Chapter 8-The Competitive Firm

Whenever economic costs exceed explicit costs, what will happen to accounting profits

(accounting) profits will exceed true (economic) profits accounting profits can disguised an economics losses

The profit-maximizing producer has no desire to produce at a rate of output where ______ is at a minimum?

ATC (Average total cost)

Accounting profit vs Economic profit

Economic profit is always less than accounting profit. Accounting profit is calculated by subtracting only the explicit costs from total revenue. Does not take into account the implicit costs of doing business. Economic profit is total revenue minus explicit and implicit costs.

An increase in wage rates (the price of factor inputs, would do what to the marginal cost of production? An improvement in technology?

Raise MC Lower MC

Fish example about marginal cost

MC rises as the rate of output increases

Why does the MC curve provide the basic foundation for the the law of supply?

MC tend to rise as output expands --an increase in output makes sense only if the PRICE of that output rises

Do perfectly competitive firms make pricing decisions?

No, they only respond to the market price They can only decide HOW MUCH TO PRODUCE since they are price takers--making a production decision

MEMORIZE: Profit, loss, and shutdown

PROFIT: p>ATC price is how much you're selling it for LOSS: p<ATC BUT p>AVC (what you're paying your workers etc) [profit maximization rule, minimizes losses here] SHUTDOWN: p<AVC

Effects of payroll taxes on short term supply behavior

Payroll taxes add to the cost of hiring labor (for example, employers must pay a 7.65 social security tax on the wages they pay employees (employees pay an identical tax)) PAYROLL TAXES INCREASE MARGINAL COSTS (MC) they change the production decision The new MC curve (MCb) intersects the price line at a lower rate of output (qb) payroll taxes, thus, tend to reduce output and employment

Total Profit and Total cost graph

Producers goal is to find a certain rate of output that maximizes total profits This can be found on this graph by measuring the distance between revenue and costs curves at all the different rates of output In the real world, most producers need other rules

What are the short-run determinants of supply?

Short-run decisions are dominated by marginal costs (change in TC/ change in output) So quantity of a good supplied will be affected by all forces that alter MC (marginal cost) Determinants of SUPPLY are -the price of factor inputs (how much should be paid for resources used in production) -technology (the available production function) -expectations (for cost, sales, technology) -taxes and subsides all of these determinants affect a producer's ability and willingness to supply output at any particular price

Does the short-run profit maximization rule guarantee profits?

When p=MC , the producer is only guaranteed "optimal" output--the best possible output for the firm given the existing market price and the (short run ) cost of production. The bets possible rate of output MAY generate loss. A firm should only shut down if the losses from continuing production exceed fixed costs. This happens when When total revenue is less than total variable costs.

monopoly

a firm that produces the entire market supply of a particular good or service

Competitive firm

a firm without market power, with no ability to alter the market price of the goods it produces

perfect competition

a market in which no buyer or seller has market power

Variable costs

costs of production that change when the rate of output is altered, such as labor and material costs

fixed costs

costs of production that do not change when the rate of output is altered, such as the cost of basis outputs and equipment

When does a productive activity reap an economic profit?

only if it earns more than its opportunity costs

profit per unit

price minus average total cost

Total profits

profit per unit * Quantity

The marginal cost curve is the _________________ for a competitive firm

short run supply curve

economic profit

the difference between total revenues and total economic costs (subtract implicit factor costs from observed accounting profits) Implicit factor costs are the opportunity cost equal to what a firm must give up in order to use a factor of production for which it already owns and thus does not pay rent

What is the incentive for producing good and services?

the expectation of profit

market structures

the number and relative size of firms in an industry

production decision

the selection of the short-run rate of output (with existing plants and equipment)

Describe a market demand curve vs a demand curve of a perfectly competitive firm

The market demand curve for a product is always downward sloping (law of demand) The demand curve confronting a perfectly competitive firm is horizontal

What is a perfectly competitive firm?

A firm whose output is so small in relation to market output that it's output decisions have no perceivable impact on price

profit maximization rule

A producer wants to supply a good only if price exceed Marginal cost (MC) MC is the lower limit for an acceptable price produce at a rate of output where marginal REVENUE equals marginal COST

Why is it easy to calculate marginal revenue when the price of a product is constant?

If you operate a catfish farm, and the wholesale price is $13 a bushel. A one unit increase in sales, increases total revenue by $13 FOR PERFECTLY COMPETITIVE FIRMS, PRICE EQUALS MARGINAL REVENUE price and marginal revenue are the same if the price of a product is constant

Are investment decisions long or short run decisions

long run

Marginal Cost Graph

marginal cost rises as the rate of output increases a competitive firm maximizes total profit at the output rate where MC=p

Economic costs

the value of all resources used in production (whether or not they recieve an explicit payment) most businesses only count EXPLICIT COSTS-the costs that they write checks for (payment made for use of a resource); they typically don't take into account IMPLICIT COSTS-costs of the labor, land, or buildings they might own. In this way true costs are underestimated; thus, true profits are overestimated.

Normal profit

A normal profit is an economic condition that occurs when the difference between a firm's total revenue and total cost is equal to zero. Simply put, normal profit is the minimum level of profit needed for a company to remain competitive in the market. the opportunity cost of capital; zero economic PROFIT This is an economic COST instead of investing in a drugstore, the owner could have earned a 10 percent return on his funds by investing in a fast food franchise or a music store or another production activity By choosing to invest in a drugstore instead, the owner was seeking a higher return on his funds--more than he could have gotten at other places ON AVERAGE ECONOMIC PROFITS ARE ZERO--only firms that get above average returns can claim economic profits

What does the Total Revenue Curve of a perfectly competitive firm look like?

An upward sloping straight line with a slope equal to Pe (Market price) Total revenue is price * Quantity If a competitive firm wanted to maximize it's total Revenue: it would just produce at capacity BUT A FIRMS GOAL IS TO MAXIMIZE PROFITS NOT REVENUES

What are the 3 possible scenarios for marginal cost and price?

MC>p: We don't want to produce an additional unit of output if marginal cost exceeds its price BC were spending more to produce that extra unit than we are getting back. TOTAL PROFITS DECLINE WHEN WE PRODUCE IT. We want to contract output in this case. p>MC: When we produce an extra unit , it brings in more revenue than it costs to produce. IT is adding to total profits. TOTAL PROFITS INCREASE. competitive firms want to expand the rate of production every time price exceeds MC. p=MC: For perfectly competitive firms, profits are maximized at the rate of output where price=marginal cost. THIS IS THE PROFIT MAXIMIZATION RULE.

Does every business have the opportunity to earn economic profit?

No, the structure of industry may prevent this ex: microsoft at one time was a monopoly on the computer operating system and could raise price without much consequence Tshirt stores have to worry about all other stores so they cant control prices as much--too many sellers

When a firm shuts down does it leave the industry?

No--the shutdown decision is a short run response. Its based on the fixed costs of an established plant and the variable costs of opening it

Total Profits formula

TR-TC

Profit

The difference between total revenue and total cost

What is the difference between profit and revenue?

The short answer is that revenue is the total of all money that a company receives from people paying for its products or services, and profit is what is left over at the very end after the company has paid for the cost of goods sold, plus all of its expenses.

How do people gain economic profits?

They are willing to take risks (entrepreneurship)--see opportunities others have overlooked. Find better methods of production etc.

Total costs increase as the rate of output expands, but the rate of cost increase varies

This means the total cost curve is not linear 1 cost rises slowly 2) gradually declines until point z 3) increases more quickly (rising slope after point z) This S-shaped curve reflects the law of diminishing returns

What does the type of profit that producers want to maximize

Total profits- NOT the amount of profit per unit

What are price takers in a competitive industry

individual firms that take the price that the market sets consumers will shop elsewhere if a firm bumps it's price up Im a price taker-trying to sell my dang furniture when everyone else in Gainesville is trying to sell theirs at the end of summer semester -__- SO POWERLESS--all depends on market price

Effect of property taxes on short term supply behavior

levied by gov small fraction of total value (like 1%)--owner of 10 million dollar factor may have to pay 100,000 a year HAVE TO BE PAID EVEN IF THE FACTORY ISN'T USED (FIXED COST) these additional fixed costs increase Total costs--shifting average total costs (ATC) upward Profit per unit is reduced by the upward shift of the ATC curve Why doesn't MC shift-Property taxes aren't based on the quantity of output produced. also production decision isn't affected by property taxes.

What distinguishes a perfectly competitive industry?

many firms-lots of firms competing for consumer's purchases Identical products- the products of many firms are identical or nearly so Low entry barriers- it's relatively easy to get in the business T-shirt business has all of these, so it's hard to maintain these profits

What are the extreme ends of market structures

monopoly and perfect competition In between : duopoly-two firms supply an entire market oligopoly-a handful of firms dominate an entire market (like with credit cards) monopolistic competition-there are enough firms to ensure some competition but not enough to have monopoly-like power (like fastfood chains)

What are the other motives of producers?

social status, recognition

Effects of profits taxes on short term supply behavior

taxes on profits of a business--only paid when profits are made (NEITHER A FIXED COST OR A VARIABLE COST [cost that varies with level of output]) Neither the MC or ATC curve moves when a profits tax is imposed--does reduce the profits of a business and may reduce investments in new businesses

Market power

the ability to alter the market price of a good or service

Marginal Revenue

the change in total revenue that results from a one-unit increase in the quantity sold

investment decision

the decision to build, buy, or lease plants and equipment; to enter or exit an industry

Marginal Cost (MC)

the increase in total cost associated with a one-unit increase in production often declines in the early stages of production and then increases as the available plants and equipment are used more intensely These changes in marginal costs cause total costs to rise slowly at first, then to pick up speed as output increases

Short run

the period in which the quantity (and quality) of some inputs can't be changed

Shutdown Point

the rate of output where price equals minimum AVC