2 Market Structure Firms are assumed to maximize economic profits Economic Profit = Revenue – Total Opportunity CostsCosts are dependent on technology and input pricesRevenue is dependent upon the market structure in which a firm operatesTherefore, the profit maximization decision must be analyzed by market structure
4 Quick OverviewMarginal benefits from a firms perspective are marginal revenue from selling outputMarginal revenue equal the extra revenue from selling another unit of outputAssuming the firm produces (does not shutdown), the firm will maximize profit (or minimize losses) where MR=MC
5 Marginal Revenue and Market Structure Competitive markets – sellers are price takers so MR = Market PriceMonopoly – the seller is a price maker and faces the entire market demand curve so MR < PriceOligopoly – the seller directly competes with a few firms so MR depends on the actions of competitorsMonopolistic Competition – sellers possess some market power and can set their own prices in the short-run, so MR<P
6 Competitive Markets or Pure Competition Assumptions revisitedMany buyers and sellersEach buyer and seller is a price takerHomogenous or identical productsCompetition is based only on the pricePerfect information or knowledgeAll firms have access to the same technologyCompetition is based upon priceFirms can freely enter or exitProfits will be eliminated in the long-run
7 Revenue in Competitive Markets The market demand and supply curves determine the equilibrium price and quantity and the price that buyers will pay and sellers receiveAs with producer surplus, sellers are price takers and the price they receive is their MR. The marginal revenue and the price remain the same no matter how much output is sold.
9 Competitive Firm in the Short-run Short-run – at least one fixed factor = fixed costs. Assume the plant size is fixed.Set MR=MC to find profit maximizing level of output. Use the average cost curves to determine whether oneOperates and earn profitsOperate and breakevenOperates and make lossesShutdowns and minimize losses
15 Short-run SupplyIndividual Firm: The short-run supply curve is MC curve above minimum AVC.Market: The short-run supply curve is the horizontal sum of all of the individual firm’s MC curves above the minimum AVC.
18 Price Determination in the Short-run Fixed plant sizes implies a fixed number of firms.Market supply and demand curve determine the price and the profit loss situations of existing firms.If demand increase, firms increase the quantity supplied by utilizing increasing capacity.The law of diminishing returns implies that supply is upward sloping at that prices will rise.
19 Long-run Supply and Price Determination Long-run – all factors are variable = no fixed costs and plant size can be changed, ALSO firms can enter and exitIf economic profits are positive, new firms will enter.If economic profits are negative, existing firms will exit.Long-run equilibrium:Firms must chose the plant that minimizes LRATC or they will suffer losses.Economic profits are reduced to zero.
23 Long-run Supply CurveConstant cost industries – horizontal or perfectly elastic supplyIncreasing cost industries – upward sloping supplySome resource may be available in limited quantities (farm land)Some resources may increase in cost or be less productive (skilled labor)Decreasing cost industries – downward sloping supplyIncreased output may stimulate increased productivity or technological change (computers)
24 Competitive Markets: Short-run and Long-run Short-run supply response to changes in demand are to increase or decrease the use of existing capacity.Long-run supply response is to build efficient plant size and increase or decrease capacity.In both the short-run and long-run, the profit maximizing behavior of firms leads to supply responses to accommodate changes in demand.In the short-run, prices act as signals and, in the long-run,prices and profits act as signals to increase or decrease output.
25 Efficiency RevisitedMaximize human satisfaction from resources = maximize total surplus = maximize consumer surplus + producer surplus.Two conditions:Produce what is most highly valued and the amount that maximizes total surplusProduce it at the least possible cost.
26 In the absence of market failures, competitive markets are efficient in both the short-run and the long-run:Supply responds to what consumers demandGoods are produced at least possible costPrice and profits are extremely important as signals for the allocation of scarce resources.Examples of when prices and profits no longer act as signal are rent controls and price supports