PERFECT COMPETITIONPowerPoint PresentationSTANDARD PROBLEMSlide 4Slide 5Slide 6Slide 7Slide 9Slide 11Slide 12Slide 14Slide 16Slide 17Recall what the marginal and average cost curves looked like in the case of our example.Now for marginal revenue and average revenue.Slide 20Slide 21Slide 22Important pointSlide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31An important point: profits are not maximized at the bottom of the AC curve.Slide 33Slide 35Slide 37Slide 39Rule to remember:Slide 42Producer Surplusslide 1Competitive firms in the short-runPERFECT COMPETITIONPERFECT COMPETITIONThis section analyzes the behavior of firms that operate in competitive markets. We take up the short-run first, and focus on two issues:1) How firms choose their outputs.2) How prices are determined.slide 2Competitive firms in the short-runIn the short-run firms have some fixed costs. In addition, in the short-run firms cannot leave an industry, and new firms cannot enter.slide 3Competitive firms in the short-runSTANDARD PROBLEMSTANDARD PROBLEMSuppose a small accounting firm producing tax return preparation services in East Lansing, Michigan, has a short-run total cost curve like the one in our example.Suppose the firm is a perfect competitor and can sell its services at a price of $44 per unit.If the firm wants to maximize profits, how many tax preparations should it produce in each time period?slide 4Competitive firms in the short-runQ TC0 50.01 63.02 71.03 76.04 82.45 97.06 130.07 174.08 233.09 314.010 460.011 656.0The total costcurve looks like this.slide 5Competitive firms in the short-run01002003004005006007000 2 4 6 8 10 12 14QTC ($)slide 6Competitive firms in the short-runThe firm’s total economic profit is total revenue minus total cost.Total revenue is price times quantity sold, where price means the revenue per unit that the firm takes in. Price is the fixed, known market price of the firm’s output.slide 7Competitive firms in the short-runTR is price times quantity.Price here is $44/unit.PQ = 3(44)The total revenue curve shows total receipts at each level of output.The dependent variable is total revenue and the independent variable is output.Q TR0 01 442 883 1324 176567891011Hidden slideslide 9Competitive firms in the short-runGraph the remaining points on the Total Revenue Curve.01002003004005006007000 2 4 6 8 10 12 14QTR($)Hidden slideslide 11Competitive firms in the short-runHere are the total revenue and cost curves.01002003004005006007000 2 4 6 8 10 12 14Q($)TCTRslide 12Competitive firms in the short-runProfit = TR - TC = 132-76Profit is total revenue minus total cost.Q TC TR PROFIT0 50.0 0 -50.01 63.0 44 -19.02 71.0 88 17.03 76.0 132 56.04 82.4 176 93.65 97.0 2206 130.0 2647 174.0 3088 233.0 3529 314.0 39610 460.0 440 -20.011 656.0 484 -172.0Hidden slideslide 14Competitive firms in the short-runPlot the missing points of the total profit curve.-300-200-10001002003004005006007000 2 4 6 8 10 12 14Q($)Hidden slideslide 16Competitive firms in the short-runWhere profit is maximized here is obvious from looking at the previous figure.The next thing to be shown is that the profit maximizing output is the output at which MARGINAL COST equals MARGINAL REVENUE.slide 17Competitive firms in the short-runThe profit maximization problem is going to be solved by looking at it from the point of view of average and marginal quantities and curves, instead of total quantities.The reason for doing this is that some problems are going to be much easier to solve if we look at the firm’s choices in terms of marginal and average revenue and cost.slide 18Competitive firms in the short-runRecall what the marginal and average cost curves looked like in the case of our example.0204060801001200 2 4 6 8 10 12 1401002003004005006007000 2 4 6 8 10 12 14$TCQ$/QMCACQslide 19Competitive firms in the short-runNow for marginal revenue and average revenue.Average revenue: The firm’s total revenue divided by output. Revenue per unit of output. The same thing as PRICE.The average revenue curve shows average revenue as a function of output. The average revenue curve is the demand curve for output as seen by the firm.In the case of perfect competition, the average revenue curve is horizontal at the going market price. The firm is a price taker.slide 20Competitive firms in the short-runTHE AVERAGE REVENUE CURVE FORA COMPETITIVE FIRM IS A HORIZONTAL LINEAT MARKET PRICE.0204060801001200 2 4 6 8 10 12 14Q$/QP=ARslide 21Competitive firms in the short-runMarginal revenue: The change in total revenue per unit change in output. The slope of the total revenue curve. MR = TR / Q.The marginal revenue curve shows marginal revenue at each level of output. Output is the independent variable, and MR is the dependent variable.For a competitive firm MR is constant.slide 22Competitive firms in the short-runTHE MARGINAL REVENUE CURVE FORA COMPETITIVE FIRM IS A HORIZONTAL LINEAT MARKET PRICE.0204060801001200 2 4 6 8 10 12 14Q$/QMRslide 23Competitive firms in the short-runImportant pointImportant pointIn perfect competition, marginal revenue and average revenue are always equal and constant for a firm.The sense of this is that a competitive firm can always sell additional units of output at the going market price.slide 24Competitive firms in the short-runThe total revenue and the corresponding marginal and average revenue curves are a “matched set.”Notice that the rules governing the relationships between total, average, andmarginal quantities holdhere.01002003004005006007000 2 4 6 8 10 12 140204060801001200 2 4 6 8 10 12 14$TRQ$/QAR=MRQslide 25Competitive firms in the short-runHere’s the cost and revenue curves togetheron the same set of axes.0204060801001200 2 4 6 8 10 12 14Q$/QMCACMRslide 26Competitive firms in the short-runWithout the datamarkers the graphslook like this.The profit maximizing outputhere is 7 units.0204060801001200 2 4 6 8 10 12 14Q$/QMCACMR=Pslide 27Competitive firms in the short-runWHY MUST 7 BE THE PROFIT MAXIMIZING OUTPUT?0204060801001200 2 4 6 8 10 12 14Q$/QMCACMR=Pslide 28Competitive firms in the short-runREASONING: 1) Take any other output, say 4. 2) Now increase output by a small amount. 3) Profits increase, so they can’t be maximized at an output of 4.0204060801001200 2 4 6 8 10 12 14Q$/QMCACMR=Pslide 29Competitive firms in the short-runBe sure you understand why profits increase when output isincreased from 4. The increase in output has two