Chapter 11 - Managerial decisions in competitive markets. In this chapter you will: Discuss three characteristics of perfectly competitive markets; apply the basic principles of marginal analysis to determine either (1) the profitmaximizing (or loss-minimizing) level of output, or (2) the profit-maximizing (or loss-minimizing) level of input usage; Explain why the demand curve facing an individual firm in a perfectly competitive industry is perfectly elastic, and why this demand curve is also the marginal revenue curve for a competitive firm;...
Managerial Economics ninth edition Thomas Maurice Chapter 11 Managerial Decisions in Competitive Markets McGrawHill/Irwin McGrawHill/Irwin Managerial Economics, 9e Managerial Economics, 9e Copyright © 2008 by the McGrawHill Companies, Inc. All rights reserved Managerial Economics Perfect Competition • Firms are price-takers • Each produces only a very small portion of total market or industry output • All firms produce a homogeneous product • Entry into & exit from the market is unrestricted 112 Managerial Economics Demand for a Competitive Price-Taker • Demand curve is horizontal at price determined by intersection of market demand & supply • Perfectly elastic • Marginal revenue equals price • Demand curve is also marginal revenue curve (D = MR) • Can sell all they want at the market price • Each additional unit of sales adds to total revenue an amount equal to price 113 Managerial Economics Demand for a Competitive Price-Taking Firm (Figure 11.2) S P0 D Q0 Quantity 114 Pane l A – Marke t ) sr all od( eci r P ) sr all od( eci r P P0 D = MR Quantity Pane l B – De mand c urve fac ing a pric e take r Managerial Economics Profit-Maximization in the Short Run • In the short run, managers must make two decisions: Produce or shut down? If produce, what is the optimal output level? 115 If shut down, produce no output and hires no variable inputs If shut down, firm loses amount equal to TFC If firm does produce, then how much? Produce amount that maximizes economic profit Profit = TR TC Managerial Economics Profit Margin (or Average Profit) Average profit (P Q P ATC ATC )Q Q Profit margin • Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) • Managers should ignore profit margin (average profit) when making optimal decisions 116 Managerial Economics Short-Run Output Decision • Firm’s manager will produce output where P = MC as long as: • TR TVC • or, equivalently, P AVC • If price is less than average variable cost (P AVC), manager will shut down 117 • Produce zero output • Lose only total fixed costs • Shutdown price is minimum AVC Managerial Economics Profit Maximization: P = $36 (Figure 11.3) Total revenue =$36 x 600 Pro fit = $21,600 $11,400 =$21,600 = $10,200 Total cost =$19 x 600 =$11,400 118 Managerial Economics Profit Maximization: P = $36 (Figure 11.4) Pane l A: To tal re ve nue & to tal c o s t Pane l B: Pro fit c urve whe n P = $36 119 Managerial Economics Short-Run Loss Minimization: P = $10.50 (Figure 11.5) Pro fit = $3,150 $5,100 Total cost = $17 x 300 == $1,950 $5,100 Total revenue = $10.50 x 300 = $3,150 11 Managerial Economics Long-Run Industry Supply • Constant cost industry • As industry output expands, input prices remain constant, & minimum LAC is unchanged • P = minimum LAC, so curve is horizontal (perfectly elastic) • Increasing cost industry • As industry output expands, input prices rise, & minimum LAC rises • Longrun supply price rises & curve is upward sloping 11 Managerial Economics Long-Run Industry Supply for a Constant Cost Industry (Figure 11.9) 11 Managerial Economics Long-Run Industry Supply for an Increasing Cost Industry (Figure 11.10) Firm’s o utput 11 Managerial Economics Economic Rent • Payment to the owner of a scarce, superior resource in excess of the resource’s opportunity cost • In long-run competitive equilibrium firms that employ such resources earn zero economic profit • Potential economic profit is paid to the resource as economic rent • In increasing cost industries, all longrun producer surplus is paid to resource suppliers as economic rent 11 Managerial Economics Economic Rent in Long-Run Competitive Equilibrium (Figure 11.11) 11 Managerial Economics Profit-Maximizing Input Usage • Profit-maximizing level of input usage produces exactly that level of output that maximizes profit 11 Managerial Economics Profit-Maximizing Input Usage • Marginal revenue product (MRP) • MRP of an additional unit of a variable input is the additional revenue from hiring one more unit of the input MRP TR L P MP • If choose to produce: • If the MRP of an additional unit of input is greater than the price of input, that unit should be hired • Employ amount of input where MRP = input price 11 Managerial Economics Profit-Maximizing Input Usage • Average revenue product (ARP) • Average revenue per worker ARP TR L P AP • Shut down in short run if ARP