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Microeconomics
Claudia Vogel
EUV
Winter Term 2009/
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
Pro t 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 su ciently 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 di cult for a rm to enter (or exit) an industry.
Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 3 / 30
Pro t Maximization and Competitive Supply Pro t Maximization
Do Firms Maximize Pro t?
The assumption of pro t 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, pro t 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 pro t are not likely to survive. Firms that do survive in competitive industries make long-run pro t maximization one of their higher priorities.
Pro t Maximization and Competitive Supply Choosing Output in the Short Run
A Competitive Firm Making a Positive Pro t
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
Pro t 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 pro t-maximizing output.
Pro t 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
Pro t Maximization and Competitive Supply The Competitive Firm's Short-Run Supply Curve
The Response of a Firm to a Change in Input Price
Pro t 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
Pro t 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.
Pro t Maximization and Competitive Supply The Short-Run Market Supply Curve
Producer Surplus versus Pro t
Producer Surplus: PS = R − VC
Pro t: π = R − VC − FC
Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 15 / 30
Pro t Maximization and Competitive Supply Choosing Output in the Long Run
Long-Run Pro t Maximization
The long-run output of a pro t-maximizing competitive rm is the point at which long-run marginal cost equals the price.
Pro t 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 pro ts.
Claudia Vogel (EUV) Microeconomics Winter Term 2009/2010 19 / 30
Pro t 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.
Pro t 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
Pro t 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
Pro t Maximization and Competitive Supply Summary
Summary 3/
In the long run, pro t-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 pro ts (^2) when all rms earn zero economic pro t, 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 pro t. Why is this true?
(^3) What is the dierence between economic pro t and producer surplus?
(^4) Why do rms enter an industry when they know that in the long run economic pro t 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 pro t in the short run?
