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The Competitive Firm

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Quantity (thousand shirts per day) Market demand. Market supply. Equilibrium price. pe ... Market conditions (supply and demand) determine the equilibrium price ... – PowerPoint PPT presentation

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Title: The Competitive Firm


1
The Competitive Firm
  • Chapter 22

2
The Profit Motive
  • The basic incentive for producing goods and
    services is the expectation of profit.
  • Profit is the difference between total revenue
    and total cost.

3
Economic Profits
  • Economic profit is the difference between total
    revenues and total economic costs.
  • Economic cost is the value of all resources used
    to produce a good or service opportunity cost.

4
Economic Profits
  • To determine a firms economic profit, all
    implicit factor costs must be subtracted from
    observed accounting profit.

5
Economic Profits
  • Normal profit is the opportunity cost of capital
    zero economic profit.
  • Economic profits represent something over and
    above normal profits.

6
Economic Profits
7
Implicit Costs
  • Entrepreneurship
  • The inducement to take on the added
    responsibilities of owning and operating a
    business is the potential for profit.
  • Risk
  • The potential for profit is not a guarantee of
    profit.
  • Substantial risks are attached to starting and
    operating a business.

8
Market Structure
  • The opportunity for profit may be limited by the
    structure of the industry.
  • Market structure is the number and relative size
    of firms in an industry.

9
Market Structure
Number of Consumers
Numerous
Monopolistic Competition
Perfect Competition
Oligopoly
Monopoly
Duopoly
Many
Several
Two
Monopsony
One
One
Several
Two
Numerous
Many
Number of Suppliers
10
Market Structure
  • Perfect competition is market in which no buyer
    or seller has market power.
  • Monopoly is a firm that produces the entire
    market supply of a particular good or service.

11
Demand Curves Market vs. Firm
  • The market demand curve for a product is always
    downward-sloping.
  • The demand curve confronting a perfectly
    competitive firm is horizontal.

12
Demand Curves Market vs. Firm
The T-shirt market
Market supply
pe
pe
Market demand
How much to produce? The short-run rate of
output (with existing plant and equipment).
13
Output and Revenues
  • The distinction between total revenue and total
    profit is important.
  • Total revenue - The price of the good multiplied
    by the quantity sold in a given time period.
  • Total revenue Price x Quantity
  • The total revenue curve of a perfectly
    competitive firm is an upward-sloping straight
    line, with a slope equal to pe.
  • Is the objective to maximize total revenue?

14
Total Revenue
15
Output and Costs
  • The primary objective of the producer is to find
    that one particular rate of output that maximizes
    profits.
  • To maximize profits a firm must consider how
    increased production will affect costs as well as
    revenues.
  • Producers are saddled with certain costs in the
    short-run.
  • Fixed
  • Variable
  • Use marginal rule MCMB

16
Total Cost
Total cost
Total costs escalate due to the law of
diminishing returns
Fixed cost
The shape of the total cost curve reflects
increasing marginal costs and the law of
diminishing returns.
17
Total Profit
Total cost
Total revenue
Profits
Losses
f
h
g
18
Marginal Revenue Price
  • The contribution to total revenue of an
    additional unit of output is called marginal
    revenue.
  • For perfectly competitive firms, price equals
    marginal revenue.

19
Marginal Revenue Price
  • Marginal revenue (MR) is the change in total
    revenue that results from a one-unit increase in
    the quantity sold.

20
Marginal Revenue Price
21
Marginal Analysis
  • A firms goal is not to maximize revenues, but to
    maximize profits.
  • Marginal revenue is compared to marginal costs to
    determine the best level of output.

22
Marginal Cost
23
Total Profit
24
Short-Run Profit-Maximization Rules for
Competitive Firm
  • Price (MR) gt MC ? increase output
  • Price (MR) lt MC ? decrease output
  • Price (MR) MC ? maintain output maximize
    profit
  • Profit-maximization rule

25
Profit-Maximizing Rate of Output
p MC
MRB
Profit-maximizing rate of output
MCB
26
Adding Up Profits
  • The profit-maximizing producer has no desire to
    produce at that rate of output where ATC is at a
    minimum.
  • The profit-maximizing producer never seeks to
    maximize per-unit profits.
  • What counts is total profits, not the amount of
    profit per unit.

Total profit total revenue total cost
Total profit (p ATC) X q
27
Alternative Views of Total Profit
28
Short-Run Supply Determinants
  • The quantity of a good supplied is affected by
    all forces that alter marginal cost including
  • The price of factor inputs.
  • Technology (the available production function).
  • Expectations (for costs, sales, technology).
  • Taxes and subsidies.

29
Short-Run Supply Curve
18
16
14
X
12
10
Y
Shutdown point
Price (per bushel)
8
6
Marginal cost curve

Short-run supply curve for competitive firm
4
2
0
1
2
3
4
5
6
7
Quantity Supplied (bushels per day)
30
The Shutdown Decision
  • The short-run profit maximization rule does not
    guarantee profits.
  • Fixed costs must be paid even if all output
    ceases.
  • A firm should shut down only if the losses from
    continuing production exceed fixed costs.
  • The shutdown point is that rate of output where
    price equals minimum AVC.
  • The shut-down decision is a short-run response.

31
The Shutdown Point
32
The Investment Decision
  • The investment decision is the decision to build,
    buy, or lease plant and equipment.
  • It also involves the decision to enter or exit an
    industry.
  • Investment decisions are long-run decisions.

33
Impact of Taxes on Business Decisions
Tax changes can alter short-run supply behavior
or long-run supply decisions.
34
If P 12, at what output rate is Total revenue
maximized? ATC minimized? Profit per unit
maximized? Total profit maximized?
35
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36
Competitive Markets
  • Chapter 23

37
Market Structure
38
The Market Supply Curve
  • Market conditions (supply and demand) determine
    the equilibrium price faced by an individual
    producer.
  • Equilibrium price The price at which the
    quantity of a good demanded in a given time
    period equals the quantity supplied.
  • Market supply The total quantities of a good
    that sellers are willing and able to sell at
    alternative prices in a given time period,
    ceteris paribus. The sum of the marginal cost
    curves of all the firms.

39
Competitive Market Supply



40
The Market Supply Curve
  • Whatever determines marginal cost also determines
    the competitive firms supply response.
  • The price of factor inputs.
  • Technology.
  • Expectations.
  • Taxes.
  • The number of firms in the industry.

41
Entry and Exit
  • Investment decisions (build, buy, or lease) shift
    the market supply curve to the right.
  • Profit motive drives investment decisions.
  • If there are economic profits, more firms will
    enter the industry increasing market supply.
  • Each firm will respond to the resulting lower
    price and profits by reducing output.

42
Market Entry
Market entry pushes price down and . . .
Reduces profits of competitive firm
S1
MC
S2
ATC
E1
f1
p1
p1
f1
Economic Profit
p2
p2
E2
Market demand
New firms enter
q1
q2
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