PAM_2000_Spring_2009_Lecture_13

PAM_2000_Spring_2009_Lecture_13 - PAM 2000 L ecture 13...

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    PAM 2000 Lecture 13 Agenda: Competitive firms and markets Residual demand curve Economic profits Firm’s shut-down decision
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    Competitive Firms and Markets Here we look at the behavior of firms in a stylized situation: perfect competition Benchmark model Assume: There are many firms and buyers Each firm produces the same homogenous good (buyers view products produced by different firms as perfect substitutes)
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    Competitive Firms and Markets  (con’t) Firms can easily enter and exit the industry Buyers and sellers know the prices charged Transaction costs are low If all these conditions hold, then this is a perfectly competitive market
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    Competitive Firms and Markets  (con’t) Each firm produces only a small share of the market output, and output is identical to that of other firms So the firm is a price-taker (takes price as given) It cannot raise its price above the market price If it did, then it would sell nothing (i.e. a very small increase in price means that q goes to zero)
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    Competitive Firms and Markets  (con’t) Revenue for firm under competition is: R = p*q Not p(q)q The price that the firm sells q for does not depend on the amount of q the firm sells It can sell all it wants to at the competitive price p
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    Competitive Firms and Markets  (con’t) It has no incentive to lower price This means that the demand curve facing a single firm in a perfectly competitive market is infinitely elastic : horizontal (in the limit) Example: Wheat market p = MR (demand curve)
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    Residual Demand Curve Residual demand curve is the demand curve faced by one firm in the market RD is market demand curve not met by other sellers at a given price D r (P) Let S o (P) be the supply of other firms at price P So D r (P) = D(P) - S o (P) RD much more elastic then D(P)
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    Residual Demand Curve for Metal Chair Firm p , $ per metal chair 93 434 0 0 500 527 q , Thousand metal chairs per year Q , Thousand metal chairs per year 66 100 63 66 100 63 S o D p , $ per metal chair (a) Firm (b) Market D r
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    Competitive Firms and Markets  (con’t) Economic Profits : Recall that profits are: π = R – C Where C are economic costs, or accounting costs plus opportunity costs Since opportunity costs are positive, economic cost exceeds accounting costs Economic profits are revenues minus economic costs
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      Competitive Firms and Markets  (con’t) So accounting profit is usually larger than economic profit, since it includes the opportunity cost of owner’s time Firm can be showing profits on paper but is actually earning losses when we include opportunity costs The profit the firm makes depends on the q it picks: Π(q) = R(q) – C(q)
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This note was uploaded on 11/14/2009 for the course PAM 2000 taught by Professor Evans,t. during the Spring '07 term at Cornell University (Engineering School).

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PAM_2000_Spring_2009_Lecture_13 - PAM 2000 L ecture 13...

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