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Competitive firms and Markets Perloff chapter 8. Competition Firms are price takers. –Firms demand curve is horizontal. Reasons for a horizontal demand.

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Presentation on theme: "Competitive firms and Markets Perloff chapter 8. Competition Firms are price takers. –Firms demand curve is horizontal. Reasons for a horizontal demand."— Presentation transcript:

1 Competitive firms and Markets Perloff chapter 8

2 Competition Firms are price takers. –Firms demand curve is horizontal. Reasons for a horizontal demand curve: –Identical products from different firms; –Freedom of entry and exit; –Perfect knowledge of prices; –Low transaction costs. Where all conditions are satisfied: Perfect Competition.

3 Profit R – C Definition of R straightforward. Costs: –Business profit includes only explicit costs, e.g. workers wages and materials. –Owner doesnt take a salary, what remains is profit. –Economic profit uses opportunity cost. –Suppose profit was £20000 but you could earn a salary of £25000, what should you do?

4 Profit maximisation, Profit > 0 < 0 q*Quantity,q, Units per day Profit 1 1 * 0 Source: Perloff

5 Output decision Produce where profit is maximised.

6 Profit maximisation, Profit > 0 < 0 q*Quantity,q, Units per day Profit 1 1 * 0 Source: Perloff

7 Output decision Produce where profit is maximised. Produce where marginal profit is zero. Marginal cost equals marginal revenue. – q) R(q) – C(q) –Marginal Profit(q) = MR(q) – MC(q) = 0 –MR(q) = MC(q)

8 Shutdown rule Shutdown if it reduces its loss. –In the short-run, shutting down means revenue and variable costs are zero. –It must continue to cover fixed costs. – R-VC-F= =-2000 – R-VC-F= =-3500 Shutdown if revenue is less than avoidable cost. –This rule is applicable in the long and short run.

9 Short-run output decision MC=MR R=pq MC=p Cost, revenue, Thousand $ qme per year 2,272 4, , – 1 MR = 8 * = $426,000 * (q) Cost,CRevenue p, $ per ton e q, Thousand metric tons of lime per year p =MR * = $426,000 AC MC, Thousand metric tons of li

10 Short run shutdown decision Shutdown if revenue less than avoidable cost. –In short run avoidable costs are variable costs.

11 Short run shutdown decision p, $ per ton q, Thousand metric tons of lime per year AVC AC MC p a e b A = $62,000 B = $36,000

12 Short run supply curve of the firm p, $ per ton q 3 = 215q 4 = 285q 1 = 50q 2 =140 e 1 e 2 e 3 e 4 p 2 p 1 p 3 p 4 0 q, Thousand metric tons of lime per year AVC MC AC S

13 Industry SR supply curve with 5 identical firms p, $ per ton q, Thousand metric tons of lime per year p, $ per ton AVC (a) Firm MC Q, Thousand metric tons of lime per year (b) Market S 3 S 4 S 5 S 2 S 1 S 1

14 Industry SR supply curve with 2 different firms p, $ per ton S 2 SS 1 0 q,Q, Thousand metric tons of lime per year

15 SR equilibrium in the market p, $ per ton q 1 = 215q 2 = 50Q 1 = 1,075Q 2 = 2500 q, Thousand metric tons of lime per year Q, Thousand metric tons of lime per year e 2 e 1 E 2 S E 1 p, $ per ton (a) Firm(b) Market AVC AC D 2 S 1 D 1 A C B

16 Supply curve of the firm in the long-run p, $ per unit 50110q, Units per year p SRAC LRMC LRAC SRMC SRAVC B A S SR S LR

17 Long run adjustment of the industry All factors are variable. Entry and exit are possible. –Entry occurs with positive long-run profits –Exit occurs with long-run losses Identical firms: –All firms make a loss when Pmin(LAC), number of firms is indeterminate. Note that elasticity of the industry supply curve increases with the number of firms.

18 Long run industry supply curve p, $ per unit 150 LRAC LRMC (a) Firm q, Hundred metric tons of oil per year 10 S 1 0 p, $ per unit (b) Market Q, Hundred metric tons of oil per year Long-run market supply 10 0

19 Upward sloping long run industry supply curve Limited entry –New firms cannot enter because of legislative control. –New firms only enter when profits exceed the costs of entry. Firms differ –Minimum LAC is lower for some firms than others. –Number of low LAC firms is limited. Input prices vary with output –Increasing cost (firms in one industry account for much of the supply of a particular input). –Decreasing cost (economies of scale in the input supplier)

20 Differing firms: the LR supply curve for cotton 0.71 Price, $ per kg 0123 Iran United States Nicaragua, Turkey Brazil Australia Argentina Pakistan Cotton, billion kg per year S

21 Increasing cost industry p, $ per unit q 1 q 2 Q 1 =n 1 q 1 Q 2 =n 2 q 2 q, Units per yearQ p 1 p 2 e 2 e 1 E 2 S E 1 p, $ per unit (a) Firm(b) Market AC 2 MC 2 1 AC 1

22 Decreasing cost industry p, $ per unit q 1 q 2 Q 1 =n 1 q 1 Q 2 =n 2 q 2 q, Units per yearQ p 1 p 2 e 2 e 1 E 2 S E 1 p, $ per unit (a) Firm (b) Market AC 2 MC 2 1 AC 1

23 Long run competitive equilibrium, $ per ton e 1 f q, Hundred metric tons of oil per year MC AVC (a) Firm AC p, $ per ton F 1 E 1 F 2 E 2 1,50002,0003,3003,600 Q, Hundred metric tons of oil per year (b) Market D 1 S SR S LR D 2 f

24 Profit in the long run Free entry –Entry occurs to the point where profits are zero –No profit in long-run equilibrium –Economic profit is revenue minus opportunity cost. Restricted entry –Entry is often limited because of a limited quantity of an input eg. land. –Profits become rent.

25 Economic Rent p, $ per bushel q* *= Rent q, Bushels of tomatoes per year AC (including rent) AC (excluding rent) MC p*


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