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Microeconomics: Perfectly Competitive Markets and Prot Maximization, Lecture notes of Microeconomics

A set of lecture notes from a Microeconomics course taught by Claudia Vogel at EUV during the Winter Term 2009/2010. The notes cover the topics of perfectly competitive markets, Prot maximization, and the relationship between marginal revenue, marginal cost, and Prot. explanations, diagrams, and examples to help students understand these concepts.

What you will learn

  • How does a competitive firm choose its output in the short run?
  • What are the three assumptions of the perfectly competitive markets model?
  • What is the relationship between marginal revenue and marginal cost at the Prot-maximizing output?
  • How does a firm maximize its Prot?
  • What is the difference between economic profit and producer surplus?

Typology: Lecture notes

2021/2022

Uploaded on 09/27/2022

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Microeconomics
Claudia Vogel
EUV
Winter Term 2009/2010
Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 1 / 30
Prot Maximization and Competitive Supply
Lecture Outline
Part II Producers, Consumers, and Competitive Markets
8
Prot Maximization and Competitive Supply
Perfectly Competitive Markets
Prot Maximization
Marginal Revenue, Marginal Cost, and Prot Maximization
Choosing Output in the Short Run
The Competitive Firm's Short-Run Supply Curve
The Short-Run Market Supply Curve
Choosing Output in the Long Run
The Industry's Long-Run Supply Curve
Summary
Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 2 / 30
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Microeconomics

Claudia Vogel

EUV

Winter Term 2009/

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 1 / 30

Prot Maximization and Competitive Supply

Lecture Outline

Part II Producers, Consumers, and Competitive Markets

(^8) Prot Maximization and Competitive Supply Perfectly Competitive Markets Prot Maximization Marginal Revenue, Marginal Cost, and Prot Maximization Choosing Output in the Short Run The Competitive Firm's Short-Run Supply Curve The Short-Run Market Supply Curve Choosing Output in the Long Run The Industry's Long-Run Supply Curve Summary

Prot Maximization and Competitive Supply Perfectly Competitive Markets

Perfectly Competitive Markets

The model of perfect competition rests on three basic assumptions: (^1) price taking, (^2) product homogeneity, and (^3) free entry and exit.

price taking: Because each individual rm sells a suciently small proportion of total market output, its decisions have no impact on market price. product homogeneity: When the products of all of the rms in a market are perfectly substituable with one another - that is, when they are homogeneous

  • no rm can raise the price of its product above the price of other rms without losing most or all of its business. free entry (or exit): Condition under which there are no special costs that make it dicult for a rm to enter (or exit) an industry.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 3 / 30

Prot Maximization and Competitive Supply Prot Maximization

Do Firms Maximize Prot?

The assumption of prot maximization is frequently used in microeconomics because it predicts business behavior reasonably accurately and avoids unnecessary analytical complications.

For smaller rms managed by their owners, prot is likely to dominate almost all decisions. In larger rms, however, managers who make day-to-day decisions usually have little contact with the owners (i.e. stockholders).

In any case, rms that do not come close to maximizing prot are not likely to survive. Firms that do survive in competitive industries make long-run prot maximization one of their higher priorities.

Prot Maximization and Competitive Supply Choosing Output in the Short Run

A Competitive Firm Making a Positive Prot

Output Rule: If a rm is producing any output, it should produce at the level at which marginal revenue equals marginal cost.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 7 / 30

Prot Maximization and Competitive Supply Choosing Output in the Short Run

A Competitive Firm Incurring Losses

Shut-Down Rule:The rm should shut down if the price of the product is less than the average variable cost of production at the prot-maximizing output.

Prot Maximization and Competitive Supply The Competitive Firm's Short-Run Supply Curve

The Short-Run Supply Curve for a Competitive Firm

The rm's supply curve is the portion of the marginal cost curve for which marginal cost is greater than average variable cost.

In the short run, the rm chooses its output, so that marginal cost MC is equal to price as long as the rm covers its average variable cost.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 9 / 30

Prot Maximization and Competitive Supply The Competitive Firm's Short-Run Supply Curve

The Response of a Firm to a Change in Input Price

Prot Maximization and Competitive Supply The Short-Run Market Supply Curve

Example: The Short-Run World Supply of Copper

Country Annual Production Marginal Cost (Thousand Metric Tons) ($ per Pound) Australia 950 1. Canada 600 1. Chile 5400 0. Indonesia 800 0. Peru 1050 0. Poland 530 1. Russia 720 0. US 1220 0. Zambia 540 0.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 13 / 30

Prot Maximization and Competitive Supply The Short-Run Market Supply Curve

Producer Surplus in the Short Run

producer surplus: Sum over all units produced by a rm of dierences between the market price of a good and the marginal cost of production.

Prot Maximization and Competitive Supply The Short-Run Market Supply Curve

Producer Surplus versus Prot

Producer Surplus: PS = R − VC

Prot: π = R − VC − FC

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 15 / 30

Prot Maximization and Competitive Supply Choosing Output in the Long Run

Long-Run Prot Maximization

The long-run output of a prot-maximizing competitive rm is the point at which long-run marginal cost equals the price.

Prot Maximization and Competitive Supply Choosing Output in the Long Run

Producer Surplus in the Long Run

In the long run, in a competitive market, the producer surplus that a rm earns on the output that it sells consists of the economic rent that it enjoys from all its scarce inputs. In the long run, all rms earn zero economic prots.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 19 / 30

Prot Maximization and Competitive Supply The Industry's Long-Run Supply Curve

Constant-Cost Industry

constant-cost industry: Industry whose long-run supply curve is horizontal.

The long-run supply curve for a constant-cost industry is, therefore, a horizontal line at a price that is equal to the long-run minimum average cost of production.

Prot Maximization and Competitive Supply The Industry's Long-Run Supply Curve

Increasing-Cost Industry

increasing-cost industry: Industry whose long-run supply curve is upward sloping.

In an increasing-cost industry, the long-run industry supply curve is upward sloping.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 21 / 30

Prot Maximization and Competitive Supply The Industry's Long-Run Supply Curve

The Eects of a Tax

output tax on a competitive rm's output

output tax on industry output

Prot Maximization and Competitive Supply Summary

Summary 3/

In the long run, prot-maximizing competitive rms choose the output at which price is equal to long-run marginal cost.

A long-run competitive equilibrium occurs under these conditions: (^1) when rms maximize prots (^2) when all rms earn zero economic prot, so that there is no incentive to enter or exit the industry; and (^3) when the quantity of the product demanded is equal to the quantity supplied.

The long-run supply curve for a rm is horizontal when the industry is a constant-cost industry in which the increased demand for inputs to production (associated with an increased demand for the product) has no eect on the market price of the inputs. But the long-run supply curve for a rm is upward sloping in an increasing-cost industry, where the increased demand for inputs causes the market price of some or all inputs to rise.

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 25 / 30

Exerxises 7

Problem 1

(^1) Why would a rm that incurs losses choose to produce rather than shut down?

(^2) In long-run equilibrium, all rms in the industry earn zero economic prot. Why is this true?

(^3) What is the dierence between economic prot and producer surplus?

(^4) Why do rms enter an industry when they know that in the long run economic prot will be zero?

(^5) True or false: A rm should always produce at an output at which long-run average cost is minimized. Explain.

Exerxises 7

Problem 2

(^1) What assumptions are necessary for a market to be perfectly competitive? Why is each of these assumptions important?

(^2) Suppose a competitive industry faces an increase in demand (i.e., the demand curve shifts upward). What are the steps by which a competitive market insures increased output? Will your answer change if the government imposes a price ceiling?

(^3) The government passes a law that allows a substantial subsidy for every acre of land used to grow tobacco. How does this program aect the long-run supply curve for tobacco?

Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 27 / 30

Exerxises 7

Problem 3

Suppose that a competitive rm's marginal cost of producing output q is given by MC (q) = 3 + 2 q. Assume that the market price of the rm's product is $9.

(^1) What level of output will the rm produce?

(^2) What is the rm's producer surplus?

(^3) Suppose that the average variable cost of the rm is given by AVC (q) = 3 + q. Suppose that the rm's xed costs are known to be $3. Will the rm be earning a positive, negative, or zero prot in the short run?