1. MICROECONOMICS: Theory & Applications
Chapter 9: Profit Maximization in Perfectly Competitive Markets
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College

2. Assumptions of Perfect Competition
Large numbers of buyers and sellers
Free entry and exit
Homogeneous products
Perfect information
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John Wiley & Sons, Inc.

3. Profit Maximization
ASSUMPTION: firms select an output level so as to maximize profit, defined as the difference between revenue and cost
“Survivor Principle” – the observation that in competitive markets, firms that do not approximate profit-maximizing behavior fail, and that survivors are those firms that, intentionally or not, make the appropriate profit-maximizing decisions.
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John Wiley & Sons, Inc.

4. The Demand Curve for a Competitive Firm
Price taker – a firm that takes prices as given and does not expect its output decisions to affect price
=>horizontal demand curve
Total revenue – price times the quantity sold
Average revenue (AR) – total revenue divided by output
Marginal revenue (MR) – the change in total revenue when there is a one-unit change in output
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5. Figure 9.1 - The Competitive Firm’s Demand Curve
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6. Table 9.1
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7. Short-Run Profit Maximization
Total profit (π) – the difference between total revenue and total cost
TR rises in proportion to output since the price is constant.
TC rises slowly at first and then more rapidly as the plant facility becomes more fully utilized and MC rises.
Total profit tends to increase and then decrease as more is produced.
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8. Figure 9.2 - Short-Run Profit Maximization: Total Curves
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9. Short-Run Profit Maximization Using Per-unit Curves
Average profit per unit (π/q) – total profit divided by number of units sold
Profit is maximized at the output level where MR=MC.
If MR>MC, profits would increase if output were increased.
If MR<MC, profits would increase if output were decreased.
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10. Figure 9.3 - Short-Run Profit Maximization Using Per-unit Curves
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11. Operating at a Loss in the Short-Run
If ATC<AR at the output-level where MC=MR => profit is negative
Two choices:
Temporarily shut-down
Permanently go-out-of-business
Question: Which choice will yield smaller loss?
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12. Figure 9.4 - Operating at a Loss in the Short-Run
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13. The Perfectly Competitive Firm’s Short-Run Supply Curve
Short-run firm supply curve – a graph of the systematic relationship between a product’s price and a firm’s most profitable output level
Supply curve = MC curve where MC > minimum point on AVC curve
Identifies most profitable output for each possible price
Shutdown point – the minimum level of average variable cost below which the firm will cease operations
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14. Figure 9.5 - The Perfectly Competitive Firm’s Short-Run Supply Curve
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15. Output Response to a Change in Input Prices
Question: What is the impact of a change in input price, holding product price constant?
1) MC will shift
2) Firm will adjust output until MC=MR
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16. Figure 9.6 - Output Response to a Change in Input Prices
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17. The Short-Run Industry Supply Curve
Short-run industry supply curve – add the quantities produced by each firm by summing the individual firms’ marginal cost curves horizontally
Assumption – variable input prices remain constant at all levels of industry output
Curve slopes upward due to law of diminishing marginal returns
Market price and output: determined by interaction between short-run industry supply curve and the market demand curve
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18. Figure 9.7 - The Short-Run Competitive Industry Supply Curve
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19. Long-Run Competitive Equilibrium
Allow enough time for all inputs to vary
Long-run cost curves include the opportunity cost of inputs
Zero economic profit – the point at which total profit is zero since price equals the average cost of production; “normal” economic return
No incentive for firms to enter or leave the industry
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20. Figure 9.8 - Long-Run Profit Maximization
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21. Long-Run Competitive Equilibrium II
Characteristics:
The firm is maximizing profit and producing where LMC=price.
There is no incentive for firms to enter or leave the industry.
The combined quantity of output of all the firms at the prevailing wage equals the total quantity consumers wish to purchase at that price.
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22. Figure 9.9 – Long-Run Competitive Equilibrium
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23. Zero Profit When Firms’ Cost Curves Differ?
When all firms in a competitive industry have identical cost curves, each firm earns zero economic profit in long-run equilibrium.
What happens if cost curves differ among firms?
There is a tendency for factor inputs to receive compensation equal to their opportunity costs. This process leads to the zero-profit equilibrium.
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24. The Long-Run Industry Supply Curve
The long-run relationship between price and industry output
depends on whether input prices are constant, increasing, or decreasing as the industry expands or contracts
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25. The Long-Run Industry Supply Curve [Three Classifications]
Constant-cost industry: an industry in which
expansion of output does not bid up input prices
long-run average production cost per unit remains unchanged, and
the long-run industry supply curve is horizontal
Increasing-cost industry: an industry in which
expansion of output leads to higher long-run average production costs
the long-run industry supply curve slopes upward
Decreasing-cost industry: an industry in which
the long-run industry supply curve slopes downward
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26. Figure 9.10 – Long-Run Supply in a Constant-Cost Industry
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27. Figure 9.11 – Long-Run Supply in an Increasing-Cost Industry
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28. Figure 9.12 – Long-Run Supply in an Decreasing-Cost Industry
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29. Comments on the Long-Run Supply Curve
The long-run supply curve is not derived by summing the long-run marginal cost curves of an industry’s firms.
A movement along the long-run industry supply curve is accompanied with the assumptions that conditions of supply remain constant, such as:
Technology
conditions of input supply factors
government regulations
weather conditions
(continued)
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30. Comments on the Long-Run Supply Curve (continued)
Although the industry may never attain a long-run equilibrium in reality, what is important is that there is a tendency for the industry to move in the direction indicated by the theory.
Economic profit is zero along a competitive industry’s long-run supply curve.
In reality, the process of adjustment from a short-run equilibrium to a long-run equilibrium may vary from the theoretical description.
Copyright 2012
John Wiley & Sons, Inc.

31. When Does the Competitive Model Apply?
The assumptions of perfect competition are stringent and are likely to be satisfied fully in very few real-world markets.
However, many market come close enough to satisfying the assumptions of perfect competition to make the model useful.
And it is useful to assess the effect of deviations from the assumptions in a real-world market.
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