A FIRM IN A PERFECTLY COMPETITIVE MARKET

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A FIRM IN A PERFECTLY COMPETITIVE MARKET
We consider a representative firm in a perfectly
competitive market.
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DEFINITION
A perfectly competitive market satisfies
the following four conditions (1) sellers sell
a homogeneous commodity or service, and buyers
are identical from the sellers point of view, in
that there are no advantages or
disadvantages associated with selling to a
particular buyer (2) both sellers and buyers are
numerous, and the sales or purchases of each
individual unit are small in relation to the
aggregate volume of transactions
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DEFINITION
(3) both buyers and sellers possess perfect
information about the prevailing price and
current bids, and they take advantage of every
opportunity to increase profits and utility (4)
entry into and exit from the market is free for
both buyers and seller.
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PERFECTLY COMETITORS OUTPUT MARKET
Since the sales of a perfectly competitive firm
are small in relation to the total market sales,
the firms sales of its entire output will not
perceptibly affect supply. Therefore how much
the firm sells will not affect market price -- a
perfectly competitive firm can sell as much (or
as little) as it wants at the market price,
without affecting the market price. The firm
views the demand for its output as perfectly
elastic at the market price.
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PERFECTLY COMETITORS OUTPUT MARKET
The firm is so small, that market supply will be
the same regardless of the amount sold by the
firm. The firm believes that it can sell
all that it wants at the market price PE, and
can sell nothing at a price above PE, since
buyers have information about prices.
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DEFINITION
Marginal revenue (MR) is the additional revenue
obtained from the sale of an additional unit of
output. MR DTR
/ DQ P
x Q / DQ
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MARGINAL REVENUE OF A PERFECT COMPETITOR
Since a perfect competitor can sell each unit
of output for the same price -- the market price
-- each unit sold brings the same additional
revenue -- market price. Therefore marginal
revenue for a perfectly competitive firm is
price MR P.
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DEFINITION
Marginal profit is the additional profit obtained
from the production and sale of an additional
unit of output. marginal profit
Dprofit / DQ
MR - MC
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PROFIT MAXIMIZING BEHAVIOR
Since perfectly a competitive firm seeks to
maximize profits, it will only produce and sell
a unit of output if doing so adds to profits.
If the additional revenue from selling an
additional unit of output exceeds the additional
cost of producing it, profits will increase.
Therefore, marginal profit will be positive, and
profits increasing, whenever marginal revenue
exceeds marginal cost.
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PROFIT MAXIMIZING OUTPUT
The cost schedules for a perfectly competitive
firm are given on the left. The firm can sell
whatever
quantity that it wants at the market price of 42.
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PROFIT MAXIMIZING OUTPUT
Marginal revenue exceeds marginal cost for the
first through the fifth units of output, so
that the additions
to profit from producing five units of output is
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PROFIT MAXIMIZING OUTPUT
1826221712 95. The sixth unit of
output neither adds to, nor decreases, profit,
while the seventh unit of
output decreases profit by 11. Assume that a firm
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PROFIT MAXIMIZING OUTPUT
will produce a unit of output as long as it
doesnt decrease profit. Then a firm with costs
an revenue on the left will
maximize profits by producing 6 units of output.
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PROFIT MAXIMIZING OUTPUT
This is where marginal profit is zero, or
where MRMC. While additions to profit total
95, the firm also has
fixed cost. Fixed cost can be calculated by
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PROFIT MAXIMIZING OUTPUT
Multiplying average fixed cost by
quantity. FCAFC x Q (ATC-AVC) Q. Then at one
unit of output
FC (59-24) x 135. Therefore profit from
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PROFIT MAXIMIZING OUTPUT
Producing and selling six units of output is sum
of the marginal profits minus fixed cost. Profit
95-35 60.
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PROFIT MAXIMIZING OUTPUT
Alternatively, TC ATC x Q and TR P x
Q, so that Profit TR - TC. Then profits
are maximum at 6 units of output.
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PROFIT MAXIMIZING OUTPUT
The firm produces the output (6) where PMC to
maximize profits.
P MC
MC
PMR
ATC
AVC
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PROFIT MAXIMIZING OUTPUT
Profit is TR - TC or (P - ATC) x Q. It is the
area of the rectangle with sides Q and P - ATC.
MC
PROFIT
PMR
ATC
AVC
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PROFIT MAXIMIZING OUTPUT
Minimum ATC is 30, while price is 25.
Therefore, there is no output level Q where price
covers total costs. However, the firm can
minimize losses by producing where PMC.
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PROFIT MAXIMIZING OUTPUT
Price is equal to marginal cost at 4 units of
output. The additions to profit are 19515.
Since fixed cost is 35 the firm has a loss of
15-35 20 at 4 units of output.
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PROFIT MAXIMIZING OUTPUT
Profits are maximized (the loss is smallest) at
an output of 4. If the firm stopped
producing, losses would equal fixed cost (35).
Producing 4 units of output, helps to pay some of
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PROFIT MAXIMIZING OUTPUT
the fixed cost. In the long run, when the firm no
longer has any fixed input, the firm will
leave this industry, and employ its resources in
its next best opportunity.
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PROFIT MAXIMIZING OUTPUT
The firm produces 4 units of output to equate
marginal revenue and marginal cost.
MC
PMC
ATC
AVC
PMR
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PROFIT MAXIMIZING OUTPUT
The firm produces 4 units of output to equate
marginal revenue and marginal cost.
MC
ECONOMIC LOSS
ATC
AVC
PMR
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PROFIT MAXIMIZING OUTPUT
If the firm produced 0 output, loss would be
fixed cost (ATC -AVC) x Q. Obviously, losses
at 4 units of output are smaller than fixed cost.
MC
FIXED COST
ATC
AVC
PMR
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PROFIT MAXIMIZING OUTPUT
Minimum AVC is 20, while price is 16. Since
price is less than min AVC, there is no output
level where revenue covers variable cost.
Therefore, the firm loses more by producing than
by not
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PROFIT MAXIMIZING OUTPUT
producing. Profits are maximized by producing
0 in the short run, and leaving the
industry in the long run. The firm will not
produce where PMC.
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PROFIT MAXIMIZING OUTPUT
If the firm produces 0 output, it will have a
loss equal to fixed cost. If it produces an
output greater than 0 it will have losses greater
than fixed cost. Therefore, when P lt min
AVC, the profit maximizing output in the short
run is 0. The firm will leave the industry in
the long run.
MC
FIXED COST
ATC
AVC
PMR
ADDITIONAL LOSS IF Q2
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SHORT-RUN PROFIT MAXIMIZING OUTPUT
SUMMARY P gt min
ATC Firm produces where PMC and
has short-run economic
profits. min ATC gt P Firm produces where
PMC, has and PgtminAVC a short-run economic
loss, and leaves
the industry in the long run. P lt min AVC
Firm produces 0 output, has
a short-run economic loss, and
leaves the industry in the
long run.
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FIRMS SHORT-RUN SUPPLY CURVE
P
In the short run, the firm will produce where
PMC, when Pgtmin AVC. Therefore the
firms short-run supply curve is its marginal
cost curve above min AVC, and zero when Pltmin
AVC.
SHORT-RUN SUPPLY CURVE
MC
ATC
AVC