Transcript Chapter
Managerial Economics
eighth edition
Thomas
Maurice
Chapter 11
Managerial Decisions in
Competitive Markets
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Perfect Competition
• Firms are price-takers
• Each produces only a very small portion
of total market or industry output
• All firms produce a homogeneous
product
• Entry into & exit from the market is
unrestricted
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Demand for a Competitive
Price-Taker
• Demand curve is horizontal at price
determined by intersection of market
demand & supply
• Perfectly elastic
• Marginal revenue equals price
• Demand curve is also marginal revenue curve
(D = MR)
• Can sell all they want at the market price
• Each additional unit of sales adds to total
revenue an amount equal to price
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Demand for a Competitive
Price-Taking Firm (Figure 11.2)
Price (dollars)
Price (dollars)
S
P0
P0
D = MR
D
0
Q0
Quantity
Panel A –
Market
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Quantity
Panel B – Demand curve
facing
a price-taker
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Profit-Maximization in the
Short Run
•
In the short run, managers must make
two decisions:
1.
Produce or shut down?
If shut down, produce no output and hires no
variable inputs
If shut down, firm loses amount equal to TFC
2. If produce, what is the optimal output
level?
If firm does produce, then how much?
Produce amount that maximizes economic profit
Profit = TR TC
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Profit Margin (or Average Profit)
( P ATC )Q
Average profit
Q
Q
P ATC Profit margin
• Level of output that maximizes total
profit occurs at a higher level than the
output that maximizes profit margin (&
average profit)
• Managers should ignore profit margin
(average profit) when making optimal
decisions
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Short-Run Output Decision
• Firm’s manager will produce output
where P = MC as long as:
• TR TVC
• or, equivalently, P AVC
• If price is less than average variable
cost (P AVC), manager will shut down
• Produce zero output
• Lose only total fixed costs
• Shutdown price is minimum AVC
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Profit Maximization: P = $36
(Figure 11.3)
TotalProfit
revenue
=$36 x -600
= $21,600
$11,400
= $21,600
= $10,200
Total cost = $19 x 600
= $11,400
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Profit Maximization: P = $36
(Figure 11.4)
Panel A: Total revenue
& total cost
Panel B: Profit curve
when P = $36
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Short-Run Loss Minimization:
P = $10.50 (Figure 11.5)
Profitcost
= $3,150
Total
= $17 -x$5,100
300
= -$1,950
= $5,100
Total revenue = $10.50 x 300
= $3,150
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Irrelevance of Fixed Costs
• Fixed costs are irrelevant in the
production decision
• Level of fixed cost has no effect on
marginal cost or minimum average
variable cost
• Thus no effect on optimal level of
output
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Summary of Short-Run Output
Decision
• AVC tells whether to produce
• Shut down if price falls below minimum
AVC
• SMC tells how much to produce
• If P minimum AVC, produce output
at which P = SMC
• ATC tells how much profit/loss if
produce
• ( P ATC )Q
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Short-Run Supply Curves
• For an individual price-taking firm
• Portion of firms’ marginal cost curve
above minimum AVC
• For prices below minimum AVC,
quantity supplied is zero
• For a competitive industry
• Horizontal sum of supply curves of all
individual firms
• Always upward sloping
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Derivation of Short-Run Supply
Curves (Figure 11.6)
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Long-Run Profit-Maximizing
Equilibrium (Figure 11.7)
Profit = ($17 - $12) x 240
= $1,200
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Long-Run Competitive Equilibrium
• All firms are in profit-maximizing
equilibrium (P = LMC)
• Occurs because of entry/exit of
firms in/out of industry
• Market adjusts so P = LMC = LAC
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Long-Run Competitive
Equilibrium (Figure 11.8)
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Long-Run Industry Supply
• Long-run industry supply curve
can be flat (perfectly elastic) or
upward sloping
• Depends on whether constant cost
industry or increasing cost industry
• Economic profit is zero for all
points on the long-run industry
supply curve for both types of
industries
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Long-Run Industry Supply
• Constant cost industry
• As industry output expands, input prices
remain constant, & minimum LAC is
unchanged
• P = minimum LAC, so curve is horizontal
(perfectly elastic)
• Increasing cost industry
• As industry output expands, input prices
rise, & minimum LAC rises
• Long-run supply price rises & curve is upward
sloping
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Long-Run Industry Supply for a
Constant Cost Industry (Figure 11.9)
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Long-Run Industry Supply for an
Increasing Cost Industry (Figure 11.10)
Firm’s output
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Economic Rent
• Payment to the owner of a scarce,
superior resource in excess of the
resource’s opportunity cost
• In long-run competitive equilibrium
firms that employ such resources
earn only normal profit
• Economic profit is zero
• Potential economic profit is paid to
the resource as rent
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Economic Rent in Long-Run
Competitive Equilibrium (Figure 11.11)
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Profit-Maximizing Input Usage
• Profit-maximizing level of input
usage produces exactly that level
of output that maximizes profit
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Profit-Maximizing Input Usage
• Marginal revenue product (MRP)
• MRP of an additional unit of a variable input is
the additional revenue from hiring one more unit
of the input
TR
MRP
P MP
L
• If choose to produce:
• If the MRP of an additional unit of input is
greater than the price of input, that unit should
be hired
• Employ amount of input where MRP = input price
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Profit-Maximizing Input Usage
• Average revenue product (ARP)
• Average revenue per worker
TR
ARP
P AP
L
• Shut down in short run if ARP < MRP
• When ARP < MRP, TR < TVC
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Profit-Maximizing Labor Usage
(Figure 11.12)
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Implementing the ProfitMaximizing Output Decision
• Step 1: Forecast product price
• Use statistical techniques from
Chapter 7
• Step 2: Estimate AVC & SMC
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•
AVC a bQ cQ
•
SMC a 2bQ 3cQ
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Implementing the ProfitMaximizing Output Decision
• Step 3: Check shutdown rule
• If P AVCmin, produce
• If P < AVCmin, shut down
• To find AVCmin, substitute Qmin into
AVC equation
Qmin
b
2c
AVCmin a bQmin cQ
2
min
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Implementing the ProfitMaximizing Output Decision
• Step 4: If P AVCmin, find output
where P = SMC
• Set forecasted price equal to
estimated marginal cost & solve for Q*
P a 2bQ 3cQ
*
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Implementing the ProfitMaximizing Output Decision
• Step 5: Compute profit or loss
• Profit = TR - TC
P Q* AVC Q* TFC
( P AVC )Q* TFC
• If P < AVCmin, firm shuts down &
profit is -TFC
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Profit & Loss at Beau Apparel
(Figure 11.13)
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Profit & Loss at Beau Apparel
(Figure 11.13)
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