Chapter 11

1. Chapter 11 Managerial Decisions in Competitive Markets

2. Perfect Competition • Firms are price-takers • Each produces only a very small portion of total market or industry output • All firms produce a homogeneous product • Entry into & exit from the market is unrestricted

3. Demand for a Competitive Price-Taker • Demand curve is horizontal at price determined by intersection of market demand & supply • Perfectly elastic • Marginal revenue equals price • Demand curve is also marginal revenue curve (D = MR) • Can sell all they want at the market price • Each additional unit of sales adds to total revenue an amount equal to price

4. S P0 P0 D = MR D Q0 Demand for a Competitive Price-Taking Firm (Figure 11.2) Price (dollars) Price (dollars) 0 0 Quantity Quantity Panel B – Demand curve facing a price-taker Panel A – Market

5. Profit = Profit-Maximization in the Short Run • In the short run, managers must make two decisions: • Produce or shut down? • If shut down, produce no output and hires no variable inputs • If shut down, firm loses amount equal to TFC • If produce, what is the optimal output level? • If firm does produce, then how much? • Produce amount that maximizes economic profit

6. Profit Margin (or Average Profit) • Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) • Managers should ignore profit margin (average profit) when making optimal decisions

7. Short-Run Output Decision • Firm’s manager will produce output where P = MC as long as: • TR  TVC • or, equivalently, P  AVC • If price is less than average variable cost (P  AVC), manager will shut down • Produce zero output • Lose only total fixed costs • Shutdown price is minimum AVC

8. Total revenue =$36 x 600 = $21,600 Profit = $21,600 - $11,400 = $10,200 Profit Maximization: P = $36(Figure 11.3) Total cost = $19 x 600 = $11,400

9. Profit Maximization: P = $36(Figure 11.4) Panel A: Total revenue & total cost Panel B: Profit curve when P = $36

10. Total cost = $17 x 300 = $5,100 Short-Run Loss Minimization: P = $10.50(Figure 11.5) Profit = $3,150 - $5,100 = -$1,950 Total revenue = $10.50 x 300 = $3,150

11. Irrelevance of Fixed Costs • Fixed costs are irrelevant in the production decision • Level of fixed cost has no effect on marginal cost or minimum average variable cost • Thus no effect on optimal level of output

12. • Summary of Short-Run Output Decision • AVC tells whether to produce • Shut down if price falls below minimum AVC • SMC tells how much to produce • If P  minimum AVC, produce output at which P = SMC • ATC tells how much profit/loss if produce

13. Short-Run Supply Curves • For an individual price-taking firm • Portion of firms’ marginal cost curve above minimum AVC • For prices below minimum AVC, quantity supplied is zero • For a competitive industry • Horizontal sum of supply curves of all individual firms • Always upward sloping

14. Derivation of Short-Run Supply Curves (Figure 11.6)

15. Long-Run Profit-Maximizing Equilibrium (Figure 11.7) Profit = ($17 - $12) x 240 = $1,200

16. Long-Run Competitive Equilibrium • All firms are in profit-maximizing equilibrium (P = LMC) • Occurs because of entry/exit of firms in/out of industry • Market adjusts so P = LMC = LAC

17. Long-Run Competitive Equilibrium (Figure 11.8)

18. Long-Run Industry Supply • Long-run industry supply curve can be flat (perfectly elastic) or upward sloping • Depends on whether constant cost industry or increasing cost industry • Economic profit is zero for all points on the long-run industry supply curve for both types of industries

19. Long-Run Industry Supply • Constant cost industry • As industry output expands, input prices remain constant, & minimum LAC is unchanged • P = minimum LAC, so curve is horizontal (perfectly elastic) • Increasing cost industry • As industry output expands, input prices rise, & minimum LAC rises • Long-run supply price rises & curve is upward sloping

20. Long-Run Industry Supply for a Constant Cost Industry (Figure 11.9)

21. Long-Run Industry Supply for an Increasing Cost Industry(Figure 11.10) Firm’s output

22. Economic Rent • Payment to the owner of a scarce, superior resource in excess of the resource’s opportunity cost • In long-run competitive equilibrium firms that employ such resources earn only normal profit • Economic profit is zero • Potential economic profit is paid to the resource as rent

23. Economic Rent in Long-Run Competitive Equilibrium(Figure 11.11)

24. Profit-Maximizing Input Usage • Profit-maximizing level of input usage produces exactly that level of output that maximizes profit

25. Profit-Maximizing Input Usage • Marginal revenue product (MRP) • MRP of an additional unit of a variable input is the additional revenue from hiring one more unit of the input • If choose to produce: • If the MRP of an additional unit of input is greater than the price of input, that unit should be hired • Employ amount of input where MRP = input price

26. Profit-Maximizing Input Usage • Average revenue product (ARP) • Average revenue per worker • Shut down in short run if ARP < MRP • When ARP < MRP, TR < TVC

27. Profit-Maximizing Labor Usage (Figure 11.12)

28. • • Implementing the Profit-Maximizing Output Decision • Step 1: Forecast product price • Use statistical techniques from Chapter 7 • Step 2: Estimate AVC & SMC

29. Implementing the Profit-Maximizing Output Decision • Step 3: Check shutdown rule • If P AVCmin, produce • If P < AVCmin, shut down • To find AVCmin, substitute Qmin into AVC equation

30. Implementing the Profit-Maximizing Output Decision • Step 4: If P  AVCmin, find output where P = SMC • Set forecasted price equal to estimated marginal cost & solve for Q*

31. Implementing the Profit-Maximizing Output Decision • Step 5: Compute profit or loss • Profit = TR - TC • If P < AVCmin, firm shuts down & profit is -TFC

32. Profit & Loss at Beau Apparel (Figure 11.13)

33. Profit & Loss at Beau Apparel (Figure 11.13)