[Recommended]chapter 10 econ Q&A

chapter 10 econ Q&A Microeconomics Perfect Competition Short Run Decisions Perfect Competition in the Long Run Should this firm shut down? PRODUCTION 500 UNITS PRICE…

chapter 10 econ Q&A
Microeconomics
Perfect Competition
Short Run Decisions
Perfect Competition in the Long Run
Should this firm shut down?
PRODUCTION
500 UNITS
PRICE
$4 PER UNIT
AFC = $2
AVC = $3
TVC = $5
Perfect Competition
Short Run Decisions
Perfect Competition
ASSUMPTIONS
There are many sellers and many buyers
Firms produce and sell homogeneous products
Perfect information
No barriers to entry
Firms are price takers
Firm demand is perfectly elastic
P = MR
Profit Maximization Rule
MR = MC
For perfectly elastic firms that maximize profit/minimize cost:
P = MR = MC
P = MC
CONTINUE TO OPERATE Perfectly Competitive Firms SHUT DOWN?
TWO CHOICES
in the short run…
1. CONTINUE
TO
OPERATE
2. SHUT DOWN
Case 1: Continue to Operate or Shut Down?
PRODUCTION
500 UNITS
PRICE
$4 PER UNIT
AFC = $2
AVC = $3
1. If the firm continues to operate…
PRODUCTION
500 UNITS
PRICE
$4 PER UNIT
AFC = $2
AVC = $3
TOTAL REVENUE = $4 * 500 = $2000
TOTAL FIXED COST = $2 * 500 = $1000
TOTAL VARIABLE COST = $3*500 = $1500
TOTAL COST = TFC + TVC = $2500
PROFIT = TR – TC = -$500
2. If the firm shuts downs…
PRODUCTION
500 UNITS
PRICE
$4 PER UNIT
AFC = $2
AVC = $3
TOTAL REVENUE = $4 * 0 = $ZERO
TOTAL FIXED COST = $2 * 500 = $1000
TOTAL VARIABLE COST = $3*0 = $0
TOTAL COST = TFC + TVC = $1000
PROFIT = TR – TC = -$1000
P=$4, Q=500, AFC=$2, AVC=$3
FIRM SHUTS DOWN
TOTAL REVENUE : 0
TOTAL COST : 1000
PROFIT : -1000
FIRM CONTINUES TO OPERATE
TOTAL REVENUE : 2000
TOTAL COST : 2500
PROFIT : -500
So the firm
continues operate, but at a loss.
CASE 2 CONTINUE TO OPERATE OR SHUT DOWN?
PRODUCTION
100 UNITS
PRICE
$7 PER UNIT
AFC = $1
AVC = $3
CONTINUE TO OPERATE OR SHUT DOWN?
PRODUCTION
100 UNITS
PRICE
$7 PER UNIT
AFC = $1
AVC = $3
TOTAL REVENUE = $7 * 100 = $700
TOTAL FIXED COST = $1 * 100 = $100
TOTAL VARIABLE COST = $3*100 = $300
TOTAL COST = TFC + TVC = $400
PROFIT = TR – TC = $300
THIS FIRM IS EARNING A PROFIT
CONTINUE TO OPERATE
Case 3: Continue to Operate or Shut Down?
PRODUCTION
800 UNITS
PRICE
$1 PER UNIT
AFC = $1
AVC = $2
If the firm continues to operate…
PRODUCTION
800 UNITS
PRICE
$1 PER UNIT
AFC = $1
AVC = $2
TOTAL REVENUE = $1 * 800 = $800
TOTAL FIXED COST = $1 * 800 = $800
TOTAL VARIABLE COST = $2*800 = $1600
TOTAL COST = TFC + TVC = $2400
PROFIT = TR – TC = -$1600
If the firm shuts down…
PRODUCTION
800 UNITS
PRICE
$1 PER UNIT
AFC = $1
AVC = $2
TOTAL REVENUE = $1 * 0 = $ ZERO
TOTAL FIXED COST = $1 * 800 = $800
TOTAL VARIABLE COST = $2*800 = $0
TOTAL COST = TFC + TVC = $800
PROFIT = TR – TC = -$800
P=$1, Q=800, AFC=$1, AVC=$2
SHUTS DOWN
TOTAL REVENUE : 0
TOTAL COST : 800
PROFIT : -800
So the firm shuts down
CONTINUES TO OPERATE
TOTAL REVENUE : 800
TOTAL COST : 2400
PROFIT : -1600
Decisions in the Short Run
Relationships with short run costs
CASE 1: AVC < P=$4 < ATC
CONTINUE TO OPERATE
PROFIT = 2000 – 2500 = -500
SHUT DOWN
PROFIT = 0 – 1500 = -1500
CASE 2: P=$7 > ATC
CONTINUE TO OPERATE
PROFIT = 700 – 400 = 300
SHUT DOWN
PROFIT = 0 – 300 = -300
CASE 3: P=$1 < AVC
CONTINUE TO OPERATE
PROFIT = 800 – 2400 = -1600
SHUT DOWN
PROFIT = 0 – 800 = -800
Summary
CASE 1  CONTINUE TO OPERATE
Price is below Average Total Cost and
Price is above Average Variable Cost
CASE 2  CONTINUE TO OPERATE
Price is above Average Total Cost
CASE 3  SHUT DOWN
Price is below Average Variable Cost
So now…why did they close?
Exercise (1 of 2)
A perfectly competitive firm is producing 4900 units per month. The average variable cost is $16, and the total cost is $147,000. If the price is projected to be $20 per unit next month, then should the firm continue to operate or shut down?
Exercise (1 of 2)
P = $20
AVC = $16
ATC = 147000 / 4900 = $30
Continues to Operate:
Loss= $49,000
Shut down:
Loss = $68,600
Microeconomics
Perfect Competition in the Long Run
Why we study market structures
Market Structure
The setting in which a firm operates.
Characteristics of markets determine decisions related to the quantity produced, and the selling price.
TYPES OF MARKET STRUCTURES
Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
Perfect Competition
ASSUMPTIONS
There are many sellers and many buyers
Each is small enough to have no influence on price
Firms produce and sell homogeneous products
Products are indistinguishable from each other (e.g., corn)
Perfect information
Buyers and sellers have all relevant info: prices, quality, source of supplies
No barriers to entry
Firms are free to enter and exit markets at will
Price Takers
Perfectly competitive firms are price takers; that is, they have no control over the market price, so individual firms face a perfectly elastic demand curve. Furthermore, P=MR…
Profit Maximizers
Profit maximizing firms set MR=MC, so…
P= MR
MR = MC
P=MC
Short Run Decisions, Case 1
P > ATC
Continue to operate
Earn a profit
Short Run Decisions, Case 2
ATC > P > AVC
Continue to operate
Incur a loss
Short Run Decisions, Case 3
P < AVC
Shut down
Incur a loss
Something to think about
Suppose the government imposes a production tax on one perfectly competitive firm in an industry. For each unit the firm produces, it must pay $1 to the government. Will consumers in this market end up paying higher prices because of the tax? Why or why not?
The tax increases the price per unit, and the new equilibrium price is the same as the old equilibrium price.
Buyers pay the full tax, and sellers pay none of the tax.
Types of Economic Efficiency
Resource Allocative Efficiency
Productive Efficiency
Types of Efficiency
Resource Allocative Efficiency
Optimal use of scarce resources
Market price = marginal cost of supply : P = MC
Types of Efficiency
Resource Allocative Efficiency
Optimum use of scarce resources
Market price = marginal cost of supply : P = MC
Productive Efficiency
Minimize resource wastage
Maximum productivity
Unit costs are the lowest possible : min(ATC)
This is not guaranteed in the short run, but is in the long run.
Perfectly Competitive Firm
P = MC
P = SRATC
Economic profit = 0
No incentive for firms to enter
Perfect Competition
Long Run Competitive Equilibrium
Assumptions
Firms are perfectly competitive ( P = MC )
P=MR, MR=MC, P=MC
Economic profit is zero ( P=SRATC )
If P > SRATC, then firms will enter the industry to earn positive economic profits
Firms have no incentive to change plant size ( SRATC = LRATC )
Compared to SRATC > LRATC, where firms have incentive to change plant size in the long run.
Implications
In long-run competitive equilibrium, firms have
no incentive to: Enter or exit industry
…because P=SRATC, and economic profits are zero
no incentive to: Produce more output, or less output
…because P=MC
no incentive to: Change plant size
…because SRATC = LRATC
——————————————————————-
Thus in the long run: P=SRATC=LRATC
Long-Run Competitive Equilibrium
P = MC
the firm has no incentive to move away from the quantity of output at which this occurs, q1
P = SRATC
no incentives for firms to enter or exit the industry (zero economic profit)
SRATC = LRATC
no incentive for the firm to change its plant size
43
Long Run Equilibrium
Industry Adjustment to a Change in Demand
Industry Adjustment to Increased Demand
Increased market demand…
Market equilibrium price rises, and so does Marginal Revenue!
P > SRATC
 Economic Profits
Incentive to produce more.
Incentive for new firms to enter industry.
Increased demand  higher market equilibrium price
P > SRATC  economic profits
 new firms enter industry
 increased market supply
 market equilibrium price falls
…how much does it fall?
Constant Cost Industry
New long run equilibrium price is same as old long run equilibrium price
Increasing Cost Industry
Initially market is in long range competitive equilibrium, then industry adjusts to a change in demand…
Increased demand  higher market equilibrium price
P > SRATC  economic profits
 new firms enter industry
 increased market supply
 market equilibrium price falls
Increasing Cost Industry
New equilibrium price is greater than the old equilibrium price
Increasing Cost Industry
P = MR = MC
P = SRATC = LRATC
New Price is higher
New SRATC, LRATC is too
Finite Resources:
Oil, Gold, Silver
Moving from one LR equilibrium to another
Constant-Cost Industry
New Long Run Price = Old Long Run Price
Agricultural commodities: corn, soybeans
Increasing-Cost Industry
New Long Run Price > Old Long Run Price
Finite natural resources: oil, metals
Decreasing-Cost Industry
New Long Run Price < Old Long Run Price
Long Run Competitive Equilibrium
Market demand increases, raising the equilibrium price.
Demand and Marginal Revenue increase for the firm
P > SRATC  attracts new firms to industry…
New firms enter industry, driving the market price down.
Until P = SRATC = LRATC
New long-run equilibrium price is less than old LR-equilibrium price
Decreasing Cost Industry
P = MR = MC
P = SRATC = LRATC
New Price is lower
New SRATC, LRATC also
Economies of scale allow The industry to produce more at a lower cost.
e.g., microchips, car parts
Moving from one LR equilibrium to another
Constant-Cost Industry
New Long Run Price = Old Long Run Price
Number of firms don’t affect production costs
Agricultural commodities: corn, soybeans
Increasing-Cost Industry
New Long Run Price > Old Long Run Price
Production costs rise as new firms enter the industry
Finite natural resources: oil, metals
Decreasing-Cost Industry
New Long Run Price < Old Long Run Price
Production costs fall as new firms enter industry
Computer chips, car parts
Can Industries Change?
The Case of the Energy Industry:
As oil, gas, and coal production gradually give way to production of energy by solar, wind and tidal power, how will this change production costs for the industry as a whole?
If the industry focuses only on oil, gas, and coal then it will an increasing cost industry, because resources are finite.
Solar, wind, and tidal power are limitless resources…
So…adding solar, wind and tidal power could transform the energy industry into a decreasing-cost industry!
Q: Impact of Discrimination
A firm’s discriminatory behavior can affect its profits in the context of the model of perfect competition
Suppose that under the conditions of long-run competitive equilibrium (zero profits), the owner of a firm chooses not to hire an excellent worker because of that worker’s race, religion or gender; what happens?
A: Impact of Discrimination
A firm’s discriminatory behavior can affect its profits in the context of the model of perfect competition
Suppose that under the conditions of long-run competitive equilibrium (zero profits), the owner of a firm chooses not to hire an excellent worker because of that worker’s race, religion or gender; what happens?
Their costs will rise above those of competitors who hire the best employees without regard to race, religion, etc.
Because they earn zero profit, the act of discrimination will raise total cost and put the firm into taking economic losses
Thank you
Please explore the following
additional graphical examples
on your own
Additional graphical examples of long run competitive equilibrium and how it relates to long run supply (LRS)
Constant-Cost Industry
New long run equilibrium price is equal to the old long run equilibrium price
Long Run Supply Curve
Perfectly Elastic
Increasing-Cost Industry
New long run equilibrium price is greater than the old long run equilibrium price.
Long Run Supply Curve
Upward sloping
Decreasing-Cost Industry
New long run equilibrium price is less than the old long run equilibrium price.
Long Run Supply Curve
Downward sloping
END OF PRESENTATION

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