Unit 3: Costs of Production and Perfect Competition Eric: When teaching the different types of markets, just give notes for perfect comp. and then go through the graphs for it. Once they understand PC, then give notes for the other 3. Copyright ACDC Leadership 2015

4 Market Structures Candy Markets Simulation Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Every product is sold in a market that can be considered one of the above market structures. For example: Fast Food Market Cars Manufactures Market for Operating Systems (Microsoft) Strawberry Market Cereal Market Monopolistic Competition (differentiated products) Oligopoly Monopoly Perfect Competition Oligopoly (3 main producers) Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Imperfect Competition Characteristics of Perfect Competition: Examples: Corn, Strawberries, Milk, etc. Many small firms Identical products (perfect substitutes) Low Barriers- Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Monopoly: Examples: The Electric Company, De Beers, One large firm (the firm is the market) Unique product (no close substitutes) High Barriers- Firms cannot enter the industry Monopolies are “Price Makers” Copyright ACDC Leadership 2015

Barriers to Entry Types of Barriers to Entry 1. Economies of Scale A monopoly wouldn’t last long if there were not high barriers to keep other firms from entering. Types of Barriers to Entry 1. Economies of Scale Ex: There is only one electric company because they are the only ones that can make electricity ay the lowest cost. This is a “natural monopoly” 2. Superior Technology 3. Geography or Ownership of Raw Materials 4. Government Created Barriers The government issues patents to protect inventors and forbids others from using their invention Copyright ACDC Leadership 2015

Four Market Structures Characteristics of Oligopolies: Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Oligopolies: Examples: Cell Phones, Service Providers, Cars A Few Large Producers (Less than 10) Identical or Differentiated Products High Barriers to Entry Control Over Price (Price Maker) Mutual Interdependence Firms must worry about the decisions of their competitors and use strategy Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Mono. Comp: Examples: Fast food, furniture, shoe stores Relatively Large Number of Sellers Differentiated Products Some control over price Low Barriers- easy for firms to enter A lot of non-price competition (Advertising) Copyright ACDC Leadership 2015

Perfect Competition Copyright ACDC Leadership 2015

Imperfect Competition The seller has NO control over price. FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Monopoly Oligopoly Imperfect Competition Characteristics of Perfect Competition: Examples: Corn, Strawberries, Milk, etc. Many small firms Identical products (perfect substitutes) Low Barriers- Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Copyright ACDC Leadership 2015

Demand for Perfectly Competitive Firms (A Horizontal straight line) Why are they Price Takers? If a firm charges above the market price, NO ONE will buy. They will go to other firms There is no reason to price low because consumers will buy just as much at the market price. Since the price is the same at all quantities demanded, the demand curve for each firm is… Perfectly Elastic (A Horizontal straight line) Copyright ACDC Leadership 2015

The Competitive Firm is a Price Taker Price is set by the Industry (all firms) Firm P S P Demand $10 $10 D Q 5000 Q Copyright ACDC Leadership 2015

The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an additional unit? 1st unit earns $10 2nd unit earns $10 Marginal revenue is constant at $10 Notice: Total revenue increases at a constant rate MR equal Average Revenue Firm P Demand $10 MR=D=AR=P Q 13 13 Copyright ACDC Leadership 2015

For Perfect Competition: Demand = MR (Marginal Revenue) The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an additional unit? 1st unit earns $10 2nd unit earns $10 Marginal revenue is constant at $10 Notice: Total revenue increases at a constant rate MR equal Average Revenue Firm P Demand $10 MR=D=AR=P Q 14 14 Copyright ACDC Leadership 2015

Maximizing PROFIT! 15 Copyright ACDC Leadership 2015

Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! To maximum profit firms must make the right output Firms should continue to produce until the additional revenue from each new output equals the additional cost. Example (Assume the price is $10) Should you produce… …if the additional cost of another unit is $5 …if the additional cost of another unit is $9 …if the additional cost of another unit is $11 Copyright ACDC Leadership 2015

Lets put costs and revenue together to calculate profit. Industry Firm (price taker) P S P MC Demand $7 $7 ATC D Q 10,000 Q Copyright ACDC Leadership 2015

How much output should be produced? How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? P $9 8 7 6 5 4 3 2 1 MC MR=D=AR=P Profit = $18 ATC Total Cost=$45 Total Revenue =$63 Q 1 2 3 4 5 6 7 8 9 10 Copyright ACDC Leadership 2015

The profit maximizing rule is also the loss minimizing rule!!! Suppose the market demand falls. What would happen if the price is lowered from $7 to $5? The MR=MC rule still applies but now the firm will make an economic loss. The profit maximizing rule is also the loss minimizing rule!!! Copyright ACDC Leadership 2015

How much output should be produced? How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue Loss =$7 MR=D=AR=P Total Cost = $42 Total Revenue=$35 Q 1 2 3 4 5 6 7 8 9 10

The Shut Down Rule 21 Copyright ACDC Leadership 2015

Assume the market demand falls even more Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing. Shut Down Rule: A firm should continue to produce as long as the price is above the AVC When the price falls below AVC then the firm should minimize its losses by shutting down Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down. Copyright ACDC Leadership 2015

Minimum AVC is shut down point SHUT DOWN! Produce Zero Price MC $9 8 7 6 5 4 3 2 1 ATC AVC Minimum AVC is shut down point Q 1 2 3 4 5 6 7 8 9 10 Copyright ACDC Leadership 2015

P<AVC. They should shut down Producing nothing is cheaper than staying open. Price MC $9 8 7 6 5 4 3 2 1 ATC Fixed Costs=$10 AVC TC=$35 MR=D=AR=P TR=$20 Q 1 2 3 4 5 6 7 8 9 10 Copyright ACDC Leadership 2015

Profit Maximizing Rule MR = MC Three Characteristics of MR=MC Rule: Rule applies to ALL markets structures (PC, Monopolies, etc.) The rule applies only if price is above AVC Rule can be restated P = MC for perfectly competitive firms (because MR = P) Copyright ACDC Leadership 2015

Practice 26 Copyright ACDC Leadership 2015

#1 MC MR=D=AR= P ATC Quantity $16 15 10 9 14 5 1. Should the firm produce? 2. What output should the firm produce? 3. What is the TR and TC at that output? 4. How much profit or loss? $16 15 10 9 5 Price MC MR=D=AR= P 14 ATC Quantity 3 7 10 12 Copyright ACDC Leadership 2015

#2 MC ATC AVC MR=D=AR=P Quantity 24 20 12 18 15 What output should the firm produce? What is TR at that output? What is TC? How much profit or loss? 24 20 12 Price MC ATC 18 AVC 15 MR=D=AR=P Quantity 3 6 8 10 Copyright ACDC Leadership 2015

#3 MC ATC AVC MR=D=AR=P Quantity $12 10 11 9 1. What output should the firm produce? 2. What is TR at MR=MC point? 3. What is TC at MR=MC point? 4. How much profit or loss? $12 10 Price MC ATC AVC 11 9 MR=D=AR=P Quantity 5 6 7 8 Copyright ACDC Leadership 2015

#4 MC MR=D=AR= P ATC Quantity $12 11 6 5 10 3 1. Should the firm produce? 2. What output should the firm produce? 3. What is the TR and TC at that output? 4. How much profit or loss? $12 11 6 5 3 Price MC MR=D=AR= P 10 ATC Quantity 3 7 10 12 Copyright ACDC Leadership 2015

B D

2007 Form B FRQ Copyright ACDC Leadership 2015

Assume the firm can sell each unit at a price of $30 Maximizing Profit Assume the firm can sell each unit at a price of $30 How many units should the firm produce to maximize profit? What is the total revenue at that quantity? How much is the profit? Output Variable Cost Fixed Total Marginal $0 $20 - 1 $12 2 $22 3 $27 4 $40 5 $60 6 $100 Copyright ACDC Leadership 2015

2006 FRQ 34 Copyright ACDC Leadership 2015

Short-run Supply Curve 35 Copyright ACDC Leadership 2015

Marginal Cost and Supply As price increases, the quantity increases $50 45 40 35 30 25 20 15 10 5 MC ATC MR5 Cost and Revenue AVC MR4 MR3 MR2 MR1 Q 1 2 3 4 5 6 7 9 36

Short-run Supply Curve: MC above AVC Marginal Cost and Supply When price increases, quantity increases When price decrease, quantity decreases $50 45 40 35 30 25 20 15 10 5 MC = Supply Short-run Supply Curve: MC above AVC ATC Cost and Revenue AVC Q 1 2 3 4 5 6 7 9 37 Copyright ACDC Leadership 2015

Marginal Cost and Supply If variable costs increase (ex: per unit tax) MC2=Supply2 $50 45 40 35 30 25 20 15 10 5 MC1=Supply1 AVC Cost and Revenue AVC When MC increases, SUPPLY decrease Q 1 2 3 4 5 6 7 9 38 Copyright ACDC Leadership 2015

Marginal Cost and Supply What if variable costs decrease (ex: subsidy)? MC1=Supply1 $50 45 40 35 30 25 20 15 10 5 MC2=Supply2 AVC Cost and Revenue AVC When MC decreases, SUPPLY increases Q 1 2 3 4 5 6 7 9 39 Copyright ACDC Leadership 2015

Marginal Cost and Supply What happens to quantity if fixed costs increase? Price MC MR=D=AR= P PF ATC1 ATC Quantity stays the same because MC/Supply doesn’t change Quantity QF Copyright ACDC Leadership 2015

Per Unit vs. Lump Sum A PER UNIT tax or subsidy is effects the VARIABLE COSTS so MC, AVC, and ATC will shift. This WILL effect the quantity produced A LUMP SUM tax or subsidy only effects FIXED COSTS so only AFC and ATC will shift. MC stays the same. This WILL NOT effect the quantity produced 41 Copyright ACDC Leadership 2015

2008 Audit Exam 18.B

No Profit, No Product