copyright © 2010, All rights reserved eStudy.us Market Structure – A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit Perfect Competition many small firms (no firm, not even the largest, can impact market price) homogeneous (identical) product (goods cannot be distinguished from one another; corn, wheat etc…) very easy entry and exit Firms operating in perfect competition are price takers ( sellers with no control over the price of the product they sell) Perfect Competition

copyright © 2010, All rights reserved eStudy.us Total Revenue – price times quantity Average Revenue – total revenue divided by the quantity Marginal revenue – the change in total revenue from an additional unit sold In Perfect Competition both AR and MR are equal to Price Revenue Firms don’t have to discount to sell more output Firms may sell large amounts of output or little output at the market price A firm’s participation in the market will not impact price

copyright © 2010, All rights reserved eStudy.us QP $ TR $0 $10 $20 $30 $40 $50 $60 $70 $80 $90 MR ---- $10 P = MR = D Perfectly Elastic Demand Revenue One Firm’s Demand Curve

copyright © 2010, All rights reserved eStudy.us Business Objective: Maximize Profit Total Profit = Total Revenue – Total Cost Achieve Profit Maximization Marginal Revenue = Marginal Cost Short-run Decisions

copyright © 2010, All rights reserved eStudy.us QP $ TR $0 $10 $20 $30 $40 $50 $60 $70 $80 $90 MR ---- $10 TFC $10 TVC $0 $4 $7 $11 $18 $28 $47 $74 $112 $162 TC $10 $14 $17 $21 $28 $38 $57 $84 $122 $172 MC ---- $4 $3 $4 $7 $10 $19 $27 $38 $50 AFC $10 $5 $3.33 $2.50 $2.00 $1.67 $1.43 $1.25 $1.11 AVC $0 $4.00 $3.50 $3.67 $4.50 $5.60 $7.83 $10.57 $14.00 $18.00 ATC $10.00 $14.00 $8.50 $7.00 $7.60 $9.50 $12.00 $15.25 $19.11 $12 Profit -$10 -$4 $3 $9 $12 $3 -$14 -$42 -$82 Short-run Decisions

copyright © 2010, All rights reserved eStudy.us MC P = MR = D Profit Maximization MR = MC $7.60 Short-run Decisions Single Firm

copyright © 2010, All rights reserved eStudy.us Rules to Maximize Profit If MR > MC – increase production If MR < MC – decrease production If MR = MC – profit-maximizing level of output Short-run Decisions

copyright © 2010, All rights reserved eStudy.us Short-run Decisions D=MR $7 $8 MCATC AVC Q $ 100 Total Revenue Total Cost $ = $1,000 TVC = $7 100 = $700 TFC= $1 100 = $100 $8 100 = $800 Economic Profit $200 TFC = $100 TVC = $700 TR = $1,000 $10 Profit = $200 Single Firm

copyright © 2010, All rights reserved eStudy.us TR = $540 Loss=90 TFC=$180 Short-run Decisions D=MR$6 MCATC AVC Q $ 90 $5 Total Cost Total Revenue $6 90 = $540 TVC = $5 90 = $450 TFC= $2 90 = $180 $7 90 = $630 Economic Loss $90 TVC = $450 $7 Single Firm

copyright © 2010, All rights reserved eStudy.us D 0 (Economic Profit) D 1 (Economic Profit equal zero) D 2 (Economic Loss – will produce) D 3 (Economic Loss – shut down point) D 4 (Economic Loss – will shut down) MCATC AVC Q $ P0P0 P1P1 P2P2 P3P3 P4P4 Short-run Decisions Economic Profit AFC Recovering some AFC Lost AVC Single Firm

copyright © 2010, All rights reserved eStudy.us Marginal Cost curve determines the quantity a firm is willing to supply at any price given: – TR > TVC or – P > AVC A firm’s short-run supply curve is the portion of the marginal-cost curve that lies above average variable cost Short-run Decisions

copyright © 2010, All rights reserved eStudy.us Fixed cost – Has already been committed – Cannot be recovered – Ignore them when making decisions Short-run Review Short run: Final Review ̶number of firms is fixed ̶each firm supplies quantity where P = MC ̶Marginal Cost is supply curve when Price > AVC ̶Market supply – add up quantity supplied by each firm

copyright © 2010, All rights reserved eStudy.us Long-run Decisions Long Run: Firms are free to change scale Firms may enter the market Firms may exit the market All inputs are variable (no fixed cost)

copyright © 2010, All rights reserved eStudy.us Parish Shoe Co. Revenue$300,000 Cost $250,000 Profit $50,000 Explicit Cost – Payment to non owners for resources Accounting Profit or Loss Teacher $30,000Implicit Cost – Opportunity cost Economic Profit or Loss $20,000 Principal $50,000 $0 Super $100,000 - $50,000 Cost Review

copyright © 2010, All rights reserved eStudy.us The Market Superintendent PrincipalTeacher Suppose the only difference in all the above cost curves is the implicit cost in production. All three producers are equal in production efficiencies and acquire resource inputs at the same price. Which chart illustrates the superintendent? Which chart illustrates the principal? Which chart illustrates the teacher? BA C C A B The superintendent should exit the industry and return to education (higher opportunity cost) Now suppose the only difference in all the above cost curves is the explicit cost in production. All three producers are teachers but are unequal in production efficiencies or acquire resource inputs at different prices. “C” exits as the result of being less efficient relative to other competitors in the industry Teacher Long-run Equilibrium

copyright © 2010, All rights reserved eStudy.us Average FirmMarket S0S0 S1S1 Normal Profit – The minimum profit necessary to keep a firm in operation Long Run Economic Profit – When firms make more than a normal profit, firms enter the industry, as supply increases, a downward pressure is put on prices Long Run Economic Loss – When firms make less than a normal profit, firms leave the industry, as supply decreases, an upward pressure is put on prices Long Run Equilibrium – At the market price that enables firms to make a normal profit Long Run Perfectly Competitive Equilibrium – (P = MR = SRMC = SRATC = LRAC) D0D0 D1D1 D2D2 P0P0 P2P2 P1P1 MCLRAC Q $ D0D0 S2S2 Q P (Economic Profit) (Economic Loss) (Normal Profit) S1S1 D1D1 P1P1 S0S0 D0D0 P0P0 (Economic Profit) Long-run Equilibrium

copyright © 2010, All rights reserved eStudy.us Long run with easy entry and exit When price > average cost – firms make economic profit – new firms enter the market When price < average cost – firms make economic loss – some firms exit the market The process of entry and exit ends when – firms still in market earn zero economic profit or normal profit – Price is equal to average total cost where total cost includes all opportunity costs accounting profit is positive – Efficient scale: Price = MC = minimum ATC – Consumers purchase output at minimum ATC in the long run Long-run Equilibrium