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L15 - Perfect Competition - 10302013.pdf

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University of Toronto St. George
James Pesando

MR = MC => q* is profit - maximizing level of output Question: Is firm earning economic profits? To answer: add ATC schedule > DIGRESION If commodity is infinitely divisible, there is a UNIQUE profit-maximizing level of output at MR=MC 1. Graphs (implicit) 2. Calculus If commodity is not infinitely divisible, there are two levels of output - before MR=MC and after MR=MC - where profit is the same 1. Numerical examples 2. See text, Table 14.2 (page 295) for an example Level of Profits: TR > TC => Profits => TR/Q > TC/Q <=> P > ATC TR = TC => Breakeven <=> P = ATC TR < TC => Loss => TR/Q P < ATC Case 1: Economic Profit (P > ATC) Profit - maximizing output: 10 (P = MC) Profit: (P - ATC) * q = (25 - 20) * 10 = 50 Case 2: Economic Loss (P < ATC) Economic Profit: (P - ATC) * q (25 - 30) *10 = - 50 INSIGHT Firm produces q=10 which implies that P > AVC since firm does not shut down Question: What would happen if firm raised price to $30. Answer: q=0 and firm loss would be greater (absolute value) than $50 Decisions of Perfectly Competitive Firm: Summary 1. Choose output (q) that maximizes profit P = MC 2. Determine if should shut down in short-run* P < AVC => shut down (Otherwise, continue to produce q) 3. Determine whether to exit industry in long-run P < ATC => exit industry (Otherwise, continue to produce q) The market for hot dog stands is perfectly competitive. The typical hot dog stand is earning economic profits. Question: 1. What will happen to the market price of hot dogs? 2.
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