MicroEconomics theory and application 12th by browning an zupan chapter 09

 Explain a competitive firm’s optimal output choice in the short run and how the firm’s shortrun supply curve may be derived through this output selection..  Understand how the long-ru

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MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

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Learning Objectives

 Outline the conditions that characterize perfect competition

 Explain why it is appropriate to assume profit maximization

on the part of firms

 Show why the fact that a competitive firm is a price taker implies that the demand curve for the firm is perfectly

horizontal

 Explain a competitive firm’s optimal output choice in the short run and how the firm’s shortrun supply curve may be derived through this output selection

 Describe the firm’s short-run supply curve

(continued)

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Learning Objectives (continued)

 Explain how the short-run industry supply curve is derived

 Define the conditions characterizing long-run competitive equilibrium

 Understand how the long-run industry supply curve

describes the relationship between price and industry output over the long run, taking into account how input prices may

be affected by an industry’s expansion/contraction

 Analyze the extent to which the competitive market model applies

 Delineate the mathematics behind perfect competition

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9.1 THE ASSUMPTIONS OF PERFECT COMPETITION

Outline the conditions that characterize perfect competition.

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The Assumptions of Perfect

Competition

 Large numbers of buyers and sellers

 Free entry and exit

 Product Homogeneity

 Perfect information

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9.2 PROFIT MAXIMIZATION

Explain why it is appropriate to assume profit maximization on the part of firms.

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Profit Maximization

 Assumption: firms select an output level so as to maximize

profit, defined as the difference between revenue and cost

 “Survivor Principle” – the observation that in competitive

markets, firms that do not approximate profit-maximizing behavior fail, and that survivors are those firms that,

intentionally or not, make the appropriate profit-maximizing decisions

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9.3 THE DEMAND CURVE FOR A

COMPETITIVE FIRM

Show why the fact that a competitive firm is a price taker implies that the demand curve for the firm is perfectly horizontal.

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The Demand Curve for a Competitive Firm

 Price taker – a firm that takes prices as given and does not

expect its output decisions to affect price

=>horizontal demand curve

 Total revenue (TR) – price times the quantity sold

 Average revenue (AR) – total revenue divided by output

 Marginal revenue (MR) – the change in total revenue

when there is a one-unit change in output

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Figure 9.1 - The Competitive Firm’s

Demand Curve

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9.4 SHORT-RUN PROFIT

MAXIMIZATION

Explain a competitive firm’s optimal output choice in the short run and how the firm’s shortrun supply curve may be derived through this output selection.

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Short-Run Profit Maximization

 Total profit (π) – the difference between total revenue and

total cost

 TR rises in proportion to output since the price is constant.

 TC rises slowly at first and then more rapidly as the plant

facility becomes more fully utilized and MC rises

 Total profit tends to increase and then decrease as more is

produced

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Table 9.1

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Figure 9.2 - Short-Run Profit

Maximization: Total Curves

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Short-Run Profit Maximization

Using Per-unit Curves

 Average profit per unit (π/q) – total profit divided by

number of units sold

 Profit is maximized at the output level where MR=MC

 If MR>MC, profits would increase if output were increased.

 If MR<MC, profits would increase if output were decreased.

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Figure 9.3 - Short-Run Profit

Maximization Using Per-unit Curves

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Operating at a Loss in the Short-Run

 If ATC<AR at the output-level where MC=MR => profit is negative

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Figure 9.4 - Operating at a Loss in the

Short-Run

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9.5 THE PERFECTLY COMPETITIVE FIRM’S SHORT-RUN SUPPLY CURVE

Describe the firm’s short-run supply curve.

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The Perfectly Competitive Firm’s Short-Run Supply Curve

 Short-run firm supply curve – a graph of the systematic

relationship between a product’s price and a firm’s most profitable output level

Supply curve = MC curve where MC > minimum point

on AVC curve

 Identifies most profitable output for each possible price

 Shutdown point – the minimum level of average variable

cost below which the firm will cease operations

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Figure 9.5 - A Competitive Firm’s

Short-Run Supply Curve

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Output Response to a Change in Input

Prices

Question: What is the impact of a change in input price,

holding product price constant?

1) MC will shift

2) Firm will adjust output until MC=MR

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Figure 9.6 – How a Firm Responds to

Input Prices Changes

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9.6 THE SHORT-RUN INDUSTRY

SUPPLY CURVE

Explain how the short-run industry supply curve is derived.

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The Short-Run Industry Supply Curve

 Short-run industry supply curve – add the quantities produced by

each firm by summing the individual firms’ marginal cost curves

horizontally

 Assumption – variable input prices remain constant at all levels of

industry output

 Curve slopes upward due to law of diminishing marginal returns

 Market price and output: determined by interaction between short-run

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Figure 9.7 - The Short-Run Competitive Industry Supply Curve

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9.7 LONG-RUN COMPETITIVE

EQUILIBRIUM

Define the conditions characterizing long-run competitive equilibrium.

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Long-Run Competitive Equilibrium

 Allow enough time for all inputs to vary

 Long-run cost curves include the opportunity cost of inputs

 Zero economic profit – the point at which total profit is zero since

price equals the average cost of production; “normal” economic return

 No incentive for firms to enter or leave the industry

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Figure 9.8 - Long-Run Profit

Maximization

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Long-Run Competitive Equilibrium II

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Figure 9.9 – Long-Run Competitive

Equilibrium

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Zero Profit When Firms’ Cost Curves

Differ?

 When all firms in a competitive industry have identical cost curves, each firm earns zero economic profit in long-run

equilibrium

 What happens if cost curves differ among firms?

There is a tendency for factor inputs to receive

compensation equal to their opportunity costs This process leads to the zero-profit equilibrium

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9.8 THE LONG-RUN INDUSTRY

SUPPLY CURVE

Understand how the long-run industry supply curve describes the

relationship between price and industry output over the long run, taking into account how input prices may be affected by an industry’s

expansion/contraction.

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The Long-Run Industry Supply Curve

 The long-run relationship between price and industry output

 It depends on whether input prices are constant, increasing,

or decreasing as the industry expands or contracts

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The Long-Run Industry Supply Curve

[Three Classifications]

 Constant-cost industry: an industry in which

 expansion of output does not bid up input prices

 long-run average production cost per unit remains unchanged, and

 the long-run industry supply curve is horizontal

 Increasing-cost industry: an industry in which

 expansion of output leads to higher long-run average production costs

 the long-run industry supply curve slopes upward

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Figure 9.10 – Long-Run Supply in a

Constant-Cost Industry

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Figure 9.11 – Long-Run Supply in an

Increasing-Cost Industry

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Figure 9.12 – Technological Advances Shift the Long-Run Supply Curve

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Comments on the Long-Run Supply

Curve

 The long-run supply curve is not derived by summing the

long-run marginal cost curves of an industry’s firms

 A movement along the long-run industry supply curve is

accompanied with the assumptions that conditions of supply remain constant, such as:

 Technology

 conditions of input supply factors

 government regulations

weather conditions

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Comments on the Long-Run Supply

 Although the industry may never attain a long-run

equilibrium in reality, what is important is that there is a tendency for the industry to move in the direction indicated

by the theory

 Economic profit is zero along a competitive industry’s run supply curve

long- In reality, the process of adjustment from a short-run

equilibrium to a long-run equilibrium may vary from the theoretical description

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9.9 WHEN DOES THE COMPETITIVE MODEL APPLY?

Analyze the extent to which the competitive market model applies.

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When Does the Competitive Model

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9.10 THE MATHEMATICS BEHIND

PERFECT COMPETITION*

Delineate the mathematics behind perfect competition.

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The Mathematics Behind Perfect

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The Mathematics Behind Perfect

Competition

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