Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes

in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Pure Competition
Copyright 2008 The McGraw-Hill Companies

Key Terms End Show 9-1

Pure Competition
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Characteristics of a Perfectly Competitive Market 1.Very Large Numbers 2.Homogeneous Product 3.Easy Entry and Exit Examples of Perfectly
Competitive Markets: Agriculture, Commodity Markets (Gold, Metals, Corn, wheat), The Stock Market

Key Terms End Show 9-2

Copyright 2008 The McGraw-Hill Companies

Perfectly Competitive Market

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Supply and Demand set the market price

Market Price Market for Wheat
Chicago Mercantile Exchange

40 30 20 15 10

Market Supply of Wheat

Market Demand for Wheat

Market Quantity Millions of Bushels of Wheat

1 2 3 4 5 6 7 8

Key Terms End Show 9-3

Buyers and Sellers are Price Takers in Perfectly Competitive Markets. Each buyer and seller is very small relative to the size of the market and therefore they have no influence over the market price.
Copyright 2008 The McGraw-Hill Companies

Profit Maximization in the Short Run

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

We assume the goal of the firm is to maximize profits

Profits =Total Revenue-Total Cost

Revenue = Price * Quantity

Total Cost discussed in preceding chapters.

Key Terms End Show 9-4

Copyright 2008 The McGraw-Hill Companies

Profit Maximization Profits = Revenues Total Costs

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Price = $20
Total Product (Output) (Q) Price Total Revenue =P*Q Total Cost (TC) Profit (+) or Loss (-)

0 20 40 60 80

20 20 20 20 20

0 400 800 1200 1600

$100 200 600 900 1400

$-100 200 200 300 200

Max Profits

Key Terms End Show 9-5

Profits are Revenues - Costs Revenues = Price * Quantity Market sets the price. The firm picks the quantity that maximizes profits Costs are determined by wages and the cost of capital.
Copyright 2008 The McGraw-Hill Companies

Profit Maximization
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

How do firms find the profit maximizing level of output?

Price = $20
Total Product (Output) (Q) Price Total Revenue =P*Q Total Cost (TC) Profit (+) or Loss (-)

0 20 40 60 80

20 20 20 20 20

0 400 800 1200 1600

$100 200 600 900 1400

$-100 200 200 300 200

Max Profits

Key Terms End Show 9-6

Firms dont have the ability to see revenues and costs for levels of output they are not producing. Marginal Analysis: If we increase or decrease output do profits go up or down?
Copyright 2008 The McGraw-Hill Companies

The Demand and Marginal Revenue Curves for a Perfectly Competitive firm
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Market sets the price. Firm can sell all they want at the market price Demand Curve for the firm is perfectly elastic at the market price. Marginal Revenue = Change Revenue/Change in Output = Market Price. Market Price = D = MR
Market for Wheat
Chicago Mercantile Exchange

Market Price

40 30

Market Supply of Wheat

Price

Farmer in Nebraska

40 30

20 15 10

Market Demand for Wheat

Market Quantity Millions of Bushels of Wheat

20 15 10

Market Price = D = MR

Key Terms End Show 9-7

1 2 3 4 5 6 7 8

20 40 60 80 100

Farmers Quantity of Wheat

Copyright 2008 The McGraw-Hill Companies

Profit Maximization
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Marginal Revenue-Marginal Cost Approach MR = MC Rule for maximizing profits

MC

Cost and Revenue

30

MR = MC
20

D = MR = P

10

Key Terms End Show 9-8

20

40

60

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

Profit Maximization
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Marginal Revenue-Marginal Cost Approach MR = MC Rule for maximizing profits

To Calculate Profits follow these steps:
Cost and Revenue
Step One: Find the output level where MR = MC. Q = 100. 30 Step Two: Calculate Revenues = Price * Quantity = 20 * 100 = $2,000

MC

ATC

20

D = MR = P

15
Step Three: Find the 10 ATC at the profit maximizing level of output. ATC = 15. Step Four: Calculate the Total Costs = ATC * Q = 15* 100 = $1,500. 20 40 60 Output where MR =MC 100

Key Terms End Show 9-9

Step Five: Calculate the Profits = Revenues Costs = $2000 $1500 = $500.

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

Profit Maximization
Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Marginal Revenue-Marginal Cost Approach MR = MC Rule for maximizing profits

To Calculate Profits follow these steps:
Cost and Revenue
Step One: Find the output level where MR = MC. Q = 100. 30

MC ATC

25
20
Step Two: Calculate Revenues = Price * Quantity = 20 * 100 = $2,000 Step Three: Find the 10 ATC at the profit maximizing level of output. ATC = 25. Step Four: Calculate the Total Costs = ATC * Q = 25* 100 = $2,500. 20 40 60 Output where MR =MC 100

D = MR = P

Key Terms End Show 9-10

Step Five: Calculate the Profits = Revenues Costs = $2000 $2500 = -$500.

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

Economics Versus Accounting Profits and Costs

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Accounting Profits = Revenues Explicit Costs Economic Profits = Revenues Explicit Cost Implicit Costs Economic Profit

Accounting - Implicit Cost Profit

Key Terms End Show 9-11

Graphs show economic profits. Cost include implicit cost.

Copyright 2008 The McGraw-Hill Companies

Stay or Exit industry in the Long Run

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Exit the industry in the long run if

Economic Profits < 0 Revenue Economic Cost < 0 P * Q ATC * Q < 0 (P ATC) * Q < 0 P < ATC

Key Terms End Show 9-12

Copyright 2008 The McGraw-Hill Companies

Shut down in the Short Run

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Key Terms End Show 9-13

Costs = $2500 Revenues = $2000 Losses = $500 Should the firm shut down in the short run? Suppose Fixed costs = $1000 and Variable Costs = $1500. Firm will lose $1000 if they shut down, instead of $500. Revenues Variable Cost = $2000 $1500 = $500. The firm can use the $500 to pay some fixed costs.

Copyright 2008 The McGraw-Hill Companies

Shut Down Points

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Exit the industry in the short run if

P < AVC

Stay open in the short run if

P > AVC

Key Terms End Show 9-14

Stay open if Revenues Variable Costs > 0 P * Q > AVC * Q P > AVC
Copyright 2008 The McGraw-Hill Companies

Market Sets the Price for Wheat Farmer takes the price as given and produces where MC= MR
Four Market Models Economic Profits = (P-ATC) * Q Pure Competition Profit = (20-11)*120 = 1080. Maximization in the Short-Run Marginal Cost Economic Profits = Accounting and Short-Run Profits Implicit Costs. Supply Changes in 30 Implicit Costs are the accounting Supply profits the firm could make Profit Maximization in elsewhere. This firm is making the Long Run $1080 more in account profits Supply 20 Readjustment then firms elsewhere = > Entry. Pure Competition and Efficiency Entry cause price to 15 Long-Run fall to $15. But profits Equilibrium Last Word are still positive (P10

Market Price 40 30 20 15 10

Market for Wheat

Market Supply of Wheat

Long Run Equilibrium for a Perfectly Competitive Firm

Market Demand for Wheat

1 2 3 4 5 6 7 8

Market Quantity Millions of Bushels of Wheat

MC

Cost and Revenue

D = MR = P ATC

ATC)*Q = $500 Entry occurs Key Terms until P=ATC and Profits are maximized End Show MR = MC
9-15

20

40

60

80

100

120

140

160

180 200

Output

Copyright 2008 The McGraw-Hill Companies

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Long Run Equilibrium for a Perfectly Competitive Firm Zero economic profits
MC

Cost and Revenue

30

20

ATC

15
10

D = MR = P

Key Terms End Show 9-16

20

40

60

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

Four Market Models Pure Competition Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

Key Terms End Show 9-17

Pure Competition Long Run Supply Curve

Copyright 2008 The McGraw-Hill Companies

Market Price

Market for Wheat

Market Supply of Wheat Market Supply of Wheat

Constant Cost industry. As an industry Four Market Models grows (demand Pure Competition increases) if Profit Maximization in the costs stay the Short-Run the same Marginal Cost then and Short-Run it is a constant Supply cost in Changesindustry. Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

20

10 Demand for Wheat Demand for Wheat Market Quantity 8 Millions of Bushels of Wheat

1 2 3 4 5 6 7

MC

Cost and Revenue

30

20

Demand shifts down and profits go back to zero

D = MR = P ATC D = MR = P

10

Key Terms End Show 9-18

20

40

60

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

As demand grows profits initially rise.

Four Market But Modelsthe increase Pure profits causes in Competition Profit entry. Maximization in the Short-Run Marginal Cost Supply Curve and Short-Run Supply out. shifts Changes in Supply Profit Long Run Supply Maximization in Curve is the Long Runthe Supply Supply Curve Readjustment that connects Pure Competition the and Efficiency LR equilibrium Long-Run Equilibrium points on the Last Word

Long Run Supply Curve is Horizontal in a Constant Cost Industry

Market Price

Market for Wheat

Short Run Equilibrium

20

Market Supply of Wheat

Market Supply of Wheat

10

Long Run Equilibrium

Long Run Supply Curve

Long Run Equilibrium

Demand for Wheat

Demand for Wheat

Demand for Wheat Market Quantity Millions of Bushels of Wheat

market supply and demand.

Key Terms End Show 9-19

Copyright 2008 The McGraw-Hill Companies

Market Price 20

Market for Wheat

S S1

Cost increase Four Market as industry Models grows Pure Competition

Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

10 D1 D

1 2 3 4 5 6 7 8

Market Quantity Millions of Bushels of Wheat

MC1 MC

Cost and Revenue

30

ATC1
20 15 10

P=20 P =15 ATC P =10

Key Terms End Show 9-20

20

40

60

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

As demand grows profits initially rise.

Four Market But Modelsthe increase Pure profits causes in Competition Profit entry. Maximization in the Short-Run Marginal Cost Supply Curve and Short-Run Supply out. shifts Changes in Supply Profit Long Run Supply Maximization in Curve is the Long Runthe Supply Supply Curve Readjustment that connects Pure Competition the and Efficiency LR equilibrium Long-Run Equilibrium points on the Last Word

Long Run Supply Curve Increasing Cost Industry

Market Price

Market for Wheat

Short Run Equilibrium

20 15 10

Market Supply of Wheat Market Supply of Wheat

Long Run Supply Curve Increasing Cost Industry

Long Run Equilibrium Long Run Equilibrium

Demand for Wheat

Demand for Wheat

market supply and demand.

Market Quantity Millions of Bushels of Wheat

Key Terms End Show 9-21

Copyright 2008 The McGraw-Hill Companies

Market Price 20

Market for Wheat

S1

Cost Decrease Four Market as industry Models grows Pure Competition

Profit Maximization in the Short-Run Marginal Cost and Short-Run Supply Changes in Supply Profit Maximization in the Long Run Supply Readjustment Pure Competition and Efficiency Long-Run Equilibrium Last Word

10 7 D D1 Market Quantity Millions of Bushels of Wheat

1 2 3 4 5 6 7 8

MC MC1

Cost and Revenue

30

20

P=20 ATC ATC1 P =10

10 7

P=7

Key Terms End Show 9-22

20

40

60

80

100

120

140

160

180 200

Output
Copyright 2008 The McGraw-Hill Companies

As demand grows profits initially rise.

Four Market But Modelsthe increase Pure profits causes in Competition Profit entry. Maximization in the Short-Run Marginal Cost Supply Curve and Short-Run Supply out. shifts Changes in Supply Profit Long Run Supply Maximization in Curve is the Long Runthe Supply Supply Curve Readjustment that connects Pure Competition the and Efficiency LR equilibrium Long-Run Equilibrium points on the Last Word

Long Run Supply Curve Decreasing Cost Industry

Market Price

Market for Wheat

Short Run Equilibrium

20 15

Market Supply of Wheat

Long Run Equilibrium Long Run Equilibrium

Market Supply of Wheat

10 7

Long Run Supply Curve Decreasing Cost Industry

Demand for Wheat

Demand for Wheat

market supply and demand.

Market Quantity Millions of Bushels of Wheat

Key Terms End Show 9-23

Copyright 2008 The McGraw-Hill Companies