UNIT II: Firms & Markets Theory of the Firm Profit Maximization Perfect Competition Review 7/14 MIDTERM 6/30

Profit Maximization Last Time The Short-Run and the Long-Run Firm and Market Supply Perfect Competition (Part 1)

Last Time We saw last time that we can solve the firm’s cost minimization problem analogously to the consumer’s utility maximization problem. Cost minimization requires that the firm produce using a combination of inputs for which the ratios of the marginal products, or the marginal rate of technical substitution, equals the ratio of the input prices: MRTS = w/r 2 Provisos: Only in the Long-Run Only part of the firm’s problem

Profit (P) = Total Revenue(TR) – Total Cost(TC) Profit Maximization The firm wants to maximize this difference: Profit (P) = Total Revenue(TR) – Total Cost(TC) TR(Q) = PQ TC(Q) = rK + wL P Price L Labor Q Quantity K Capital w Wage Rate r Rate on Capital Q = f(K,L) Revenue Cost

Profit Maximization Last time: we considered a firm that produces output according to the following production function. Q = 4K½L½ and w = $18 and r = $36. How much will it cost this firm to produce 10 units of output in the long-run? Q units? The long-run total cost curve (TC(Q)) represents the minimum cost to produce Q units of output.

Cost Minimization in the Long-Run How much will it cost this firm to produce 10 units of output in the long-run? Q = 4K1/2L1/2 w = 18; r = 36 MRTS = MPL/MPK MPL = 2K1/2L-1/2 MPK = 2K-1/2L1/2 MRTS = K/L. = w/r = 18/36 = L = 2K. The firm’s optimal factor proportion (given technology and factor prices).

Cost Minimization in the Long-Run How much will it cost this firm to produce 10 units of output in the long-run? L = 2K Tangency between the isoquant and an isocost curve shows the economically efficient combination K*, L*. Hence, the condition for optimal factor proportion is: MRTS = w/r K K* Q = 10 L* L

Cost Minimization in the Long-Run How much will it cost this firm to produce 10 units of output in the long-run? L = 2K The condition for optimal factor proportion is: MRTS = w/r . This is LR condition! Why? Because some factors (K) are fixed in the SR. K K* Q = 10 L* L

Cost Minimization in the Long-Run How much will it cost this firm to produce Q units of output in the long-run? L = 2K Another way to think about this: TC is a projection of the firm’s long-run output expansion path: the locus of optimal factor bundles (K,L) for different levels of Q. K K* Q = 10 L* L

Cost Minimization in the Long-Run How much will it cost this firm to produce Q units of output in the long-run? TC(Q) = 18L + 36K = 9Q/(2)1/2 + 9Q/(2)1/2 = 18/(2)1/2(Q) = 12.73Q MC(Q) = 12.73 = AC(Q) K K* We can solve for the firm’s long run total cost function for any level of output. Q = 10

Cost Minimization Graphically: Q = 4K1/2L1/2 w = 18; r = 36 In the SR, K = 16 TCsr = 576 + 18(Q/16)2 $ TClr = 12.73Q At this point, 16 units of capital is optimal. MC = 12.73 Fixed Costs = rK = $576 Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) $ Consider a firm with long-run total costs TC. TC Q1 Q2 Q3 Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) $ To maximize profits, the firms finds Q where distance between TC and TR is greatest. the same slope. TR = PQ TC Q1 Q2 Q3 Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) $ To maximize profits, the firms finds Q where distance between TC and TR is greatest. same slope. TC TR = PQ Q1 Q2 Q3 Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) $ To maximize profits, the firms finds Q where distance between TC and TR is greatest. same slope. TC TR = PQ Q1 Q2 Q3 Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) $ To maximize profits, the firm finds Q where distance between TC and TR is greatest. This will be where they have the same slope.. slope. TR = PQ Pmax TC Q1 Q2 Q3 Q* Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) Marginal Analysis: If TC is rising faster than TR, reduce Q. If TR is rising faster than TC, increase Q. $ TR = PQ Pmax TC Q1 Q2 Q3 Q* Q

Profit Maximization Profit (P) = Total Revenue(TR) – Total Cost(TC) Marginal Analysis: Recall: slope TR = MR slope TC = MC Hence, to maximize profits: MR = MC $ TR = PQ Pmax TC Q1 Q2 Q3 Q* Q

Profit (P) = Total Revenue(TR) – Total Cost(TC) Profit Maximization The firm wants to maximize this difference: Profit (P) = Total Revenue(TR) – Total Cost(TC) TR(Q) = PQ TC(Q) = rK + wL P Price L Labor Q Quantity K Capital w Wage Rate r Rate on Capital Q = f(K,L) Revenue Cost

Profit Maximization Demand for the firm’s output is given by Q = 100 – 2P. Find the firm’s profit maximizing level of output. Q = 4K1/2L1/2 w = 18; r = 36 Q = 100 – 2P => P = 50 – 1/2Q TR = PQ = (50 – 1/2Q)Q = 50Q – 1/2 Q2 MR = 50 – Q = MC = 12.73 => Q* = 37.27; P* = 31.37

Profit Maximization Demand for the firm’s output is given by Q = 100 – 2P. Find the firm’s profit maximizing level of output. Q = 4K1/2L1/2 w = 18; r = 36 Q = 100 – 2P => P = 50 – 1/2Q TR = PQ = (50 – 1/2Q)Q P = TR – TC = 50Q – 1/2 Q2 – 12.73Q FOC: dP/dQ = 50 – Q – 12.73 = 0 => Q* = 37.27; P* = 31.37

Profit Maximization in the Long-Run We solved the firm’s optimization problem focusing on the profit output level, Q*, but it is important to emphasize that the optimization principle also tell us about input choices.   When the firm chooses an output level Q* that maximizes P for given factor prices (w, r), the firm has simultaneously solved for L* and K*. To produce Q* = 37.27 (given the production function, Q = 4K1/2L1/2, and optimal factor proportion, L = 2K), we find: L* = 6.58; K* = 3.29. Finally, P = TR–TC = PQ–12.73Q = (31.37–12.73)37.27 = $694.71. Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run We saw that the firm maximizes profit by choosing a level of output such that marginal revenue equals marginal cost MR = MC. In the long-run, this implies that the firm will be utilizing its optimal factor proportion, such that MRTS = w/r. In the short-run, however, K is fixed, so the firm will not be able to optimally adjust factor proportions. Does the firm maximize profits by setting MR = MC in the short-run? Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run We saw that the firm maximizes profit by choosing a level of output such that marginal revenue equals marginal cost MR = MC. In the long-run, this implies that the firm will be utilizing its optimal factor proportion, such that MRTS = w/r. In the short-run, however, K is fixed, so the firm will not be able to optimally adjust factor proportions. Does the firm maximize profits by setting MR = MC in the short-run? How? Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run We solved the firm’s optimization problem focusing on the output level, but it is important to emphasize that the optimization principle also tell us about input choices.   When the firm chooses an output level (Q*) that maximizes profit for given factor prices (w, r), the firm has simultaneously solved for L* and K*. In the short-run, the firm also maximizes P by setting MR = MC. But because K is fixed, the problem is simply one of optimal utilization of labor. In other words, the firm asks, “On the margin, can I increase my profit by adding (or subtracting) another unit of labor from the production process?” Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run Q = 4K1/2L1/2 w = 18; r = 36 K = 16 P = 10 MR = MC TR = PQ = 10Q TC = rK + wL = 36(16) + 18L [ Q = 16L½ => L = (Q/16)2 ] TC = 36(16) + 18(Q/16)2 = 576 + 18(Q/16)2 MR = 10 = MC = (36/256)Q => Q* = 71.1; L* = 19.8 Revenue Cost

Profit Maximization in the Short-Run In the short-run, the firm’s profit maximizing calculus weighs the benefit of hiring an additional unit of labor versus its cost. If the firm can add (subtract) another unit of labor and increase revenue by more than it increases cost, it should add (subtract) it, and it should keep on adding (subtracting) until MR = MC. Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run What does an additional unit of L contribute to P? First, hiring an additional unit of L increases the firm’s output (Q) By how much? MPL = dQ/dL. MRPL = dTR = P dQ dL dL = P (MPL) Marginal Revenue Product (MRP) The dollar amount added to revenue from an additional unit of labor (capital). For a Price-taker this can be rewritten as: Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run What does an additional unit of L contribute to P? But hiring an additional unit of L also increases the firm’s total costs. MFCL = w Marginal Factor Cost (MFC) The dollar amount added to total cost from an additional unit of labor (capital). Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy… NOTE (for fixed K): MC = dTC/dQ = w (dL/dQ) MC = w (1/MPl)

Profit Maximization in the Short-Run So the firm’s short-run optimality condition can be rewritten as: MRPL = MFCL If the firm can add (subtract) another unit of labor and increase revenue by more than it increases cost, it should add (subtract) it, and it should keep on adding (subtracting) until MRPL = MFCL. This, in turn, is what determines the firm’s (short-run) demand for labor: P (MPL) = w Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run Consider a price-taking firm that is currently producing 450 units of output at a price of $2.50 per unit. In the short run, the firm’s capital stock is fixed at 16 machine-hours. The firm is currently employing 100 hours of labor at a wage of $10/hour, and the at a rental rate (r) is $10/hour. With this mix of inputs MPK=2 and MPL= 4. Is the firm maximizing profits in the short run? Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run Is the firm maximizing profits in the short run? Yes. MRPL = P(MPL) = 2.50(4) = 10 = w = MFCL MR = P = $2.50; MC = w/MPL = $10/4 = $2.50 Does it matter that MPL/MPK = w/r (4/2 = 10/10) ? Does it matter that P = TR-TC = 1125 – 1160 = -35 ? Shut down rule: If P < AVC, Q = 0. The firm would lose at its fixed costs ($160) if it shut down, or $35 if it produces q = 450. Profit max = Loss min. What matters is variable costs, because fixed costs are spent (“sunk”) in the short run. Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Profit Maximization in the Short-Run Is the firm maximizing profits in the short run? Yes. MRPL = P(MPL) = 2.50(4) = 10 = w = MFCL MR = P = $2.50; MC = w/MPL = $10/4 = $2.50 Does it matter that MPL/MPK = w/r (4/2 = 10/10) ? Does it matter that P = TR-TC = 1125 – 1160 = -35 ? Shut down rule: If P < AVC, Q = 0. The firm would lose its fixed costs ($160) if it shut down, or $35 if it produces Q = 450. What matters is variable costs, because fixed costs are spent (“sunk”) in the short run. Profit max = Loss min. Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Supply in the Short-Run TC $ P = TR – TC = 0 PRICE TAKER P = MR TR At price Po, the firm earns 0 profit. Q MC AC P = MR Q* Q

Supply in the Short-Run TC $ P = TR – TC > 0 PRICE TAKER P = MR If the price rises … Output rises … Q MC AC P = MR Q Q

Supply in the Short-Run TC $ P = TR – TC > 0 PRICE TAKER P = MR If the price rises … And the firm earns profit Q MC AC P = MR Q Q

Supply in the Short-Run TC $ P = TR – TC < 0 PRICE TAKER P = MR If the price decreases… Output falls TR Q MC AC P = MR Q Q

Supply in the Short-Run TC $ P = TR – TC < 0 PRICE TAKER P = MR If the price decreases… And the firm has losses TR Q MC AC P = MR Q Q

Supply in the Short-Run TC $ P = TR – TC < 0 PRICE TAKER P = MR The firm will continue to produce (< Q*) iff P > AVC … Losses are less than fixed costs. TR Q MC AC AVC P = MR Q

Supply in the Short-Run TC $ P = TR – TC < 0 PRICE TAKER P = MR The firm’s short-run supply curve is in orange Where MR = MC and P > AVC. Q MC AC AVC Q

Supply in the Long-Run In the short run, firms adjust to price signals by varying their utilization of labor (variable factors). In the long-run, firms adjust to profit signals by varying plant size (fixed factors); and entering or exiting the market. What determines the number of firms in the long-run? Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Supply in the Long-Run Short-run equilibrium with three firms. Firm A is making positive profits, Firm B is making zero profits, and Firm C is making negative profits (losses). q: firm Q: market MC $ P MC MC AC AC AC q q q Firm A Firm B Firm C

Supply in the Long-Run Short-run equilibrium with three firms. Firm A is making positive profits, Firm B is making zero profits, and Firm C is making negative profits (losses). MC $ P MC MC AC AC AVC AC q q q Firm A Firm B Firm C

Supply in the Long-Run Short-run equilibrium with three firms. Firm A is making positive profits, Firm B is making zero profits, and Firm C is making negative profits (losses). In the long run, Firm C will exit the market. $ P MC MC AC AC q q q Firm A Firm B Firm C

Supply in the Long-Run In the long-run, inefficient firms will exit, and new firms will enter, as long as some firms are making positive economic profits. $ P MC MC MC AC AC AC q q q Firm A Firm B Firm D

Supply in the Long-Run In the long-run, if there are no barriers to entry, then new firms have access to the most efficient production technology. We call this the efficient scale. $ P* MC MC MC AC AC AC q* q q* q q* q Firm A Firm D Firm E

Supply in the Long-Run The long-run supply curve. P* is the lowest possible price associated with non-negative profits, P* = ACmin. s1=(mc1) $ P* s2 Sn, where n is the number of firms in the market. s3 s4 Q

Supply in the Long-Run The long-run supply curve. We can eliminate portions of the individual firms’ supply curves below P* (firms will exit). s1 $ P* s2 s3 s4 Q

Supply in the Long-Run The long-run supply curve. We can also eliminate portions of the individual firms’ supply curves above P* (demand will be met by another firm’s supply curve). s1 $ P* s2 s3 s4 Q

Supply in the Long-Run The long-run supply curve. As the number of firms increases, the long run supply curve approximates a straight line at P* = ACmin. $ ACmin = P* LRS Q

Supply in the Long-Run Long-run equilibrium. Firms are producing at the efficient scale. P* = ACmin; P = 0. $ P* $ MC AC a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. LRS D q* q Q* Q

Perfect Competition Perfect Competition Equilibrium and Efficiency General Equilibrium Welfare Analysis

Perfect Competition Profit (P) = Total Revenue(TR) – Total Cost(TC) Price-Taker P is given; can sell any amount at P. Later we will look at other possible assumptions, e.g., monopoly. $ TR = PQ To maximize profits, the firm finds Q where distance between TC and TR is greatest. This will be where they have the same slope: MR = MC. TC Pmax Q1 Q2 Q3 Q* Q

Perfect Competition Assumptions Firms are price-takers: can sell all the output they want at P*; can sell nothing at any price > P*. Homogenous product: e.g., wheat, t-shirts, long-distance phone minutes. Perfect factor mobility: in the long run, factors can move costlessly to where they are most productive (highest w, r). Perfect information: firms know everything about costs, consumer demand, other profitable opportunities, etc.

Perfect Competition Properties Firms earn zero (economic) profits. Price is equal to marginal cost. Firms produce at minimum average cost, i.e., “efficient scale.” Market outcome is Pareto-efficient. Later, we will consider the welfare implications

The Short-Run & the Long-Run Perfect Competition The Short-Run & the Long-Run In the short-run, firms adjust to price signals by varying their utilization of labor (variable factors). In the long-run, firms adjust to profit signals by varying plant size (fixed factors); and entering or exiting the market. We can use this info to solve for the long-run competitive equilibrium. P = 0 Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy… P = 0

Perfect Competition Consider a perfectly competitive industry characterized by the following total cost and demand functions:   TC = 100 + q2 QD = 1000 – 20P Find the market equilibrium in the long-run. How many firms are in the market? a) Find the equilibrium level of output, price and profits and draw a graph of your answer. What levels of consumer and total surplus would result?

Perfect Competition TC = 100 + q2 QD = 1000 – 20P 1) p = TR – TC = 0 = Pq – (100 + q2) = 0 p = (2q)q – (100 + q2) = 0 2q2 – 100 - q2 = 0 q2 = 100; q* = 10 $ MC = 2q $ 2) P = MC = 2q AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS q* = 10 q 600 Q

Perfect Competition TC = 100 + q2 QD = 1000 – 20P 1) p = TR – TC = 0 = Pq – (100 + q2) = 0 p = (2q)q – (100 + q2) = 0 2q2 – 100 - q2 = 0 q2 = 100; q* = 10 $ P* = 20 MC = 2q $ AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS q* = 10 q 600 Q

Perfect Competition TC = 100 + q2 QD = 1000 – 20P 3) Firms produce at ACmin i) AC = MC 100/q + q = 2q 100 + q2 = 2q2 q2 = 100; q* = 10 ii) AC’ = 0 -100/q2 + 1 = 0 $ P* = 20 MC = 2q $ AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS q* is the efficient scale q* = 10 q 600 Q

Perfect Competition TC = 100 + q2 QD = 1000 – 20P n = 60 $ $ MC = 2q AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS D q* = 10 q Q* = 600 Q n = 60

Perfect Competition TC = 100 + q2 QD = 1500 – 20P n = 60 $ $ MC = 2q AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS D’ D q* = 10 q Q* = 600 Q n = 60

Perfect Competition TC = 100 + q2 QD’ = 1500 – 20P q.n = (MC/2)n = (P/2)n => QS = ??? SRS $ P* = 20 MC = 2q $ AC = 100/q + q SRS P’= MR a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS D’ D q’ = 15 q Q’ = 900 Q n = 60

Perfect Competition TC = 100 + q2 QD’ = 1500 – 20P q.n = (MC/2)n = (P/2)n => QS = 30P SRS $ P* = 20 MC = 2q $ AC = 100/q + q SRS P’ = 30 a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS D’ D q’ = 15 q Q’ = 900 Q n = 60

Perfect Competition TC = 100 + q2 QD’ = 1500 – 20P n = 110 $ $ MC = 2q AC = 100/q + q a) We solve the problem in a similar manner as under perfect competition, but in monopoly, we know that price > MC. Start by finding the MR curve.   Q =180 - 6P fi P = 30 - (1/6)Q TR = 30Q - (1/6)q2 fi MR = 30 - (1/3)Q Since TC = 100 + 6q, MC = 6. Setting marginal revenue equal to marginal cost, we find that the monopolist’s profit-maximizing level of output is 72, resulting in a market price of 18. The monopolist’s revenue is equal to P x Q = 1296. It’s costs are equal to 532 (variable costs of 6 per unit, plus the fixed cost of 100). Profits are therefore equal to 764. AVC = q LRS D’ D q* = 10 q Q** = 1100 Q n = 110

The Short-Run & the Long-Run Perfect Competition The Short-Run & the Long-Run In the short-run, firms adjust to price signals by varying their utilization of labor (variable factors). In the long-run, firms adjust to profit signals by varying plant size (fixed factors); and entering or exiting the market. What determines the number of firms in long run equilibrium? Later we will look at situations in which a firm may have a strategy of entry deterrence as a long-run strategy…

Perfect Competition In the Long-Run … Firms earn zero (economic) profits. Price is equal to marginal cost. Firms produce at minimum average cost, i.e., “efficient scale.” Market outcome is Pareto-efficient.