area. AC SS110 20 P = MR = AR15 LOSSES 15 P1 = MR1 = AR1 DD Quantity Quantity Market Q* Firm 60Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 9– 19

×