Maximization Profit and Competitive Supply
Chapter 8
A C T I V E L E A R N I N G
Identifying a firm's profit
Determine this firm's total profit. Identify the area on the graph that represents the firm's profit.
A competitive firm Costs, P MC P = $10 $6 MR ATC
50
Q
2
The Response of a Firm to a Change in Input Price
When the marginal cost of production for a firm increases (from MC1 to MC2), the level of output that maximizes profit falls (from q 1 to q 2 ). The shaded area in the figure gives the total savings to the firm (or equivalently, the reduction in lost profit) associated with the reduction in output from q 1 to q 2.
Industry Supply in the Short Run
Because the third firm has a lower average variable cost curve than the first two firms, the market supply curve S begins at price P 1 and follows the marginal cost curve of the third firm MC3 until price equals P 2, when there is a kink. For P 2 and all prices above it, the industry quantity supplied is the sum of the quantities supplied by each of the three firms.
Producer Surplus in the Short Run
producer surplus Sum over all units produced by a firm of differences between the market price of a good and the marginal cost of production. The producer surplus for a firm is measured by the yellow area below the market price and above the marginal cost curve, between outputs 0 and q*, the profit-maximizing output. Alternatively, it is equal to rectangle ABCD because the sum of all marginal costs up to q* is equal to the variable costs of producing q*.
Producer Surplus versus Profit
Producer surplus = PS = R - VC Profit = = R - VC - FC
Producer Surplus in the Short Run
The producer surplus for a market is the area below the market price and above the market supply curve, between 0 and output Q*.
Long-Run Profit Maximization
The firm maximizes its profit by choosing the output at which price equals long-run marginal cost LMC. In the diagram, the firm increases its profit from ABCD to EFGD by increasing its output in the long run.
Long-Run Competitive Equilibrium
ze ro e c o no mic pro fit A firm is earning a normal return on its investment--i.e., it is doing as well as it could by investing its money elsewhere. e ntry and e xit In a market with entry and exit, a firm enters when it can earn a positive longrun profit and exits when it faces the prospect of a long-run loss.
Long-Run Competitive Equilibrium Entry and Exit
Positive profit encourages entry of new firms and causes a shift to the right in the supply curve to S 2. The long-run equilibrium occurs at a price of $30, where each firm earns zero profit and there is no incentive to enter or exit the industry.
Long-Run Competitive Equilibrium
A long-run competitive equilibrium occurs when three conditions hold:
1.
All firms in the industry are maximizing profit. No firm has an incentive either to enter or exit the industry because all firms are earning zero economic profit. The price of the product is such that the quantity supplied by the industry is equal to the quantity by demanded consumers.
2.
3.
Long-Run Competitive Equilibrium
e c o no mic re nt: Amount that firms are willing to pay for an input less the minimum amount necessary to obtain it. pro duc e r s urplus in the lo ng run: In the long run, in a competitive market, the producer surplus that a firm earns on the output that it sells consists of the economic rent that it enjoys from all its scarce inputs.
Producer Surplus in the LongRun
In long-run equilibrium, all firms earn zero economic profit. In (a), a baseball team in a moderate-sized city sells enough tickets so that price ($7) is equal to marginal and average cost. In (b), the demand is greater, so a $10 price can be charged. The team increases sales to the point at which the average cost of production plus the average economic rent is equal to the ticket price. When the opportunity cost associated with owning the franchise is taken into account, the team earns zero economic profit.
The Industry's Long-Run Supply Curve
Lo ng -Run S upply in a Co ns tant-Co s t Indus try When demand increases, initially causing a price, the firm initially increases its output from q 1 to q 2. But the entry of new firms causes a shift to the right in industry supply. Because input prices are unaffected by the increased output of the industry, entry occurs until the original price is obtained.
The long-run s upply curve for a cons tant-cos t indus try is , the re fore , a horiz ontal line at a price that is e qual to the long-run m inim um ave rage cos t of production.
The Industry's Long-Run Supply Curve
Lo ng -Run S upply in an Inc re as ing -Co s t Indus try When demand increases, initially causing a price rise, the firms increase their output from q 1 to q 2. In that case, the entry of new firms causes a shift to the right in supply from S 1 to S 2 . Because input prices increase as a result, the new long-run equilibrium occurs at a higher price than the initial equilibrium.
In an incre as ing-cos t indus try, the long-run indus try s upply curve is upward s loping.
Effects of a Tax
Effe c t o f an Output Tax o n a Co mpe titive Firm's Output An output tax raises the firm's marginal cost curve by the amount of the tax. The firm will reduce its output to the point at which the marginal cost plus the tax is equal to the price of the product.
Effects of a Tax
Effe c t o f an Output Tax o n Indus try Output An output tax placed on all firms in a competitive market shifts the supply curve for the industry upward by the amount of the tax. This shift raises the market price of the product and lowers the total output of the industry.
A C T I V E L E A R N I N G
Identifying long-run equilibrium
A number of stores offer film developing as a service to their customers. Suppose that each store offering this service has a cost function C(q) = 50 + 0.5q + 0.08q2 and a marginal cost MC = 0.5 + 0.16q. If the going rate for developing a roll of film is $8.50, is the industry in long-run equilibrium? If not, find the price associated with long-run equilibrium.