lecture12 - Profit Maximization and Competitive Supply...

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Chapter 8 Profit Maximization and Competitive Supply
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Key topics 1. competitive firm is a price taker 2. profit maximization 3. competition in short run (SR) 4. competition in long run (LR) 1. competitive firms earn zero LR profit
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Do competitive firms pass through 100% of cost increases to customers? Why are there mini-banks in grocery stores? Why do unprofitable steel firms continue to operate for years? Which way do manufacturing market supply curves slope?
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Major question facing a firm "How much output should we produce?"
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Optimal output to pick profit-maximizing level of output, firm must consider its cost function how much it can sell at a given price (demand) market structure number of firms in the market ease of enter and exit firm’s ability to differentiate its product from its rivals’
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Why start with competition frequently observed market structure has desirable properties, so it is useful to compare other market structure to competition
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Competition consumers believe that all firms sell identical products firms freely enter and exit market buyers and sellers know the prices charged by firms transaction costs are low
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Price taking if all 4 conditions hold each firm is a price taker: firm cannot affect market prices even if some of conditions don't hold, firms may be price takers for example, if entry of new firms is limited but there are many firms, no firm can successfully raise its price
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Meaning of “competitive firms” to most people: firms that are rivals for the same customers to economists: firm is a price taker competitive firm ignores individual rival’s behavior in deciding how much to produce
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Why would a competitive firm be a price taker? answer : it has no choice competitive firm faces a demand curve that is horizontal at the market price
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Residual Demand Curve
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Profit maximization economists assume that a firm maximizes its profit competitive firm that did not profit maximize would lose money and be driven out of business
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Profit
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Business vs. economic profit business profit: revenue minus business cost (only explicit cost) economic profit: revenue minus economic cost (explicit + implicit cost: opportunity cost) because explicit cost economic cost, business profit economic profit we always use economic profit
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Example: Own your own firm you pay explicit costs (wages, materials,. ..) you do not pay yourself a salary you receive a business profit of $20,000 per year your opportunity cost is $25,000, so you have an economic loss of $5,000
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Profit function
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to maximize its profit, any firm (not just competitive firms) must answer two questions: output decision : if the firm produces, what output level, q *, maximizes its profit or minimizes its loss? shut-down decision
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This note was uploaded on 08/01/2008 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at University of California, Berkeley.

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lecture12 - Profit Maximization and Competitive Supply...

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