chapter 8 profit maximization and competitive supply

Chapter Profit Maximization and Competitive Supply Topics to be Discussed  Perfectly Competitive Markets  Profit Maximization  Marginal Revenue, Marginal Cost, and Profit Maximization  Choosing Output in the Short-Run Chapter Slide Topics to be Discussed  The Competitive Firm’s Short-Run Supply Curve  Short-Run Market Supply  Choosing Output in the Long-Run  The Industry’s Long-Run Supply Curve Chapter Slide Perfectly Competitive Markets  Characteristics of Perfectly Competitive Markets 1) Price taking 2) Product homogeneity 3) Free entry and exit Chapter Slide Perfectly Competitive Markets  Price Taking  The individual firm sells a very small share of the total market output and, therefore, cannot influence market price.  The individual consumer buys too small a share of industry output to have any impact on market price. Chapter Slide Perfectly Competitive Markets  Product Homogeneity  The products of all firms are perfect substitutes.  Examples  Agricultural products, oil, copper, iron, lumber Chapter Slide Perfectly Competitive Markets  Free Entry and Exit  Buyers can easily switch from one supplier to another.  Suppliers can easily enter or exit a market. Chapter Slide Profit Maximization  Do firms maximize profits?  Possibility of other objectives  Revenue maximization  Dividend maximization Chapter Slide Profit Maximization  Do firms maximize profits?  Implications of non-profit objective  Over the long-run investors would not support the company  Without profits, survival unlikely  Long-run profit maximization is valid and does not exclude the possibility of altruistic behavior. Chapter Slide Marginal Revenue, Marginal Cost, and Profit Maximization  Determining the profit maximizing level of output  Profit ( π ) = Total Revenue - Total Cost  Total Revenue (R) = Pq  Total Cost (C) = Cq  Therefore: π (q ) = R(q) − C (q) Chapter Slide Long-Run Competitive Equilibrium •Profit attracts firms •Supply increases until profit = $ per unit of output $ per unit of output Firm Industry S1 LMC $40 LAC $30 P1 S2 P2 D q2 Output Q1 Q2 Output Choosing Output in the Long Run  Long-Run Competitive Equilibrium 1) MC = MR 2) P = LAC  No incentive to leave or enter  Profit = 3) Equilibrium Market Price Chapter Slide Long-Run Supply in a Constant-Cost Industry $ per unit of output Economic profits attract new firms. Supply increases to S2 and the market returns to long-run equilibrium. MC AC $ per unit of output P2 Q1 increase to Q2. Long-run supply = SL = LRAC. Change in output has no impact on input cost. S1 S2 C P2 A P1 B SL P1 D1 q1 q2 Output Q1 Q2 D2 Output Long-Run Supply in a Constant-Cost Industry  In a constant-cost industry, long-run supply is a horizontal line Chapter Slide Long-Run Supply in an Increasing-Cost Industry $ per unit of output MC2 AC2 $ per unit of output Due to the increase in input prices, long-run equilibrium occurs at a higher price. S1 S2 SL MC1 P2 AC1 P2 P3 P3 P1 P1 B A D1 q1 q Output Q1 Q2 Q3 D2 Output Long-Run Supply in a Increasing-Cost Industry  In a increasing-cost industry, long-run supply curve is upward sloping. Chapter Slide Long-Run Supply in an Decreasing-Cost Industry $ per unit of output Due to the decrease in input prices, long-run equilibrium occurs at a lower price. $ per unit of output MC1 MC2 S1 S2 AC1 P2 P2 AC2 P1 P1 P3 P3 A B SL D1 q1 q2 Output Q1 Q2 Q3 D2 Output Long-Run Supply in a Increasing-Cost Industry  In a decreasing-cost industry, long-run supply curve is downward sloping. Chapter Slide The Industry’s Long-Run Supply Curve  The Effects of a Tax  In an earlier chapter we studied how firms respond to taxes on an input.  Now, we will consider how a firm responds to a tax on its output. Chapter Slide Effect of an Output Tax on a Competitive Firm’s Output Price ($ per unit of output) MC2 = MC1 + tax An output tax raises the firm’s marginal cost by the amount of the tax. MC1 The firm will reduce output to the point at which the marginal cost plus the tax equals the price. t P1 AVC2 AVC1 q2 Chapter q1 Output Slide Effect of an Output Tax on Industry Output Price ($ per unit of output) S2 = S + t S1 t P2 Tax shifts S1 to S2 and output falls to Q2. Price increases to P2. P1 D Q2 Chapter Q1 Output Slide Summary  The managers of firms can operate in accordance with a complex set of objectives and under various constraints.  A competitive market makes its output choice under the assumption that the demand for its own output is horizontal. Chapter Slide Summary  In the short run, a competitive firm maximizes its profit by choosing an output at which price is equal to (shortrun) marginal cost.  The short-run market supply curve is the horizontal summation of the supply curves of the firms in an industry. Chapter Slide Summary  The producer surplus for a firm is the difference between revenue of a firm and the minimum cost that would be necessary to produce the profitmaximizing output. Chapter Slide Summary  In the long-run, profit-maximizing competitive firms choose the output at which price is equal to long-run marginal cost.  The long-run supply curve for a firm can be horizontal, upward sloping, or downward sloping. Chapter Slide End of Chapter [...]... Marginal Cost, and Profit Maximization  Comparing R(q) and C(q)  Output levels beyond q*:   MC > MR Cost, Revenue, Profit $ (per year) C(q) R(q) A Profit is decreasing B 0 q0 q* π (q) Output (units per year) Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization ∆R MR = ∆q π = R-C ∆C MC = ∆q Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization Profits are maximized... Marginal Cost, and Profit Maximization  The Competitive Firm  The competitive firm’s demand  Individual producer sells all units for $4 regardless of the producer’s level of output  If the producer tries to raise price, sales are zero Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  The Competitive Firm  AR = MR = P  Profit  Maximization MC(q) = MR = P Chapter 8 Slide Choosing... production and cost analysis with demand to determine output and profitability Chapter 8 Slide A Competitive Firm Making a Positive Profit MC Price 60 ($ per unit) 50 40 Lost profit for q 1 < q* A D Lost profit for q 2 > q* ATC C B 30 AVC At q*: MR = MC and P > ATC π = (P - ATC) x q* q1 : MR > MC and 20 q2: MC > MR and q*: MC = MR but MC falling 10 0 AR=MR=P or ABCD 1 q0 2 3 4 5 6 Chapter 8 7 8 9 q1 q... higher profit at higher output B 0 q0 q* π (q) Output (units per year) Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  Comparing R(q) and C(q)  Question: Why is profit negative when output is zero? Cost, Revenue, Profit $ (per year) C(q) R(q) A B 0 q0 q* π (q ) Output (units per year) Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  Comparing R(q) and. .. : ∆π ∆R ∆C = − = 0 or ∆q ∆q ∆q MR − MC = 0 so that MR(q) = MC(q) Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  The Competitive Firm  Price taker  Market output (Q) and firm output (q)  Market demand (D) and firm demand (d)  R(q) is a straight line Chapter 8 Slide Demand and Marginal Revenue Faced by a Competitive Firm Price $ per bushel Price $ per bushel Firm $4 d... Revenue, Profit $ (per year) C(q) MR > MC   R(q) A Indicates higher profit at higher output Profit is increasing B 0 q0 q* π (q) Output (units per year) Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  Comparing R(q) and C(q)  Output level: q*   MR = MC Cost, Revenue, Profit $ (per year) C(q) R(q) A Profit is maximized B 0 q0 q* π (q) Output (units per year) Chapter 8 Slide... Marginal Cost, and Profit Maximization  Marginal revenue is the additional revenue from producing one more unit of output  Marginal cost is the additional cost from producing one more unit of output Chapter 8 Slide Marginal Revenue, Marginal Cost, and Profit Maximization  Comparing R(q) and C(q)  Output levels: 0- q0:  C(q)> R(q)  Cost, Revenue, Profit ($s per year) C(q) Negative profit  FC +... = P2, then q = q2 Chapter 8 Slide A Competitive Firm’s Short-Run Supply Curve Price ($ per unit) S = MC above AVC MC P2 ATC P1 AVC P = AVC Shut-down q1 Chapter 8 q2 Output Slide A Competitive Firm’s Short-Run Supply Curve  Observations:  Supply is upward sloping due to diminishing returns  Higher price compensates the firm for higher cost of additional output and increases total profit because it... reducing output Input cost increases and MC shifts to MC2 and q falls to q2 MC1 $5 q2 Chapter 8 q1 Output Slide Industry Supply in the Short Run MC1 MC2 $ per unit MC3 The short-run industry supply curve is the horizontal summation of the supply curves of the firms P3 P2 P1 0 2 4 5 7 8 10 Chapter 8 15 Quantity 21 Slide S The Short-Run Market Supply Curve  Producer Surplus in the Short Run  Firms earn... firm should shutdown Chapter 8 Slide A Competitive Firm’s Short-Run Supply Curve Price ($ per unit) The firm chooses the output level where MR = MC, as long as the firm is able to cover its variable cost of production MC P2 ATC P1 AVC What happens if P < AVC? P = AVC q1 Chapter 8 q2 Output Slide A Competitive Firm’s Short-Run Supply Curve  Observations: P = MR  MR P  = MC = MC Supply is the amount . Chapter 8 Profit Maximization and Competitive Supply Chapter 8 Slide 2 Topics to be Discussed  Perfectly Competitive Markets  Profit Maximization  Marginal Revenue, Marginal Cost, and Profit. Cost, and Profit Maximization Chapter 8 Slide 16  Comparing R(q) and C(q)  Output levels beyond q * :  MC > MR  Profit is decreasing Marginal Revenue, Marginal Cost, and Profit Maximization R(q) 0 Cost, Revenue, Profit $. (Q) and firm output (q)  Market demand (D) and firm demand (d)  R(q) is a straight line Marginal Revenue, Marginal Cost, and Profit Maximization Demand and Marginal Revenue Faced by a Competitive