Profit Maximization, Supply, Market Structures, and Resource AllocationMarket StructureMarket StructuresQuick Overview of Supply and Resource Allocation in MarketsPowerPoint PresentationSlide 6Slide 7Slide 8Slide 9Marginal Revenue and Market StructureCompetitive Markets or Pure CompetitionRevenue in Competitive MarketsTable 1 Total, Average, and Marginal Revenue for a Competitive FirmCompetitive Firm in the Short-runTable 2 Profit Maximization: A Numerical ExampleFigure 1 Profit Maximization for a Competitive FirmConditions for Profits, Breakeven, Losses and ShutdownFigure 5 Profit as the Area between Price and Average Total CostSlide 19Short-run SupplyFigure 3 The Competitive Firm’s Short Run Supply CurveFigure 6 Market Supply with a Fixed Number of FirmsPrice Determination in the Short-runLong-run Supply and Price DeterminationFigure 7 Market Supply with Entry and ExitFigure 8 An Increase in Demand in the Short Run and Long RunSlide 27Long-run Supply CurveCompetitive Markets: Short-run and Long-runEfficiency RevisitedSlide 31Profit Maximization, Supply, Market Structures, and Resource AllocationMarket Structure•Firms are assumed to maximize economic profits •Economic Profit = Revenue – Total Opportunity Costs = Explicit and Implicit Costs•Costs are dependent on technology and input prices•Revenue is dependent upon the market structure in which a firm operates•Therefore, the profit maximization decision must be analyzed by market structuresMarket Structures•Competitive Markets•Monopoly•Oligopoly•Monopolistic CompetitionQuick Overview of Supply and Resource Allocation in Markets•Marginal benefits from a firms perspective are marginal revenue from selling output•Marginal revenue equal the extra revenue from selling another unit of output•Assuming the firm produces (does not shutdown), the firm will maximize profit (or minimize losses) where MR=MC•The level of output will determine the costs of production (measured by ATC)•Comparing price to average costs show if the firm is making profits, losses or will shutdown production•All the buyers in the market combined form the market demand curve and all the sellers for the market supply curve•Market demand and supply determine the price and along with firms’ costs determine economic profits (hereafter simply profits)•Changes in demand and supply, cause market prices to change, and thus cause profits to rise or fall•In the short-run, existing firms in an industry change production as price changes.•In the transition to the long-run, firms enter or exit an industry depending on whether profits are greater than or less than zero.•In the long-run, profits are driven to zero or to the level of NORMAL profits (accounting profits that just cover all opportunity costs).•Resource allocation is determined by:–Buyers and sellers follow their self-interest•Buyers maximize utility•Seller maximize profit–Market demand reflects buyer behavior (and thus each individual buyers behavior) and market supply reflect seller behaviors (and thus individual firm behavior)–Prices signal increases or decreases in quantity demand and supply and profits signal resources to enter or exit an industry causing market supply to change–Long-run equilibrium occurs where:•The price paid by the consumer, which is equal to the marginal benefit of another unit, is just equal to the marginal cost, which is equal to the opportunity cost of another unit to society. MB = MC•From the videos, –Resources dedicated to farming have decreased –If rents are not controlled, the supply of housing will respond to increased demand without shortages–The same is true of gasoline and water–Also, in class, DVDs versus VCRs•This is Adam Smith’s “Invisible Hand at work”. –Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally neither intends to promote the public interest, nor knows how much he is promoting it...He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. Wealth of Nations, 1776)Marginal Revenue and Market Structure•Competitive markets – sellers are price takers so MR = Market Price, MR =P•Monopoly – the seller is a price maker and faces the entire market demand curve so MR < Price•Oligopoly – the seller directly competes with a few firms so MR depends on the actions of competitors•Monopolistic Competition – sellers possess some market power and can set their own prices in the short-run, so MR<PCompetitive Markets or Pure Competition•Assumptions revisited–Many buyers and sellers•Each buyer and seller is a price taker–Homogenous or identical products•Competition is based only on the price–Perfect information or knowledge•All firms have access to the same technology•Competition is based upon price–Firms can freely enter or exit•Profits will be eliminated in the long-runRevenue in Competitive Markets•The market demand and supply curves determine the equilibrium price and quantity and the price that buyers will pay and sellers receive•As with producer surplus, sellers are price takers and the price they receive is their MR. The marginal revenue and the price remain the same no matter how much output is sold.Table 1 Total, Average, and Marginal Revenue for a Competitive FirmCopyright©2004 South-WesternCompetitive Firm in the Short-run•Short-run – at least one fixed factor = fixed costs. Assume the plant size is fixed.•Set MR=MC to find profit maximizing level of output. Use the average cost curves to determine whether one –Operates and earn profits–Operate and breakeven–Operates and make losses–Shutdowns and minimize lossesTable 2 Profit Maximization: A Numerical ExampleCopyright©2004 South-WesternFigure 1 Profit Maximization for a Competitive FirmCopyright © 2004 South-WesternQuantity0CostsandRevenueMCATCAVCMC1Q1MC2Q2The firm maximizesprofit by producing the quantity at whichmarginal cost equalsmarginal revenue.QMAX P = MR1 = MR2 P = AR = MRConditions for Profits, Breakeven, Losses and