1. Unit 3: Costs of Production and Perfect Competition
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2. 4 Market Structures Candy Markets Simulation Copyright
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3. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Every product is sold in a market that can be considered one of the above market structures.
For example:
Fast Food Market
Cars Manufactures
Market for Operating Systems (Microsoft)
Strawberry Market
Cereal Market
Monopolistic Competition (differentiated products)
Oligopoly
Monopoly
Perfect Competition
Oligopoly (3 main producers)
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4. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
Many small firms
Identical products (perfect substitutes)
Low Barriers- Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.
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5. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Monopoly:
Examples: The Electric Company, De Beers,
One large firm (the firm is the market)
Unique product (no close substitutes)
High Barriers- Firms cannot enter the industry
Monopolies are “Price Makers”
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6. Barriers to Entry Types of Barriers to Entry 1. Economies of Scale
A monopoly wouldn’t last long if there were not high barriers to keep other firms from entering.
Types of Barriers to Entry
1. Economies of Scale
Ex: There is only one electric company because they are the only ones that can make electricity ay the lowest cost. This is a “natural monopoly”
2. Superior Technology
3. Geography or Ownership of Raw Materials
4. Government Created Barriers
The government issues patents to protect inventors and forbids others from using their invention
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7. Four Market Structures Characteristics of Oligopolies:
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Oligopolies:
Examples: Cell Phones, Service Providers, Cars
A Few Large Producers (Less than 10)
Identical or Differentiated Products
High Barriers to Entry
Control Over Price (Price Maker)
Mutual Interdependence
Firms must worry about the decisions of their competitors and use strategy
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8. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Mono. Comp:
Examples: Fast food, furniture, shoe stores
Relatively Large Number of Sellers
Differentiated Products
Some control over price
Low Barriers- easy for firms to enter
A lot of non-price competition (Advertising)
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9. Perfect Competition
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10. Imperfect Competition The seller has NO control over price.
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples: Corn, Strawberries, Milk, etc.
Many small firms
Identical products (perfect substitutes)
Low Barriers- Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.
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11. Demand for Perfectly Competitive Firms (A Horizontal straight line)
Why are they Price Takers?
If a firm charges above the market price, NO ONE will buy. They will go to other firms
There is no reason to price low because consumers will buy just as much at the market price.
Since the price is the same at all quantities demanded, the demand curve for each firm is…
Perfectly Elastic
(A Horizontal straight line)
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12. The Competitive Firm is a Price Taker Price is set by the Industry
(all firms)
Firm P S P
Demand
$10
$10 D Q
5000 Q
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13. The Competitive Firm is a Price Taker Price is set by the Industry
What is the additional revenue for selling an additional unit?
1st unit earns $10
2nd unit earns $10
Marginal revenue is constant at $10
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue
Firm P
Demand
$10
MR=D=AR=P Q 13 13
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14. For Perfect Competition: Demand = MR (Marginal Revenue)
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional revenue for selling an additional unit?
1st unit earns $10
2nd unit earns $10
Marginal revenue is constant at $10
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue
Firm P
Demand
$10
MR=D=AR=P Q 14 14
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15. Maximizing PROFIT! 15
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16. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
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17. Profit Maximizing Rule Short-Run Profit Maximization
MR=MC
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11 17
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18. Lets put costs and revenue together to calculate profit.
Industry
Firm
(price taker) P S P MC
Demand $7 $7
ATC D Q
10,000 Q
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19. How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? P $9 8 7 6 5 4 3 2 1 MC
MR=D=AR=P
Profit = $18
ATC
Total Cost=$45
Total Revenue =$63 Q
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20. The profit maximizing rule is also the loss minimizing rule!!!
Suppose the market demand falls. What would happen if the price is lowered from $7 to $5?
The MR=MC rule still applies but now the firm will make an economic loss.
The profit maximizing rule is also the loss minimizing rule!!!
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21. How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1
ATC
Cost and Revenue
Loss =$7
MR=D=AR=P
Total Cost = $42
Total Revenue=$35 Q

22. The Shut Down Rule 22
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23. Assume the market demand falls even more
Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing.
Shut Down Rule:
A firm should continue to produce as long as the price is above the AVC
When the price falls below AVC then the firm should minimize its losses by shutting down
Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.
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24. Minimum AVC is shut down point
SHUT DOWN! Produce Zero
Price MC $9 8 7 6 5 4 3 2 1
ATC
AVC
Minimum AVC is shut down point Q
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25. P<AVC. They should shut down
Producing nothing is cheaper than staying open.
Price MC $9 8 7 6 5 4 3 2 1
ATC
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20 Q
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26. Profit Maximizing Rule
MR = MC
Three Characteristics of MR=MC Rule:
Rule applies to ALL markets structures (PC, Monopolies, etc.)
The rule applies only if price is above AVC
Rule can be restated P = MC for perfectly competitive firms (because MR = P)
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27. Practice 27
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28. #1 MC MR=D=AR= P ATC Quantity $16 15 10 9 14 5
1. Should the firm produce?
2. What output should the firm produce?
3. What is the TR and TC at that output?
4. How much profit or loss?
Yes 10
TR=$140
TC=$100
$16 15 10 9 5
Profit=$40
Price MC
MR=D=AR= P 14
ATC
Quantity
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29. #2 MC ATC AVC MR=D=AR=P Quantity 24 20 12 18 15
What output should the firm produce?
What is TR at that output?
What is TC?
How much profit or loss? 6
$90
$120
Loss= $30 24 20 12
Price MC
ATC 18
AVC 15
MR=D=AR=P
Quantity
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30. #3 MC ATC AVC MR=D=AR=P Quantity $12 10 11 9
1. What output should the firm produce?
2. What is TR at MR=MC point?
3. What is TC at MR=MC point?
4. How much profit or loss?
Zero Shutdown
(Price below AVC)
$45
$55
Loss=Only Fixed Cost $5
$12 10
Price MC
ATC
AVC 11 9
MR=D=AR=P
Quantity
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31. #4 MC MR=D=AR= P ATC Quantity $12 11 6 5 10 3
1. Should the firm produce?
2. What output should the firm produce?
3. What is the TR and TC at that output?
4. How much profit or loss?
Yes 10
TR=$100
TC=$60
$12 11 6 5 3
Profit=$40
Price MC
MR=D=AR= P 10
ATC
Quantity
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32. B D

33. 2007 Form B FRQ
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34. 2007 Form B FRQ
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35. Assume the firm can sell each unit at a price of $30
Maximizing Profit
Assume the firm can sell each unit at a price of $30
How many units should the firm produce to maximize profit?
What is the total revenue at that quantity?
How much is the profit?
Output
Variable
Cost
Fixed
Total
Marginal $0
$20 - 1
$12 2
$22 3
$27 4
$40 5
$60 6
$100
5 Units
$150 Total Revenue ($30 x 5)
$70 Profit ($150 - $80)
Notice that at 6 units the firm is still making profit. It’s just not maximizing profit
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36. Maximizing Profit
Output
Variable
Cost
Fixed
Total
Marginal $0
$20 - 1
$12 2
$22 3
$27 4
$40 5
$60 6
$100 TR MR
Profit -
$30
-$2
$60
$18
$90
$43
$120
$150
$70
$180
5 Units
$150 Total Revenue ($30 x 5)
$70 Profit ($150 - $80)
Notice that at 6 units the firm is still making profit. It’s just not maximizing profit
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37. 2006 FRQ 37
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38. 2006 FRQ 38
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39. Short-run Supply Curve39
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40. Marginal Cost and Supply As price increases, the quantity increases
$50 45 40 35 30 25 20 15 10 5 MC
ATC
MR5
Cost and Revenue
AVC
MR4
MR3
MR2
MR1 Q 40

41. Short-run Supply Curve: MC above AVC
Marginal Cost and Supply
When price increases, quantity increases
When price decrease, quantity decreases
$50 45 40 35 30 25 20 15 10 5 MC
= Supply
Short-run
Supply Curve:
MC above AVC
ATC
Cost and Revenue
AVC Q 41
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42. Marginal Cost and Supply
If variable costs increase (ex: per unit tax)
MC2=Supply2
$50 45 40 35 30 25 20 15 10 5
MC1=Supply1
AVC
Cost and Revenue
AVC
When MC increases, SUPPLY decrease Q 42
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43. Marginal Cost and Supply
What if variable costs decrease (ex: subsidy)?
MC1=Supply1
$50 45 40 35 30 25 20 15 10 5
MC2=Supply2
AVC
Cost and Revenue
AVC
When MC decreases, SUPPLY increases Q 43
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44. Marginal Cost and Supply
What happens to quantity if fixed costs increase?
Price MC
MR=D=AR= P PF
ATC1
ATC
Quantity stays the same because MC/Supply doesn’t change
Quantity QF
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45. Per Unit vs. Lump Sum
A PER UNIT tax or subsidy is effects the VARIABLE COSTS so MC, AVC, and ATC will shift.
This WILL effect the quantity produced
A LUMP SUM tax or subsidy only effects FIXED COSTS so only AFC and ATC will shift. MC stays the same.
This WILL NOT effect the quantity produced 45
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46. 2008 Audit Exam
18.B

47. No Profit, No Product