Preview:- Perfectly competitive (price taker) market- Roles for profit maximization- Conditions for SR equilibrium- LR equilibriumPerfectly Competitive Market:- Large number of firms producing identical products- No barriers to entry or exitEach firm is such a small producer, so no effect on the market itself $ S' S $0.50D Market for avocadoes$ $0.50 d (perfectly elastic)q/tFarm (individual for avocadoes)If that one farm left the market, the supply curve on the market will change slightly to the leftMarginal = AdditionalMarginal Revenue: (MR) is the additional revenue from selling one more unit$ $0.50 d=mr q/t 100Demand curve is also marginal revenue curve and average rateIf sell above $0.50, then it won't sellNo incentive to pay for advertisingNo need to pay less than $0.50Rules for Profit Maximization:- Should the firm shut down or should it continue to produce?o Rule: Shut down if $ receiving is less than $ of average variable cost (P < AVC) If $ > AVC, the new (variable) costs will be covered, and at least some of the fixed costs will be paid-Example: Selling lettuceApril $1.00/crate Planting costs Fixed costMay $1.00/crate Irrigation Fixed cost5 June *** $1.00/crate HarvestPrice = $2.00/cratePlowing under at 0 costsPrice is $2.50. The AVC cost is $1.00You have $1.50 to pay off some fixed costs.If you harvest, you lose $0.50/crateIf you don't harvest, you lose $2.00/crateProfit maximization usually loss of minimization- How much should the firm produce?o Rule: The firm should produce all units when MR is greater or equal to MC Profit = TR - TC TR is MR and TC is MC Δ in producing one more unit$ MCP* MRq/tProfit max; cost min.$ MCAVCq/tShould not produce Q0.50 because below AVC curve.For a perfectly competitive firm, the MC above AVC is the firm's S curve1.501.251.000.50Q1.50Q1.25Q1.00Q 0.50MC curve above AVC curve is the supply curve---- lowest $ that they shut down$ Firm 1 Firm 2 Firm 3 Industry.50 1 0 0 1.75 2 1 0 31.00 3 2 1 61.25 4 3 2 91.50 5 4 3 12When another firm is introduced, the supply curve shifts out.$ Firm 1 Firm 2 Firm 3 Firm 4 Industry.50 1 0 0 0 1.75 2 1 0 0 31.00 3 2 1 1 71.25 4 3 2 2 111.50 5 4 3 3 15- How much profit is the firm making?o Rule: Profit = TR - TC Average profit = p - ATCTR /q = (p/q) x q TC/q = ATC MC AVCShould continue to produceWill make a profit$2.00 P*$1.50 ATCQ (1000)d = mr = acFIRM A FIRM BFIRM CC should not be producing because $ is lower than AVCB is making a lossA is making zero economic costsConditions for SR equilibrium:P*MCAVCMCATCAVCP*MCATCAVCP*SR equilibrium: no incentive for firms to change the amount they are producing1. Market demand = market supply at P*2. All firms are producing where P is greater than or equal to AVC3. All firms are producing where MR = MCFirms A & B can run making a SR
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