Title: The Competitive Firm
1The Competitive Firm
2The 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.
3Economic 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.
4Economic Profits
- To determine a firms economic profit, all
implicit factor costs must be subtracted from
observed accounting profit.
5Economic Profits
- Normal profit is the opportunity cost of capital
zero economic profit.
- Economic profits represent something over and
above normal profits.
6Economic Profits
7Implicit 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.
8Market 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.
9Market 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
10Market 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.
11Demand 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.
12Demand 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).
13Output 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?
14Total Revenue
15Output 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
16Total 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.
17Total Profit
Total cost
Total revenue
Profits
Losses
f
h
g
18Marginal 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.
19Marginal Revenue Price
- Marginal revenue (MR) is the change in total
revenue that results from a one-unit increase in
the quantity sold.
20Marginal Revenue Price
21Marginal 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.
22Marginal Cost
23Total Profit
24Short-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
25Profit-Maximizing Rate of Output
p MC
MRB
Profit-maximizing rate of output
MCB
26Adding 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
27Alternative Views of Total Profit
28Short-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.
29Short-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)
30The 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.
31The Shutdown Point
32The 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.
33Impact of Taxes on Business Decisions
Tax changes can alter short-run supply behavior
or long-run supply decisions.
34If P 12, at what output rate is Total revenue
maximized? ATC minimized? Profit per unit
maximized? Total profit maximized?
35(No Transcript)
36Competitive Markets
37Market Structure
38The 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.
39Competitive Market Supply
40The 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.
41Entry 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.
42Market 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