Ch08_Pindyckfinal

# Ch08_Pindyckfinal - Chapter 8 Profit Maximization and...

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Chapter 8 Profit Maximization and Competitive Supply

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Dr. Carlos Asarta Chapter 8 2 Perfectly Competitive Markets The model of perfect competition can be used to study a variety of markets Basic assumptions of Perfectly Competitive Markets 1. Price taking 2. Product homogeneity 3. Free entry and exit
Dr. Carlos Asarta Chapter 8 3 When are Markets Competitive? Few real products are perfectly competitive Many markets are, however, highly competitive They face relatively low entry and exit costs Highly elastic demand curves

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Dr. Carlos Asarta Chapter 8 4 Marginal Revenue, Marginal Cost, and Profit Maximization We can study profit maximizing output for any firm, whether perfectly competitive or not Profit ( π ) = Total Revenue - Total Cost If q is output of the firm, then total revenue is price of the good times quantity Total Revenue (R) = Pq
Dr. Carlos Asarta Chapter 8 5 Marginal Revenue, Marginal Cost, and Profit Maximization Costs of production depends on output Total Cost (C) = C(q) Profit for the firm, π , is difference between revenue and costs ) ( ) ( ) ( q C q R q - = π

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Dr. Carlos Asarta Chapter 8 6 Profit Maximization – Short Run 0 Cost, Revenue, Profit (\$s per year) Output C(q) R(q) A B π (q) q 0 q* Profits are maximized where MR (slope at A) and MC (slope at B) are equal Profits are maximized where R(q) – C(q) is maximized
Dr. Carlos Asarta Chapter 8 7 Marginal Revenue, Marginal Cost, and Profit Maximization Profit is maximized at the point at which an additional increment to output leaves profit unchanged MC MR MC MR q C q R q C R = = - = = - = - = 0 0 π

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Dr. Carlos Asarta Chapter 8 8 The Competitive Firm Demand curve faced by an individual firm is a horizontal line Firm’s sales have no effect on market price Demand curve faced by whole market is downward sloping Shows amount of goods all consumers will purchase at different prices
Dr. Carlos Asarta Chapter 8 9 The Competitive Firm d \$4 Output (bushels) Price \$ per bushel 100 200 Firm Industry D \$4 Price \$ per bushel Output (millions of bushels) 100

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Dr. Carlos Asarta Chapter 8 10 The Competitive Firm The competitive firm’s demand Individual producer sells all units for \$4 regardless of that producer’s level of output MR = P with the horizontal demand curve For a perfectly competitive firm, profit maximizing output occurs when AR P MR q MC = = = ) (
Dr. Carlos Asarta Chapter 8 11 q 2 A Competitive Firm 10 20 30 40 Price 50 MC AVC ATC 0 1 2 3 4 5 6 7 8 9 10 11 Output q * AR=MR=P A q 1 : MR > MC q 2 : MC > MR q*: MC = MR q 1 Lost Profit Lost Profit

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Dr. Carlos Asarta Chapter 8 12 A Competitive Firm – Positive Profits 10 20 30 40 Price 50 0 1 2 3 4 5 6 7 8 9 10 11 Output q 2 MC AVC ATC q * AR=MR=P A q 1 D C B Profits are determined by profit per unit times quantity Profit per unit = P-ATC(q*) = A to B Total Profit = ABCD
Chapter 8

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Ch08_Pindyckfinal - Chapter 8 Profit Maximization and...

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