2023Ch9SumMcBr - Product Markets Perfect Competition...

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Product Markets Perfect Competition Chapter 9
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Outline Profit maximization Total revenue - total cost method Short run losses Marginal revenue - marginal cost method Application problem Product market models Short run analysis of perfect competition Long run analysis of perfect competition
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In the study of microeconomics, industries are broken down into four models: perfect competition, monopoly, monopolistic competition and oligopoly. We study a representative firm in each model with the assumption that each firm is out to maximize total economic profit. Total economic profit (EP) is the difference between total revenue (TR) and total cost (TC). By formula, EP = TR – TC, with total cost being the sum of explicit and implicit costs, including a normal profit. Remember, this is different than accounting where only explicit costs are considered. If TR>TC, EP is positive. Negative EP would be the same as an economic loss, with TR<TC. When TR=TC, EP is zero and the firm is receiving just a normal profit. If EP=0, the firm would be breaking even. Profit maximization
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The goal of a firm is to maximize profits or minimize losses. To find this level of output, mathematically there are two approaches: the total revenue–total cost approach and the marginal method. The total revenue-total cost approach is simple: calculate revenue, calculate cost, and then take the difference. This three-step process is as follows: TR = P x Q TC = TFC + TVC EP = TR – TC You would need to do this at each level of output and then compare to see where economic profit is the greatest or economic loss the smallest. Total revenue – total cost method
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You might think that a firm would automatically close down if it suffered losses. But, if the goal is to minimize losses, the firm would produce as long as variable costs are being covered. To illustrate, let’s say that TFC = $100 and TVC = $200. TC would, therefore, be $300. What if TR was only $260. The firm would suffer an economic loss of $40 ($300-260). But if the firm shuts down, there is still a cost associated with zero output: TFC. In this case, the firm would lose $100 if it shut down. It is better to lose $40 by producing than $100 by shutting down (in the short run). In this example, although the $260 TR was less the $300 TC, it was greater than the $200 TVC, meaning all of TVC and $60 of TFC was paid, leaving $40 as the loss. The key is, as long as TR>TVC, losses will be smaller producing than they would shutting down. Short run losses: continue or shut down?
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Mathematically, there is another way to determine the most profitable level of output. This second method is referred to as the marginal method, where marginal revenue is compared to marginal cost. Marginal revenue refers to additional revenue, while
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2023Ch9SumMcBr - Product Markets Perfect Competition...

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