Unit 6 - Profit Maximization of a Purely Competitive Firm

1. Unit 6 - Profit Maximization of a Purely Competitive Firm • Types of Industries We distinguish between four types of industries: • Pure (Perfect) Competition • Monopolistic Competition • Oligopoly • Monopoly Microeconomics

2. Unit 6 - Profit Maximization of a Purely Competitive Firm • Pure Competition A purely competitive industry has the following characteristics: • Many sellers • Low barriers to enter • Competitors’ products are identical • Buyers have perfect information Microeconomics

3. Unit 6 - Profit Maximization of a Purely Competitive Firm • Profit Maximization Profit = Total Revenue (TR) - Total Cost (TC) Example 1A firm sells 100 products at $2.00 each. Its total cost is $160. What is its profit? Microeconomics

4. Unit 6 - Profit Maximization of a Purely Competitive Firm • Profit Maximization Example 1 answerProfit = TR – TCTR = P x Q = $2 x 100 = $200 Profit = $200 - $160 = $40 Microeconomics

5. Unit 6 - Profit Maximization of a Purely Competitive Firm • Marginal and Average Revenue Because one firm in pure competition is a small part of the entire market, it can supply more products to the market without significantly affecting the supply and the price. For example, if the market price is $2, then a purely competitive firm can sell 100 products at $2, 110 products at $2, or 120 products at $2. Microeconomics

6. Unit 6 - Profit Maximization of a Purely Competitive Firm • Marginal and Average Revenue Marginal revenue is the additional revenue per product. For example, if at Q = 100, TR = $200, and at Q = 110, TR = $220, then MR = $20 / 10, or $2. Average revenue is the revenue per product. If at Q = 100, TR = $200, then AR = $200 / 100, or $2. Microeconomics

7. Unit 6 - Profit Maximization of a Purely Competitive Firm • Marginal and Average Revenue Demand and revenue for a purely competitive firm, which sells a product at $2 is as follows: Microeconomics

8. Unit 6 - Profit Maximization of a Purely Competitive Firm • A Purely Competitive Firm’s Total Revenue Curve Price, Revenue Total Revenue 240 220 200 100 110 120 Quantity Microeconomics

9. Unit 6 - Profit Maximization of a Purely Competitive Firm • A Purely Competitive Firm’s Demand, Marginal, and Average Revenue Curves Demand, AR, MR 2.00 D = MR = AR Quantity 100 110 120 Microeconomics

10. Unit 6 - Profit Maximization of a Purely Competitive Firm • A Purely Competitive Firm’s Cost and Revenue Curves AR, MR, Price, Costs MC ATC 2.00 D = MR = AR AVC Quantity Microeconomics

11. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Profit-maximizing Quantity AR, MR, Price, Costs MC ATC MR=MC 2.00 D = MR = AR AVC Quantity Qpm Microeconomics

12. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Profit Area AR, MR, Price, Costs MC ATC MR=MC 2.00 D = MR = AR 1.80 AVC 100 Quantity Microeconomics

13. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Case of a Loss AR, MR, Price, Costs MC ATC 1.60 D = MR = AR AVC Qlm Quantity Microeconomics

14. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Case of a Loss and a Shut-down AR, MR, Price, Costs MC ATC AVC 1.20 D = MR = AR Quantity Microeconomics

15. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Long-run Equilibrium Price and Quantity AR, MR, Price, Costs MC ATC AVC 1.75 D = MR = AR Qlr Quantity Microeconomics

16. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Farming Industry Characteristics of farming industries in industrialized countries include: • There are many farmers. • There are relatively low barriers to enter the farming industry. • Farmers competing in the same market sell identical or nearly identical products. • Buyers of agricultural products have significant information about the product. Microeconomics

17. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Farming Industry and Elasticity Supply of agricultural products has increased considerably during the past century. Demand for agricultural products has increased as well, but not as much supply, because: • Income inelasticity of demand for food is low. • Price elasticity of demand for food is low. Microeconomics

18. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Farming Industry • Revenue (TR) of many farmers has decreased, because real prices (P) have decreased. TR = P x QP has decreased considerably. Q (quantity sold) has increased, but less than proportionately. Microeconomics

19. Unit 6 - Profit Maximization of a Purely Competitive Firm • The Farming Industry In industrialized countries, the following programs have been implemented:1. Price Supports2. Acreage Restrictions3. Target Prices4. Direct Subsidies and Loan Programs5. Foreign Import Restrictions Microeconomics

20. Unit 6 - Profit Maximization of a Purely Competitive Firm PricePer Bushel D surplus S $5.00 $3.00 Quantity Demanded of Wheat in Hundreds 10 12 15 Price Supports

21. Unit 6 - Profit Maximization of a Purely Competitive Firm PricePer Bushel S2 S1 $6.00 $3.00 D Quantity Demanded of Wheat in Hundreds 10 12 Acreage Restrictions

22. Unit 6 - Profit Maximization of a Purely Competitive Firm PricePer Bushel D S $4.50 DeficiencyPayment of$4.50 - $1.50 = $3.00 $3.00 $1.50 Quantity Demanded of Wheat in Hundreds 12 15 Target Prices

23. Unit 6 - Profit Maximization of a Purely Competitive Firm • Other Farm Subsidy Programs Direct subsidies and soft loans to farmers increase farmers’ incomes and raise taxes. Import restrictions support domestic farmers by restricting competition and supply. Consumers pay higher prices. Yearly cost of U.S. farm programs is approximately $20 billion. Microeconomics