ECO101H1 Lecture Notes - Marginal Revenue, Perfect Competition, Demand Curve

47 views6 pages
user avatar
Published on 16 Oct 2011
School
UTSG
Department
Economics
Course
ECO101H1
Professor
Page:
of 6
Topic 8 Perfect Competition
(Week eight Nov 1st - Nov 10th)
Outline:
1. Definition;
2. Total Revenue, Marginal Revenue, and Average Revenue;
3. Profit Maximizing Output
-- MC = MR = P;
-- Firms MC curve = Firms SS curve (if P > AVC);
-- Shut down point;
4. Level of Profits;
5. Entry and exit;
6. Short-Run and Long-Run Impact of a shift in Demand;
7. Long-Run market supply curve;
Definition
Perfect Competition:
-- Many buyers and sellers of identical product (so action of each buyer or seller exerts no impact on the
market price);
-- Freedom of entry and exit of firms (no barrier to entry/exit)
Key Implication:
-- Each firm is a price taker, meaning each firm faces an infinitely elastic demand curve at the market price;
--- In the short run, the number of firms is fixed;
In the long run, the number of firms can vary.
Individual Firm Market
TR/AR/MR for perfectly competitive firm
TR
Total Revenue
Q X P
AR
Average Revenue
TR / Q (price)
MR
Marginal Revenue
(the revenue of producing an additional unit of output)
TR/Q
(is price, since the firm faces perfectly
elastic demand)
MR = P for perfectly competitive firm.
Quantity
Price
PPrice
ee
Quantity
Price
PPrice
ee
SS
DD
market price
Notation:
DD/SS market demand/supply
dd/ss Individual firms demand/
supply.
Profit-Maximizing Output
-- At what level of output should a firm choose to produce to maximize profit?
Individual Firm
Perfectly competitive firm produces at the profit-maximizing level where MR = MC.
-- Firms supply curve and MC curve
Firm
Therefore, the supply curve of a perfectly competitive firm is its MC curve, and it reflects the
profit-maximizing rule.
-- Shut Down Point: Application 1 A barber shop with 6-month lease
Question: Should the barber ship stay open until the lease expires?
1. Revenue: Q = 100; P = $15.
TR = 100 X 15 = $1,500.
2. Costs: lease is $500/mo.; wages for barbers and other variable costs total $1,200/mo.
TC = TFC + TVC = $1,700/mo. (assume no implicit costs).
-- If the shop stays open: profit = -$200;
If the shop shuts down: profit = -$500 (the shop still needs to pay the lease);
-- Therefore, the shop should stay open as long as total revenue can cover total variable cost. (fixed costs
are not calculated since the firm needs to pay them anyway.)
TR > TVC also means P > AVC (TR/Q > TVC/Q)
Production level (ss curve):
When P > AVC (the firm stays open), ss = MC curve;
When P < AVC (the firm shuts down), ss=0.
Q1 Q0 Q2 Quantity
Price
PPrice
ee
MC
MR = P
At Q1, MR > MC: the revenue of producing an additional unit of
output exceeds the cost of it; the firm should expand
output;
At Q2, MR < MC: the cost of producing an additional unit of
output exceeds the revenue of it; the firm should
contract output;
At Q0, MR = MC: the revenue of producing an additional unit of
output equals the cost of it; this is the profit
maximizing level of output for the firm.
15 16 17 Quantity
Price
PPrice
ee
12
11
10
The firms supply curve measures:
-- quantity of output a firm is willing to produce at certain price.
If the price if 10, which is also the firms MR, the firm will produce at
15 units where MC is 10 = MR.
In essence, because the firms marginal cost curve determines the
quantity of goods the firm is willing to supply at given price, it is the
competitive firms supply curve.
MC
Level of Profit
Q: if MR = MC and the firm is producing at a profit-maximizing level of output, is the firm then earning an
economic profit?
A: not sufficient information. To calculate economic profit, ATC is needed. (compare P with ATC).
Level of Profit:
TR > TC Economic Profits (TR/Q) > (TC/Q) P > ATC
TR = TC Breaks Even (TR/Q) = (TC/Q) P = ATC
TR < TC Economic Loss (TR/Q) < (TC/Q) P < ATC
1. Economic Profits (P > ATC)
2. Zero Economic Profit (P = ATC: Breaks Even)
Quantity
Price
PPrice
ee
AVC
ATC
Firms short-run
supply curve
Shut-down Point
Insights
1. Firms shut down if TR < TVC (fixed costs are
irrelevant);
2. TR < TVC (TR/Q) < (TVC/Q)
P < AVC;
3. Firms supply curve = firms MC curve where P >
AVC
(P > AVC, ss = MC;
P < AVC, ss=0.)
10 Quantity
Price
PPrice
ee
25
20
MC
ATC
MR=P
Profit-Maximizing Output: 10 (MC=MR)
Profit = (P-ATC) X Q = (25-20) X 10 = 50
10 Quantity
Price
PPrice
ee
MC
ATC
MR=P
25
Profit-Maximizing Output: 10 (MC=MR)
Profit = 0 since ATC = P
Note: in the short run its not necessarily the shut
down point, since the firm can still cover its variable
cost.
MC

Document Summary

Topic 8 perfect competition (week eight nov 1st - nov 10th) Outline: definition, total revenue, marginal revenue, and average revenue, profit maximizing output. - firm"s mc curve = firm"s ss curve (if p > avc); - shut down point: level of profits, entry and exit, short-run and long-run impact of a shift in demand, long-run market supply curve; - many buyers and sellers of identical product (so action of each buyer or seller exerts no impact on the market price); - freedom of entry and exit of firms (no barrier to entry/exit) - each firm is a price taker, meaning each firm faces an infinitely elastic demand curve at the market price; -- in the short run, the number of firms is fixed; In the long run, the number of firms can vary. Total revenue (the revenue of producing an additional unit of output) Dd/ss market demand/supply dd/ss individual firm"s demand/ market price supply.