SC ECON 221 - Perfect Competition (5 pages)

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Perfect Competition



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Perfect Competition

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This lecture continues to cover perfect competition in markets, profit maximization and when markets should stay in a market or exit a market.


Lecture number:
16
Pages:
5
Type:
Lecture Note
School:
University Of South Carolina-Columbia
Course:
Econ 221 - Prin of Microeconomics
Edition:
1
Unformatted text preview:

ECON 221 Lecture 16 Outline of Last Lecture I Firms decision making a Maximizing profits b Different types of competition II Cost Curves a Total Cost Curve b Average Total Cost Curve III Short Run vs Long Run costs IV Market Structure Outline of Current Lecture I Profit Maximization II Market Profitability III Short Run Production IV Breakeven Price V Shutdown Price Current Lecture Many buyers many sellers with very little market power Identical products Buyers and sellers are price takers Free entry and exit of markets o Because a firm is a price taker they cannot impact prices These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute The firm always receives the market price when it sells a unit of a good MR always equals price regardless of quantity produced for perfectly competitive firms Profit Maximization o Profit TQ Q K L TC Q K L o A firm wants to produce one more unit of a good if it will add to profit o o That is add to profit if TR Q 1 TC Q 1 TR Q TC Q TR Q MR Q TC Q MC Q TR Q TC Q MR Q MC Q For perfectly competitive markets produce more if P MC Q Stop at the Q where P MC Q When price goes up Quantity produced goes up Law of Supply And profit increases this is what drives the Law of Supply Build other cost curves into graph to see profit graphically o An important note Average Total Cost ATC TC Q So TC ATC Q Just like Total Revenue TR P Q In Summary To maximize profits a firm should choose the Q such that MR Q MR Q In perfectly competitive industries MR Q P for any Q because firms are price takers o So choose Q that MC Q P However even when firms choose the Q that maximizes profit that doesn t always mean that they re making a positive profit o When should a firm even bother entering a market Profit 0 if TR Q TC Q where Q is the point where P MC Q P x Q TC Q ATC x Q P ATC P ATC Q P MC Q ATC Q Recall that MC crosses at ATV at the minimum of ATC so if MC P ATC then we know that MC P min ATC More general condition o Firm will be profitable if P min ATC Breakeven Price o P min ATC is the breakeven price because it is the price where firms will breakeven earning an economic profit of exactly 0 o How much should a firm produce Goal is to maximize profit Answer Q where MC MR Profit Total Revenue Total Cost Price x Quantity Average Total Cost to produce x Quantity Average Total Cost curve Total cost Quantity So Total Cost Average Total Cost x Quantity Similar to Total Revenue TR Price x Quantity Short run production o Assuming profit 0 shut down immediately only if o Profit Q 0 Profit Q Q o TR Q 0 TC Q 0 TR Q Q TC Q Q o 0 FC P x Q FC VC Q o AVC Q P VC Q TR o So shut down immediately if you can t cover your variable costs When is production profitable Profit 0 if TR Q TC Q where Q is the point where P MC Q P x Q TC Q P ATC Q P MC Q ATC Q o But recall that MC crosses ATC at the minimum of ATC so if MC P ATC then we will know that MC P min ATC o So a more general condition a firm will be profitable if P min ATC Break Even Price o Because of this condition we call P min ATC the break even price because it s the price where firm s will just break even earning an economic profit of exactly 0 P min ATC Profits 0 P min ATC Profits 0 Shut down price Shutdown price is P min AVC o P min AVC stay open in short run o P min AVC shut down immediately So far How much should firms produce Q where MR MC which maximizes profits When will maximized profits be profitable P min ATC So clearly a firm shouldn t enter a market if it knows that it s min ATC P Similarly in the long run a firm should definitely exit the market if min ATC P What about the short run Should a firm exit immediately if unprofitable Recall that by short run we just mean the period where a firm can t adjust it s fixed inputs and therefore is forced to pay it s fixed costs o So in the short run a firm must pay the fixed cost whether it shuts down or not o Assuming Profit 0 shut down immediately only if Profit Q 0 Profit Q Q o TR Q 0 TC Q 0 TR Q Q TC Q Q 0 FC P x Q FC VC Q AVC Q P VC Q TR So shut down immediately if you can t even cover your variable costs Shut down price o Just like the break even price the shutdown price is P min AVC P min AVC stay open in short run close in long run P min AVC shut down immediately What do perfectly competitive markets look like in the long run Suppose all firms have the same sorts of costs Currently firms in the market are making profits What happens when highest profit is negative o Leave immediately o Leave in the long run


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