2 Competition Firms are price takers. Firm’s 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 p = R – C Definition of R straightforward. Costs: Business profit includes only explicit costs, e.g. workers wages and materials.Owner doesn’t 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 p , Profit p * Profit D p < 0 D p > 0 1 1 q q*Quantity,q, Unitsper daySource: Perloff
5 Output decisionProduce where profit is maximised.
6 Profit maximisation p , Profit p * Profit D p < 0 D p > 0 1 1 q q*Quantity,q, Unitsper daySource: Perloff
7 Output decision Produce where profit is maximised. Produce where marginal profit is zero.Marginal cost equals marginal revenue.p(q) = R(q) – C(q)Marginal Profit(q) = MR(q) – MC(q) = 0MR(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.p=R-VC-F= =-2000p=R-VC-F= =-3500Shutdown if revenue is less than avoidable cost.This rule is applicable in the long and short run.
9 Short-run output decision Cost, revenue,Thousand $Short-run output decisionCost,CRevenue4,800MR=82,2721p*1,846MC=MRR=pqMC=p426p(q)100p* = $426,000–100140284q, Thousand metric tons of lime per yearp, $ per ton10MCACe8p=MRp* = $426,0006.506140284q, Thousand metric tons of lime per year
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 tonMCACb6.12AVC6.00A=$62,0005.50peB=$36,0005.145.00a=36=62TC=6.12*100000=612000VC=514000TR=550000TR-TC=-62000FC=( )*100000=9800050100140q, Thousand metric tons of lime per year
12 Short run supply curve of the firm , $ per tonSe48p4e3AC7p3AVCe26p2e15p1MCq= 50q=140q= 215q= 2851234q, Thousand metric tons of lime per year
13 Industry SR supply curve with 5 identical firms (a) Firm(b) Marketp, $ per tonp, $ per ton7712S3S1SSS46.476.47AVCS56655MC5014017550150250700100200q, Thousand metric tonsQ, Thousand metric tonsof lime per yearof lime per year
14 Industry SR supply curve with 2 different firms , $ per tonS2S1S87652550100140165215315450q,Q, Thousand metric tons of lime per year
15 SR equilibrium in the market (a) Firm(b) Marketp, $ per tonp, $ per ton818SSD1e177E6.971ACABD26.206AVC6C55Ee22q= 50q= 215Q= 250Q= 1,0752121q, Thousand metric tonsQ, Thousand metric tonsof lime per yearof lime per year
16 Supply curve of the firm in the long-run , $ per unitSSRSLRLRACSRACSRAVC35pAB28252420LRMCSRMC50110q, Units per year
17 Long run adjustment of the industry All factors are variable.Entry and exit are possible.Entry occurs with positive long-run profitsExit occurs with long-run lossesIdentical firms:All firms make a loss when P<min(LAC), industry supply is zero.All firms make a profit if P>min(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 (a) Firm(b) Marketp, $ per unitp, $ per unitS1LRACLong-run market supply1010LRMC150Q, Hundred metric tons of oil per yearq, Hundred metric tons of oil per year
19 Upward sloping long run industry supply curve Limited entryNew firms cannot enter because of legislative control.New firms only enter when profits exceed the costs of entry.Firms differMinimum LAC is lower for some firms than others.Number of low LAC firms is limited.Input prices vary with outputIncreasing 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 Price, $ per kgIran1.71SUnited States1.56Nicaragua, Turkey1.43Brazil1.27Australia1.15Argentina1.08Pakistan0.711234566.8Cotton, billion kg per year
21 Increasing cost industry (a) Firm(b) Marketp, $ per unitp, $ per unitMC2MC1AC2SAC1eE22p2eE11p1qqq, Units per yearQ=nqQ=nqQ, Units per year12111222
22 Decreasing cost industry (a) Firm(b) Marketp, $ per unit1p, $ per unitMCMC2AC1AC2e1Ep11e2E2p2Sqqq, Units per yearQ=nqQ=nqQ, Units per year12111222
23 Long run competitive equilibrium (a) Firm(b) Market, $ per tonp, $ per tonD12MCDACSSRfAVCF221111E2SLR10e10Ef1F11771001501651,5002,0003,3003,600q, Hundred metric tonsQ, Hundred metric tonsof oil per yearof oil per year
24 Profit in the long run Free entry Restricted entry Entry occurs to the point where profits are zeroNo profit in long-run equilibriumEconomic profit is revenue minus opportunity cost.Restricted entryEntry is often limited because of a limited quantity of an input eg. land.Profits become rent.
25 Economic Rent p , $ per bushel MC AC (including rent) AC (excluding rent)p*p*= Rentbegin by assuming that the land is not paid for. AC includes opportunity cost, owners of land could rent land to other potential farmers who want to produce tomatoes.q*q, Bushels of tomatoes per year