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Pure Competition P = MC CHAPTER TWENTY-THREE Copyright McGraw-Hill, Inc. 1999.

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Presentation on theme: "Pure Competition P = MC CHAPTER TWENTY-THREE Copyright McGraw-Hill, Inc. 1999."— Presentation transcript:

1 Pure Competition P = MC CHAPTER TWENTY-THREE Copyright McGraw-Hill, Inc. 1999

2 Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Copyright McGraw-Hill, Inc. 1999 Four Market Models Pure Competition:

3 Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Very Large Numbers Very Large Numbers Copyright McGraw-Hill, Inc. 1999 Four Market Models Pure Competition:

4 Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Very Large Numbers Very Large Numbers Standardized Product Standardized Product Copyright McGraw-Hill, Inc. 1999 Four Market Models Pure Competition:

5 Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Very Large Numbers Very Large Numbers Standardized Product Standardized Product “Price Taker” “Price Taker” Copyright McGraw-Hill, Inc. 1999 Four Market Models Pure Competition:

6 Four Market Models Market Structure Continuum PureCompetition PureMonopoly MonopolisticCompetition Oligopoly Pure Competition: Very Large Numbers Very Large Numbers Standardized Product Standardized Product “Price Taker” “Price Taker” Free Entry and Exit Free Entry and Exit Copyright McGraw-Hill, Inc. 1999

7 Demand to a Competitive Seller Perfectly Elastic Demand Copyright McGraw-Hill, Inc. 1999 In a perfectly competitive market, each individual firm does not have enough power to limit supply in order to raise price. If they charge a higher price no one will buy it from them.

8 Demand to a Competitive Seller Perfectly Elastic Demand Price Taker Role Copyright McGraw-Hill, Inc. 1999

9 Demand to a Competitive Seller Perfectly Elastic Demand Price Taker Role Total Revenue Copyright McGraw-Hill, Inc. 1999

10 Demand to a Competitive Seller Perfectly Elastic Demand Price Taker Role Total Revenue Average Revenue Copyright McGraw-Hill, Inc. 1999

11 Demand to a Competitive Seller Perfectly Elastic Demand Price Taker Role Total Revenue Average Revenue Marginal Revenue Graphically... Copyright McGraw-Hill, Inc. 1999 Both of these equal demand which equals price – MR. DARP

12 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue $131 0 $ 0 ]QuantityDemanded(Sold) Copyright McGraw-Hill, Inc. 1999

13 $131 131 131 0 1 $ 0 131 $131 ] Copyright McGraw-Hill, Inc. 1999 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

14 $131 131 131131 0 1 2 $ 0 131262 ]$131131 ] Copyright McGraw-Hill, Inc. 1999 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

15 $131 131 131131131 0 1 23 $ 0 131262393 ]$131131131 ] ] Copyright McGraw-Hill, Inc. 1999 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

16 $131 131 131131131131 0 1 234 $ 0 131262393524 ]$131131131131 ] ] ] Copyright McGraw-Hill, Inc. 1999 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

17 $131 131 131131131131131131131131131131 0 1 2345678910 $ 0 131262393524655786917104811791310 ]$131131131131131131131131131131 ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 ProductPrice(AverageRevenue) TotalRevenueMarginalRevenue QuantityDemanded(Sold)

18 Perfect Competition Demand, Marginal Revenue, and Total Revenue Price, average and marginal revenue, total revenue (dollars) P Quantity Demanded (sold) 1 2 3 4 5 6 7 8 9 10 11791048 917 9177866555243932621310 Copyright McGraw-Hill, Inc. 1999

19 Perfect Competition Demand, Marginal Revenue, and Total Revenue D = MR P 1 2 3 4 5 6 7 8 9 10 11791048 917 9177866555243932621310 Copyright McGraw-Hill, Inc. 1999 Price, average and marginal revenue, total revenue (dollars) Quantity Demanded (sold) This is not market demand but demand for the individual firm. Because there are so many producers of an identical product, the firm in a purely competitive industry must take the going market price.

20 Perfect Competition Demand, Marginal Revenue, and Total Revenue TR D = MR P 1 2 3 4 5 6 7 8 9 10 11791048 917 9177866555243932621310 Copyright McGraw-Hill, Inc. 1999 Price, average and marginal revenue, total revenue (dollars) Quantity Demanded (sold)

21 Short Run Profit Maximization Two Approaches... Copyright McGraw-Hill, Inc. 1999

22 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Copyright McGraw-Hill, Inc. 1999

23 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Should the firm produce? Copyright McGraw-Hill, Inc. 1999

24 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Should the firm produce? What quantity should be produced? Copyright McGraw-Hill, Inc. 1999

25 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Should the firm produce? What quantity should be produced? What profit or loss will be realized? Copyright McGraw-Hill, Inc. 1999

26 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Produce in the short-run if it can realize Should the firm produce? What quantity should be produced? What profit or loss will be realized? Copyright McGraw-Hill, Inc. 1999

27 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Produce in the short-run if it can realize 1- A profit (or) Should the firm produce? What quantity should be produced? What profit or loss will be realized? Copyright McGraw-Hill, Inc. 1999

28 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach Produce in the short-run if it can realize 1- A profit (or) 2- A loss less than its fixed costs Should the firm produce? What quantity should be produced? What profit or loss will be realized? Copyright McGraw-Hill, Inc. 1999

29 TotalCostTotalProduct TotalFixedCostTotalVariableCost Total-Revenue-Total Cost Approach

30 0 1 2345678910 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost Total-Revenue-Total Cost Approach

31 0 1 2345678910 $ 100 $ 100 100 100 100100100100100100100100 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost Total-Revenue-Total Cost Approach

32 0 1 2345678910 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost Total-Revenue-Total Cost Approach

33 0 1 2345678910 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost Total-Revenue-Total Cost Approach

34 0 1 2345678910 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $71 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

35 0 1 2345678910 $ 0 71142213284355426497568639710 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $71 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

36 TotalCost 0 1 2345678910 TotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $71 - $100 - $100 - 119 - 128 - 127 - 116 - 115 - 124 - 143 - 182 - 241 - 320 Total-Revenue-Total Cost Approach $ 0 71142213284355426497568639710 Copyright McGraw-Hill, Inc. 1999

37 TotalCost 0 1 2345678910 TotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $71 - $100 - $100 - 119 - 128 - 127 - 116 - 115 - 124 - 143 - 182 - 241 - 320 Total-Revenue-Total Cost Approach $ 0 71142213284355426497568639710 Copyright McGraw-Hill, Inc. 1999 No profit and the loss is greater than its fixed costs Shut Down!

38 TotalCost 0 1 2345678910 TotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $71 - $100 - $100 - 119 - 128 - 127 - 116 - 115 - 124 - 143 - 182 - 241 - 320 Total-Revenue-Total Cost Approach $ 0 71142213284355426497568639710 Copyright McGraw-Hill, Inc. 1999 No profit and the loss is greater than its fixed costs Shut Down! How about a higher price?

39 0 1 2345678910 $ 0 81162243324405486567648729810 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $81 - $100 - $100 - 109 - 108 - 97 - 76 - 65 - 64 - 73 - 102 - 151 - 220 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

40 0 1 2345678910 $ 0 81162243324405486567648729810 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $81 - $100 - $100 - 109 - 108 - 97 - 76 - 65 - 64 - 73 - 102 - 151 - 220 Still no profit but losses are less than the firm’s fixed costs Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

41 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit 0 1 2345678910 $ 0 81162243324405486567648729810 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $81 - $100 - $100 - 109 - 108 - 97 - 76 - 65 - 64 - 73 - 102 - 151 - 220 Keep producing in the short-run: Look at a higher price Copyright McGraw-Hill, Inc. 1999 Still no profit but losses are less than the firm’s fixed costs

42 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach 0 1 2345678910 $ 0 131262393524655786917104811791310 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $131 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Can you see the profit maximization? Copyright McGraw-Hill, Inc. 1999

43 0 1 2345678910 $ 0 131262393524655786917104811791310 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $131 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

44 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit 0 1 2345678910 $ 0 131262393524655786917104811791310 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $131 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Graphically... Copyright McGraw-Hill, Inc. 1999

45 Total-Revenue-Total Cost Approach 1,7001,6001,5001,4001,3001,2001,1001,000 900 900 800 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 P Total revenue and total costs (dollars) Copyright McGraw-Hill, Inc. 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Q

46 Total-Revenue-Total Cost Approach 1,7001,6001,5001,4001,3001,2001,1001,000 900 900 800 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 P Total revenue and total costs (dollars) TotalRevenue Copyright McGraw-Hill, Inc. 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Q

47 Total-Revenue-Total Cost Approach 1,7001,6001,5001,4001,3001,2001,1001,000 900 900 800 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 P Total revenue and total costs (dollars) TotalRevenue TotalCost Copyright McGraw-Hill, Inc. 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Q

48 Total-Revenue-Total Cost Approach 1,7001,6001,5001,4001,3001,2001,1001,000 900 900 800 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 P Total revenue and total costs (dollars) TotalRevenue TotalCost { MaximumEconomicProfits$299 Break-Even Point (Normal Profit)TR(P=$131) Break-Even Point (Normal Profit) Copyright McGraw-Hill, Inc. 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Q

49 Marginal Revenue - Marginal Cost Approach Copyright McGraw-Hill, Inc. 1999 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach

50 Marginal Revenue - Marginal Cost Approach MR = MC Rule Features: Copyright McGraw-Hill, Inc. 1999 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach

51 Marginal Revenue - Marginal Cost Approach MR = MC Rule Features: MR = MC profit maximization in all markets MR = MC profit maximization in all markets Copyright McGraw-Hill, Inc. 1999 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach

52 Marginal Revenue - Marginal Cost Approach MR = MC Rule Features: MR = MC profit maximization in all markets MR = MC profit maximization in all markets Competitive markets maximize at P = MC Competitive markets maximize at P = MC Copyright McGraw-Hill, Inc. 1999 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach

53 Marginal Revenue - Marginal Cost Approach MR = MC Rule Features: MR = MC profit maximization in all markets MR = MC profit maximization in all markets Competitive markets maximize at P = MC Competitive markets maximize at P = MC Firms should produce MR=MC provided Firms should produce MR=MC provided MR (P) > AVC, if not then shut down. Copyright McGraw-Hill, Inc. 1999 Short Run Profit Maximization Two Approaches... Total-Revenue-Total Cost Approach

54 0 1 2345678910 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 Marginal-Revenue-Marginal Cost Approach ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

55 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 Marginal-Revenue-Marginal Cost Approach ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

56 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 Marginal-Revenue-Marginal Cost Approach $ 131 131131131131131131131131131 ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

57 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Marginal-Revenue-Marginal Cost Approach $ 131 131131131131131131131131131 ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

58 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss MarginalRevenue 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Marginal-Revenue-Marginal Cost Approach $ 131 131131131131131131131131131 ] ] ] ] ] ] ] ] ] ] The same profit maximizingresult! Copyright McGraw-Hill, Inc. 1999

59 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 - $100 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 Marginal-Revenue-Marginal Cost Approach $ 131 131131131131131131131131131 ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 The same profit maximizingresult! Graphically...Graphically...

60 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 Copyright McGraw-Hill, Inc. 1999

61 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q MR 200150100 50 50 0 131 Copyright McGraw-Hill, Inc. 1999

62 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q MR AVC 200150100 50 50 0 131 Copyright McGraw-Hill, Inc. 1999

63 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q MR AVC ATC 200150100 50 50 0 131 Copyright McGraw-Hill, Inc. 1999

64 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q MC MR AVC ATC 200150100 50 50 0 131 Copyright McGraw-Hill, Inc. 1999

65 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 131 MC MR AVC ATC Economic Profit 97.78 Copyright McGraw-Hill, Inc. 1999

66 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q MC MR AVC ATC 200150100 50 50 0 131 97.78 MR = MC OptimumSolution Copyright McGraw-Hill, Inc. 1999 Economic Profit

67 Marginal Revenue - Marginal Cost Approach... to Short-run loss minimization Copyright McGraw-Hill, Inc. 1999

68 Marginal Revenue - Marginal Cost Approach... to Short-run loss minimization If the price is lowered from $131 to $81 Copyright McGraw-Hill, Inc. 1999

69 Marginal Revenue - Marginal Cost Approach... to Short-run loss minimization If the price is lowered from $131 to $81 The MR = MC point changes... Copyright McGraw-Hill, Inc. 1999

70 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 Marginal-Revenue-Marginal Cost Approach ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

71 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 MC AVC ATC Copyright McGraw-Hill, Inc. 1999

72 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 81 MC MR AVC ATC Copyright McGraw-Hill, Inc. 1999 To minimize losses always look at the place where MR = MC in the increasing portion of the MC curve.

73 0 1 2345678910 $ 0 81162243324405486567648729810 $ 100 $ 100 100 100 100100100100100100100100 $ 0 90170240300370450540650780930 $ 100 1902703404004705506407508801030 Price: $81 - $100 - $100 - 109 - 108 - 97 - 76 - 65 - 64 - 73 - 102 - 151 - 220 Copyright McGraw-Hill, Inc. 1999 TotalCostTotalProduct TotalFixedCostTotalVariableCost TotalRevenue Profit Total-Revenue-Total Cost Approach

74 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 81 MC MR AVC ATC Economic Loss Copyright McGraw-Hill, Inc. 1999

75 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 81 MC MR AVC ATC Copyright McGraw-Hill, Inc. 1999 Economic Loss With economic losses, at what point should the firm shut down operations?

76 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 71 MC MR AVC ATC Copyright McGraw-Hill, Inc. 1999 When price is inadequate to meet minimum AVC, the firm should shut down Economic Loss

77 0 1 2345678910 90807060708090110130150 100.00 100.00 50.00 50.00 33.33 33.3325.0020.0016.6714.2912.5011.1110.0090.0085.0080.0075.0074.0075.0077.1481.2586.6793.00190.00135.00113.33100.0094.0091.6791.4393.7594.78103.00 Marginal-Revenue-Marginal Cost Approach ] ] ] ] ] ] ] ] ] ] Copyright McGraw-Hill, Inc. 1999 AverageTotalCost TotalProduct AverageFixedCostAverageVariableCost MarginalCost TotalEconomicProf./Loss Price = MarginalRevenue

78 Total revenue and total costs (dollars) Marginal-Revenue-Marginal Cost Approach 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 P Q 200150100 50 50 0 71 MC MR AVC ATC Copyright McGraw-Hill, Inc. 1999 When price is inadequate to meet minimum AVC, the firm should shut down Economic Loss Another use of the marginal cost curve...

79 P = MC Short - run Supply Curve P Q MC AVC ATC At every price, the MR = MC point changes the quantity being exchanged... Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

80 P = MC Short - run Supply Curve P Q MC AVC ATC P3P3P3P3 MR 3 Q3Q3Q3Q3 Record the quantity being supplied for each price Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

81 Marginal-Revenue-Marginal Cost Approach P Q MC AVC ATC MR 2 MR 3 P2P2P2P2 P3P3P3P3 Q2Q2Q2Q2 Q3Q3Q3Q3 At a lower price a lower quantity will be supplied Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

82 Marginal-Revenue-Marginal Cost Approach P Q MC AVC ATC MR 2 MR 3 MR 4 P2P2P2P2 P3P3P3P3 P4P4P4P4 Q3Q3Q3Q3 Q4Q4Q4Q4 At a higher price a greater quantity will be supplied Q2Q2Q2Q2 Break-even (normal profit) point Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

83 Marginal-Revenue-Marginal Cost Approach P Q MC AVC ATC MR 2 MR 3 MR 4 MR 5 P2P2P2P2 P3P3P3P3 P4P4P4P4 P5P5P5P5 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Q5Q5Q5Q5 Break-even (normal profit) point Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

84 Q Marginal-Revenue-Marginal Cost Approach P P1P1P1P1 MC MR 1 AVC ATC MR 2 MR 3 MR 4 MR 5 P2P2P2P2 P3P3P3P3 P4P4P4P4 P5P5P5P5 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Q5Q5Q5Q5 Break-even (normal profit) point Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999 Firm should not produce unless revenue is at least able to meet AVC

85 Marginal-Revenue-Marginal Cost Approach P Q P1P1P1P1 MC MR 1 AVC ATC MR 2 MR 3 MR 4 MR 5 P2P2P2P2 P3P3P3P3 P4P4P4P4 P5P5P5P5 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Q5Q5Q5Q5 Break-even (normal profit) point Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999 The Marginal Cost Curve at points above AVC represent the short-run supply curve

86 Marginal-Revenue-Marginal Cost Approach P Q P1P1P1P1 MC MR 1 AVC ATC MR 2 MR 3 MR 4 MR 5 P2P2P2P2 P3P3P3P3 P4P4P4P4 P5P5P5P5 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 Q5Q5Q5Q5 Short-run Supply Curve (blue) Costs and revenues (dollars) Copyright McGraw-Hill, Inc. 1999

87 Marginal-Revenue-Marginal Cost Approach P Q MC 1 AVC 1 If costs increase... the supply curve effectively shifts to the left Copyright McGraw-Hill, Inc. 1999

88 Marginal-Revenue-Marginal Cost Approach P Q MC 1 AVC 1 If costs increase... the supply curve effectively shifts to the left MC 2 AVC 2 Copyright McGraw-Hill, Inc. 1999

89 Marginal-Revenue-Marginal Cost Approach P Q MC 1 AVC 1 If costs decrease... the supply curve effectively shifts to the right MC 2 AVC 2 Copyright McGraw-Hill, Inc. 1999

90 Short-run Competitive Equilibrium P Q P Q D Industry Firm (price taker) TotalIndustryDemand Copyright McGraw-Hill, Inc. 1999

91 Short-run Competitive Equilibrium P Q P Q 8000 D S=  MC’s Industry Firm (price taker) $111 Include the firm’s costs MC Copyright McGraw-Hill, Inc. 1999

92 Short-run Competitive Equilibrium P Q MC AVC ATC P Q 8000 D S=  MC’s Industry Firm (price taker) The firm “takes” the Industry Price $111 Copyright McGraw-Hill, Inc. 1999

93 Short-run Competitive Equilibrium P Q MC AVC ATC 8 D P Q 8000 D S=  MC’s Industry Firm (price taker) $111 $111 Copyright McGraw-Hill, Inc. 1999

94 Short-run Competitive Equilibrium P Q MC AVC ATC 8 D P Q 8000 D S=  MC’s Industry Firm (price taker) EconomicProfit $111 $111 Copyright McGraw-Hill, Inc. 1999

95 Short-run Competitive Equilibrium P Q MC AVC ATC 8 D P Q 8000 D S=  MC’s Industry Firm (price taker) EconomicProfit $111 $111 Copyright McGraw-Hill, Inc. 1999 How about the long-run?

96 Long-run Profit Maximization Assumptions... Copyright McGraw-Hill, Inc. 1999

97 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Copyright McGraw-Hill, Inc. 1999

98 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Identical Costs Identical Costs Copyright McGraw-Hill, Inc. 1999

99 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Identical Costs Identical Costs Constant-Cost Industry Constant-Cost Industry Copyright McGraw-Hill, Inc. 1999

100 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Identical Costs Identical Costs Constant-Cost Industry Constant-Cost Industry Goal... Copyright McGraw-Hill, Inc. 1999

101 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Identical Costs Identical Costs Constant-Cost Industry Constant-Cost Industry Goal... Price = Minimum ATC Copyright McGraw-Hill, Inc. 1999

102 Long-run Profit Maximization Assumptions... Entry and Exit Only Entry and Exit Only Identical Costs Identical Costs Constant-Cost Industry Constant-Cost Industry Goal... Price = Minimum ATC Zero Economic Profit Model... Copyright McGraw-Hill, Inc. 1999

103 P Q MC P Q D1D1D1D1 S1S1S1S1 Industry Firm (price taker) ATC MR $60$50$40 $100$90,000 $60$50$40 $100,000 What happens if demand decreases... Copyright McGraw-Hill, Inc. 1999 Long-run Profit Maximization

104 P Q MC P Q D1D1D1D1 S1S1S1S1 Industry Firm (price taker) ATC MR $60$50$40 $100$90,000 D2D2D2D2 $60$50$40 $100,000 Short-run losses at lower prices... Copyright McGraw-Hill, Inc. 1999 Long-run Profit Maximization

105 P Q MC P Q D1D1D1D1 S1S1S1S1 Industry Firm (price taker) ATC MR $60$50$40 $100$90,000 D2D2D2D2 S3S3S3S3 $100,000...cause a reduction in supply and... $60$50$40 Copyright McGraw-Hill, Inc. 1999 Long-run Profit Maximization

106 P Q MC P Q D1D1D1D1 S1S1S1S1 Industry Firm (price taker) ATC MR $60$50$40 $100$90,000 D2D2D2D2 S3S3S3S3 $60$50$40 $100,000...returns to a new equilibrium Copyright McGraw-Hill, Inc. 1999 Long-run Profit Maximization

107 Pure Competition and Efficiency Productive Efficiency Copyright McGraw-Hill, Inc. 1999

108 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Copyright McGraw-Hill, Inc. 1999 Goods produced in the least costly way. The firm is producing the greatest output consistent with its costs.

109 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Copyright McGraw-Hill, Inc. 1999 Requires that goods be produced according to that which is most valued by society.

110 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Copyright McGraw-Hill, Inc. 1999

111 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Copyright McGraw-Hill, Inc. 1999

112 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Copyright McGraw-Hill, Inc. 1999 Society values that product more and firms will enter.

113 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Copyright McGraw-Hill, Inc. 1999 Society values that product less and firms will leave.

114 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC Copyright McGraw-Hill, Inc. 1999

115 P Q MC P Q D1D1D1D1 S1S1S1S1 Industry Firm (price taker) ATC MR $60$50$40 $100$90,000 $60$50$40 $100,000 What happens if demand decreases... Copyright McGraw-Hill, Inc. 1999 Long-run Profit Maximization

116 Pure Competition and Efficiency Productive Efficiency Price = Minimum ATC Allocative Efficiency Price = MC Underallocation Price > MC Overallocation Price < MC Copyright McGraw-Hill, Inc. 1999 Resources are efficiently allocated under competition

117 u pure competition u pure monopoly u monopolistic competition u oligopoly u imperfect competition u price taker u average revenue u total revenue u marginal revenue u break-even point u MR = MC rule u short-run supply curve u long-run supply curve u constant-cost industry u increasing-cost industry u decreasing-cost industry u productive efficiency u allocative efficiency Copyright McGraw-Hill, Inc. 1999

118 Coming Next... Pure Monopoly Chapter 24 Copyright McGraw-Hill, Inc. 1999

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