UNIT 6. Pricing under different market structures. Perfect Competition


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1 UNIT 6 ricing under different market structures erfect Competition
2 Market Structure erfect Competition ure Monopoly Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.
3 erfect Competition Firms are pricetakers 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 3
4 Demand for a Competitive rice Taker Demand curve is horizontal at price determined by intersection of market demand & supply erfectly 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 4
5 Demand for a Competitive ricetaking Firm S rice (dollars) 0 rice (dollars) 0 D = MR 0 0 Q 0 D Quantity anel A Market Quantity anel B Demand curve facing a pricetaker 5
6 ShortRun Market Supply and Demand Graph Market Firm Market Supply MC ATC ATC rofits = D = MR Market Demand Q Q profit max Q 146
7 rofitmaximization in the Short Run In the short run, managers must make two decisions: 1. roduce or shut down? If shut down, produce no output and hire no variable inputs If shut down, firm loses amount equal to TFC 2. If produce, what is the optimal output level? If firm does produce, then how much? roduce amount that maximizes economic profit rofit = π = TR TC 7
8 Determining rofits Graphically: A Firm with rofit ATC MC = MR rofits MC ATC AVC = D = MR Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects ATC ATC at Q profit max Q profit max Q Since >ATC at the profit maximizing quantity, this firm is earning profits 148
9 Determining rofits Graphically: A Firm with Losses MC Find output where MC = MR, this is the profit maximizing Q ATC ATC at Q profit max Losses Q profit max MC = MR ATC AVC = D = MR Q Find profit per unit where the profit max Q intersects ATC Since <ATC at the profit maximizing quantity, this firm is earning losses 149
10 Determining rofits Graphically: A Firm with Zero rofit or Losses Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects ATC Since =ATC at the profit maximizing quantity, this firm is earning zero profit or loss =ATC MC = MR Q profit max MC ATC AVC ATC at Q profit max = D = MR Q 1410
11 Determining rofits Graphically: The Shutdown Decision The shutdown point is the point below which the firm will be better off if it shuts down than it will if it stays in business MC ATC If >min of AVC, then the firm will still produce, but earn a loss AVC If <min of AVC, the firm will shut down If a firm shuts down, it still has to pay its fixed costs Shut down Q profit max = D = MR Q 1411
12 ShortRun Output Decision Firm s manager will produce output where = MC as long as: TR TVC or, equivalently, AVC If price is less than average variable cost ( < AVC), manager will shut down roduce zero output Lose only total fixed costs Shutdown price is minimum AVC 12
13 Irrelevance of Fixed Costs Fixed costs are irrelevant in the production decision Level of fixed cost has no effect on marginal cost or minimum average variable cost Thus no effect on optimal level of output 13
14 The Competitive Firm s Short run Supply ortion of MC curve above AVCmin MC curve gives the relationship between and Qs MC ATC AVC Shut down = D = MR Q profit max Q 1414
15 Determinants of Market Supply The number of firms in the industry The average size of firms in the industry measured by quantity of fixed inputs employed The price of variable inputs used by firms in the industry The technology employed in the industry. 15
16 Summary of ShortRun Output Decision AVC tells whether to produce Shut down if price falls below minimum AVC SMC tells how much to produce If minimum AVC, produce output at which = SMC ATC tells how much profit/loss if produce π = ( ATC )Q 16
17 rofit & Loss at Beau Apparel 17
18 rofit & Loss at Beau Apparel 18
19 LongRun Competitive Equilibrium All firms are in profitmaximizing equilibrium ( = LMC) Occurs because of entry/exit of firms in/out of industry Market adjusts so = LMC = LAC 19
20 LongRun Competitive Equilibrium Market adjusts so = LMC = LAC LMC Since =LAC at the profit maximizing quantity, this firm is earning zero profit =LAC MC = MR LAC ATC at Q profit max = D = MR Q profit max Q 1420
21 Class Exercise 1. The marginal cost of a firm under perfect competition is given by the equation MC = Q F. The market price is $50 per unit. Determine the firm s profitmaximizing level of output. 2. For a perfectly competitive firm, longrun average cost is: LAC = Q F +.5Q F2., where Q F denotes the firm s output. Determine the firm s longrun profitmaximizing output and price. 21
22 Class Exercise Solved 1. The The firm maximizes its profit by setting: = MC. Therefore, we have 50 = Q F, or Q F = 15. The firm s supply curve is derived as follows: = Q F. 2. In the long run, under perfect competition, firms will produce at the minimum point on their LAC curve. To find the minimum of LAC, we set dlac/dq equal to 0. Therefore, Q F = 0, so that Q F = 20. The firm s demand curve is horizontal and tangent to LAC. Therefore, price is equal to the minimum value of LAC. We find minimum LAC to be: (20)(20) +.5(20) = 100. Thus, C =
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