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Lecture 15

Lecture 15-Perfect Competition pt.2

4 Pages
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School
University of Toronto St. George
Department
Economics
Course
ECO101H1
Professor
Jack Carr
Semester
Fall

Description
Thursday, November 5th, 2009. Perfect Competition MR = MC => q* is profit-maximizing level of output Question: Is firm earning economic profits? Is firm breaking even (zero economic profits)? Is firm suffering economic loss? To answer: add ATC schedule Ù compare P to ATC Economic Profit = Total Revenue Minus Total Opportunity Cost (Explicit + Implicit) Most Important Implicit Opportunity Cost: Invested Capital (Equity) ,QYHVWHG&DSLWDOHDUQV³QRUPDOUDWHRISURILW´Æ Economic Profit = Zero (and Accounting Profit is Positive) Level of profits: 1. Firm maximizes profits by producing where P = MC 2. Levels of profits: TR > TC => profits => TR/Q > TC/Q Ù P > ATC TR = TC => breakeven Ù P = ATC TR < TC => loss => TR/Q < TC/Q Ù P < ATC P MR [= P] q* MC q www.notesolution.com Case 1: Economic Profit (P > ATC) Profit-maximizing output: 10 (P = MC) Profit: (P ± ATC) * q = (25 ± 20) * 10 = 50 Case 3: Economic Loss (P < ATC) Economic Profit: (P ± ATC) * q = (25 ± 30) * 10 = -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 Æ shut down (Otherwise, continue to produce q) P P = MR 10 MC q ATC 25 20 P = MR 10 q ATC 25 30 MC P www.notesolution.com Individual Firm q0 MC dd Q1 P0 Market SS DD ATC P1 Q0 DD1 q1 dd1 3. Determine whether to exit industry in long-run P < ATC Æ exit industry (Otherwise, continue to produce q) Long-Run Equilibrium 1. Firm is maximizing profits (produces q0 where MR = MC) 2. Zero economic profit (Ù ³QRUPDOUDWHRISURILW´EHFDXVHDWT0, P = ATC 3. No incentive for firms to enter or exit the industry Entry and Exit 1. If firms in industry are earning (economic) profits, other firms enter (and industry supply curve shifts to right) 2. If firms in industry are suffering (economic) losses, firms exit (and industry supply curve shifts to left) Short-Run versus Long-Run Impact of An Increase in Demand Short-Run Firm q0 MC P0 = MR Q0 P0 Market SS DD ATC www.notesolution.com Prior to study of competitive markets analysis ends with market adjustment in short-run Yet firms now earn economic profits (P1 > ATC) => in long run, new firms enter industry and SS shifts right to SS1 and price falls ,IWKLVLV³FRQVWDQWFRVW´LQGXVWU\SULFHIDOOVWR30 (initial price) and industry output rises Long-Run Q1 P0 Market SS DD P1 Q2 Q0 DD1 SS1 (New Firms Enter) www.notesolution.comth Thursday, November 5 , 2009. Perfect Competition P MC MR [= P] q* q MR = MC => q* is profit-maximizing level of output Question: Is firm earning economic profits? Is firm breaking even (zero economic profits)? Is firm suffering economic loss? To answer: add ATC schedule compare P to ATC Economic Profit = Total Revenue Minus Total Opportunity Cost (Explicit + Implicit) Most Important Implicit Opportunity Cost: Invested Capital (Equity) ,3;0890,5L9,O0,7383472,O7,90415741L9 Economic Profit = Zero (and Accounting Profit is Positive) Level of profits: 1. Firm maximizes profits by producing where P = MC 2. Levels of profits: TR > TC => profits => TRQ > TCQ P > ATC TR = TC => breakeven P = ATC TR < TC => loss => TRQ < TCQ P < ATC www.notesolution.com
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