Competition Chapter 8

Recall: Producer Decision-making Optimal behavior: choose the right input combination or right production level Goal: –Max production at given cost –Min cost for given output level  Max profit profit = TR – TC TR = P Q P: determined by market

Market Structures Perfect competition Imperfect competition Imperfect Monopolistic competition Oligopoly Monopoly

Goal: Maximize Profit  = TR – TC Recall: –TC = TFC + TVC = wL + rK –ATC = TC / Q –MC = Δ(TC)/ΔQ

Total Revenue: TR TR = PQ AR = PQ/Q = P MR = Δ(PQ)/ΔQ = (ΔP*Q)/ΔQ + (P*ΔQ)/ΔQ = (ΔP /ΔQ ) Q + P(ΔQ/ΔQ )

Profit-Maximizing Output Decision rule:  is maximized when MR = MC profit is maximized at the quantity of output where the marginal revenue of the last unit produced is equal to its marginal cost.

under perfect competition ΔP=0  MR =P Decision rule:  is maximized when P=MC

Perfect Competition Perfectly competitive market: all participants are price takers Perfectly competitive industry: all producers are price-takers Price taker: whose action has no effect on market price Price-taking producer: market price does not change because of the quantity he sells. Price-taking consumer: market price does not change because of the amount he buys.

Perfect Competition: Characteristics Many buyers and sellers and each is so small that no one can affect price individually (for sellers, no one has large market share) All firms produce a homogeneous product (identical / standardized) at least consumers think so Free entry and exit each firm has complete knowledge about production and cost

Short-Run optimal output level Goal: maximize profit Demand facing the industry: downward sloping Demand facing the firm: horizontal (all are price takers, and no one is large enough to affect market price) Optimal output level determined by D=P=MC

Short-Run optimal output level: various profit situations Rule: produce at P=MC. Positive Economic Profit: when D=MR=P>ATC at P=MC Operating at a loss: when AVC<D=MR=P<ATC at P=MC Shut Down: when D=MR=P<AVC at P=MC The break-even price: the market price at which the firm earns zero profits (P=ATC).

Costs and Production in the Short-Run

Principles: MC tells how much to produce (produce up to the amount where P=MC) ATC tells how much profit or loss is made if the firm decides to produce (profit = (P - ATC) * Q). AVC tells whether to keep producing (keep producing only when P>AVC at P=MC)

Summary (P. 220, Table 9-4)

Profitability and Market Price

The Short-Run Production Decision A firm will cease production in the short-run if the market price falls below the shut-down price, which is equal to minimum average variable cost.