Chapter11 fi 2010


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Chapter11 fi 2010

  1. 1. Chapter 11 Managerial Decisions in Competitive Markets
  2. 2. Perfect Competition <ul><li>Firms are price-takers </li></ul><ul><ul><li>Each produces only a very small portion of total market or industry output </li></ul></ul><ul><li>All firms produce a homogeneous product </li></ul><ul><li>Entry into & exit from the market is unrestricted </li></ul>11-
  3. 3. Demand for a Competitive Price-Taker <ul><li>Demand curve is horizontal at price determined by intersection of market demand & supply </li></ul><ul><ul><li>Perfectly elastic </li></ul></ul><ul><li>Marginal revenue equals price </li></ul><ul><ul><li>Demand curve is also marginal revenue curve (D = MR) </li></ul></ul><ul><li>Can sell all they want at the market price </li></ul><ul><ul><li>Each additional unit of sales adds to total revenue an amount equal to price </li></ul></ul>11-
  4. 4. Demand for a Competitive Price-Taking Firm (Figure 11.2) 11- Quantity Price (dollars) Quantity Price (dollars) Panel A – Market Panel B – Demand curve facing a price-taker 0 0 D S P 0 Q 0 P 0 D = MR
  5. 5. Profit-Maximization in the Short Run <ul><li>In the short run, managers must make two decisions: </li></ul><ul><ul><li>Produce or shut down? </li></ul></ul><ul><ul><ul><li>If shut down, produce no output and hires no variable inputs </li></ul></ul></ul><ul><ul><ul><li>If shut down, firm loses amount equal to TFC </li></ul></ul></ul><ul><ul><li>If produce, what is the optimal output level? </li></ul></ul><ul><ul><ul><li>If firm does produce, then how much? </li></ul></ul></ul><ul><ul><ul><li>Produce amount that maximizes economic profit </li></ul></ul></ul>11- Profit =
  6. 6. Profit Margin (or Average Profit) <ul><li>Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) </li></ul>11-
  7. 7. Short-Run Output Decision <ul><li>Firm’s manager will produce output where P = MC as long as: </li></ul><ul><ul><li>TR  TVC </li></ul></ul><ul><ul><li>or, equivalently, P  AVC </li></ul></ul><ul><li>If price is less than average variable cost (P  AVC) , manager will shut down </li></ul><ul><ul><li>Produce zero output </li></ul></ul><ul><ul><li>Lose only total fixed costs </li></ul></ul><ul><ul><li>Shutdown price is minimum AVC </li></ul></ul>11-
  8. 8. Profit Maximization: P = $36 (Figure 11.3) 11- Total cost = $19 x 600 = $11,400 Total revenue =$36 x 600 = $21,600 Profit = $21,600 - $11,400 = $10,200
  9. 9. Short-Run Loss Minimization: P = $10.50 (Figure 11.5) 11- Total revenue = $10.50 x 300 = $3,150 Profit = $3,150 - $5,100 = -$1,950 Total cost = $17 x 300 = $5,100
  10. 10. Irrelevance of Fixed Costs <ul><li>Fixed costs are irrelevant in the production decision </li></ul><ul><ul><li>Level of fixed cost has no effect on marginal cost or minimum average variable cost </li></ul></ul><ul><ul><li>Thus no effect on optimal level of output </li></ul></ul>11-
  11. 11. <ul><li>AVC tells whether to produce </li></ul><ul><ul><li>Shut down if price falls below minimum AVC </li></ul></ul><ul><li>SMC tells how much to produce </li></ul><ul><ul><li>If P  minimum AVC , produce output at which P = SMC </li></ul></ul><ul><li>ATC tells how much profit/loss if produce </li></ul>Summary of Short-Run Output Decision 11- •
  12. 12. Short-Run Supply Curves <ul><li>For an individual price-taking firm </li></ul><ul><ul><li>Portion of firms’ marginal cost curve above minimum AVC </li></ul></ul><ul><ul><li>For prices below minimum AVC , quantity supplied is zero </li></ul></ul><ul><li>For a competitive industry </li></ul><ul><ul><li>Horizontal sum of supply curves of all individual firms; always upward sloping </li></ul></ul><ul><ul><li>Supply prices give marginal costs of production for every firm </li></ul></ul>11-
  13. 13. Short-Run Firm & Industry Supply (Figure 11.6) 11-
  14. 14. Long-Run Profit-Maximizing Equilibrium (Figure 11.7) 11- Profit = ($17 - $12) x 240 = $1,200
  15. 15. Long-Run Competitive Equilibrium <ul><li>All firms are in profit-maximizing equilibrium (P = LMC) </li></ul><ul><li>Occurs because of entry/exit of firms in/out of industry </li></ul><ul><ul><li>Market adjusts so P = LMC = LAC </li></ul></ul>11-
  16. 16. Long-Run Competitive Equilibrium (Figure 11.8) 11-
  17. 17. Long-Run Industry Supply <ul><li>Long-run industry supply curve can be flat (perfectly elastic) or upward sloping </li></ul><ul><ul><li>Depends on whether constant cost industry or increasing cost industry </li></ul></ul><ul><li>Economic profit is zero for all points on the long-run industry supply curve for both types of industries </li></ul>11-
  18. 18. Long-Run Industry Supply <ul><li>Constant cost industry </li></ul><ul><ul><li>As industry output expands, input prices remain constant, & minimum LAC is unchanged </li></ul></ul><ul><ul><li>P = minimum LAC , so curve is horizontal (perfectly elastic) </li></ul></ul><ul><li>Increasing cost industry </li></ul><ul><ul><li>As industry output expands, input prices rise, & minimum LAC rises </li></ul></ul><ul><ul><li>Long-run supply price rises & curve is upward sloping </li></ul></ul>11-
  19. 19. Long-Run Industry Supply for a Constant Cost Industry (Figure 11.9) 11-
  20. 20. Long-Run Industry Supply for an Increasing Cost Industry (Figure 11.10) 11- Firm’s output
  21. 21. Profit-Maximizing Input Usage <ul><li>Profit-maximizing level of input usage produces exactly that level of output that maximizes profit </li></ul>11-
  22. 22. Profit-Maximizing Input Usage <ul><li>Marginal revenue product (MRP) </li></ul><ul><ul><li>MRP of an additional unit of a variable input is the additional revenue from hiring one more unit of the input </li></ul></ul>11- <ul><li>If choose to produce: </li></ul><ul><ul><li>If the MRP of an additional unit of input is greater than the price of input, that unit should be hired </li></ul></ul><ul><ul><li>Employ amount of input where MRP = input price </li></ul></ul>
  23. 23. Profit-Maximizing Input Usage <ul><li>Average revenue product (ARP) </li></ul><ul><ul><li>Average revenue per worker </li></ul></ul>11- <ul><li>Shut down in short run if ARP < MRP </li></ul><ul><ul><li>When ARP < MRP, TR < TVC </li></ul></ul>
  24. 24. Profit-Maximizing Labor Usage (Figure 11.12) 11-