3070 module 9
Suppose you are the manager of a watchmaking firm operating in a competitive market. Your cost of production is given by C = 400 + 2q^2 where q is the level of output and C is total cost. If the price of a watch is $120, how many watches should you produce to maximize profits? Profit?
1. 30 watches MC = P = Q so MC = 400 = 4Q *MC = 4Q (partial derivative) 2. profit = R - C *revenue = Q x P *cost = plug Q into cost function in the long run, firms will enter the industry
The data in the table to the right give the total cost, C, and marginal cost, MC, for a firm at each possible level of output, q. 1. What is marginal revenue when the market price is $56? 2. What is marginal revenue when the market price is $46? 3. What happens to the firm's output choice and profit if the price of the product falls from $56 to $46.
1. MR = 56 as the price of the market is given means, the firm is in a perfectly competitive market where MR=P=AR 2. MR = 46 3. Output will decrease from 10 to 8 Revenue will decrease from 150 to 59
What happens in a perfectly competitive industry when economic profit is greater than zero?
A. Firms may move along their LRAC curves to new outputs. B. Existing firms may get larger. C. New firms may enter the industry. D. There may be pressure on prices to fall.
demand and marginal revenue for a competitive firm
demand for an individual firm firm is horizontal and equal to the price while demand for the industry is downward sloping
What assumptions are necessary for a market to be perfectly competitive? For a market to be perfectly competitive,
firms must be price takers, firms must produce a homogeneous product, and firms must be able to easily enter and exit the market.
If firms can easily enter and exit a market, then
firms will earn zero economic profit earn zero economic profit in the long run.
A firm's producer surplus equals its economic profit when
fixed costs are zero
output rule
if a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost MR = MC
monopolistic competition
lots of buyers and sellers with slightly differentiated products
perfect competition
lots of sellers for identical (homogeneous) products products to many buyers so that no one has an influence on the price; no market power or barriers to entry
A perfectly competitive firm should shut down in the short run if
price is below average variable cost
If firms produce a homogeneous product, then
products will be perfectly substitutable with one another
Why would a firm that incurs losses choose to produce rather than shut down? In a perfectly competitive industry, if a firm is incurring losses, then it might choose to produce in the short run because
revenue is greater than variable costs, resulting in smaller losses than would result from shutting down.
Monopoly
single producer of a product selling a good or service to many buyers 1. High barriers to entry 2. Market power
producer surplus
the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives * the area below the market price and above the market supply curve, between 0 and output Q*. PS /= profit
profit
total revenue minus total cost
Suppose a large corporation produces airplanes in a perfectly competitive industry. The data in the following table give information about the cost of producing a particular type of airplane (in thousands), where quantity is q, total cost is C, and marginal cost is MC. Airplanes sell for $116 thousand. Suppose this firm has the capacity to produce up to 11 airplanes of this particular type. 1. If the company manager's goal is to maximize revenue, how many airplanes will the firm produce? 2. Firm's profit? 3. maximizing profit? 4. firms profit when maximized?
1. When P is fixed, the firm maximizes profit at maximum quantity 2. Profit = revenue - cost 3. highest MC while still below market P 4. P = R - C
Suppose the market for apples is perfectly competitive. The short-run average total cost and marginal cost of growing apples for an individual grower are illustrated in the figure to the right. Assume that the market price for apples is $30.00 per box. What is the profit-maximizing quantity for apple growers to produce?
1. firms max profit where MR = MC, since the firm is perfectly competitive, apple growers are price takers and MR = P --> max where P = MC 2. profit = TR - TC Profit = quantity x (P - ATC) = 30 x (7.5-4.5) 3. The firm will earn positive profit at any point above the minimum ATC
Using the data in the following table, show what happens to the firm's output choice and profit if the fixed cost of production increases from $100 to $130 to $160, where q is the quantity and C is the total cost. Assume that the price of output is $54. 1. If the fixed cost of production is $100 2. fixed $130 *What general conclusions can you reach about the effects of fixed costs on the firm's output choice?
1. output = highest Q with MC below P 2. profit = P(Q) - TC in each category The firm's output choice *is unaffected by fixed costs because such costs leave marginal costs unchanged.
Assumptions of a perfectly competitive market
1. price taking 2. product homogeneity (perfectly substitutable) 3. free entry and exit
In perfect competition, a firm's marginal revenue is
1. the change in the firm's total revenue divided by the change in the firm's output. 2. the additional revenue the firm earns when it sells one more unit of output. 3. equal to price.
unique for a perfectly competitive firm
D = AR = MR = P = MC
A competitive firm has the following short-run cost function: C(q) = 1q^3 - 8q^2 + 32q + 4 Find marginal cost (MC), average cost (AC), and average variable cost (AVC).
Marginal cost is 3q^2 - 16q + 32 average cost = The marginal cost, average cost, and average variable cost curves are illustrated in the figure to the right. The marginal cost curve is C1, the average cost curve is C3, and the average variable cost curve is C2. the firm will not produce at any price below the minimum point on the average variable cost curve *minimum AVC is where MC = AVC *AVC = VC/Q *the supply curve is the portion of the marginal cost curve that is above the minimum point on the average variable cost curve *to find P at which the firm would produce q units, plut into cost equation
in the short run a firms should shut down if
P < AVC
in the short run a firms should produce if
Produceif P > ATC P < ATC P > AVC (covers some of fixed costs)
Suppose that a competitive firm has a total cost function of C (q) = 410 + 15q + 2q^2 MC (q) = 15 + 4q P = $127
Set MC = P, and solve for Q Revenue = P(Q) Cost = plug Q into cost function TC = Rev - cost
buyer
a consumer who has the willingness and ability to buy a good or service; demanders
Oligopoloy
a few dominant sellers of a good or service to many buyers with some barrier to entry 1. Strategic interactions 2. could be standardized or differentiated
seller
a firm or business or producer creating or manufacturing a product or service for sale; suppliers
market
a group of buyers and sellers of a particular good or service
condominium
a housing unit that is individually owned but provides access to common facilities that are paid for and controlled jointly by an association of owners
In long-run equilibrium, all firms in the industry earn zero economic profit. Why is this true? All firms in perfectly competitive industries earn zero economic profit in the long run because
a positive profit would induce firms to enter, decreasing price and profit, and a negative profit would induce firms to exit, increasing price and profit.
cooperative
an association of businesses or people jointly owned and operated by members for mutual benefit
In a decreasing-cost industry, the long-run industry supply curve is
downward sloping
If firms are price takers, then
they will produce where price equals marginal cost.
short-run profit maximization by a competitive firm
Π = R - C Π per unit = P - ATC
