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Unformatted text preview: Perfect Competition I. Short Run Firm Price and Output Decisions
Price: Charge the market price. Output: Rule: 1. To maximize profits, produce Q up to the point where short-run MC = MR (= P) IV. Short-Run Firm Price and Output Decisions 3 Logic:. If P > MC, profits rise if another unit is produced. If P < MC, then profits would fall by producing another unit. Put another way, the marginal benefit of producing another unit of the good is Marginal Revenue (MR), which equals P in the perfectly competitive case. Thus, the rule is expand output as long as marginal benefit (= MR = P) is greater than MC. 2. Check to see whether profits would be greater if the firm shut down. If TR > TVC, the firm should operate. If TR < TVC, the firm should shutdown. Reason: Profit = TR - TC = TR - TVC - TFC. If the firm shuts down, Profit = - TFC Hence, profits would be greater (or losses smaller) only if TR > TVC. (Note: this part of the rule could be expressed: Operate if P > AVC; shut down if P < AVC. This follows form the previous relation. Since TR = P x Q > TVC = Q x AVC, dividing both sides by Q yields P > AVC.) Example 7 What happens if the price of an input changes? (Say the price of labor falls.)
4 This set ofApplication:TAllocation of Production among Multiple Plants rules implies: he supply curve of the competitive firm in the short-run equals MC above minimum AVC. Yet another approach. Maximize output for each level expenditures. Rearrange Equation (1) as: (3) or, maximum output, given expenditures, is obtained when the marginal product of an input per dollar spent on the input is the same. Predictions: Increase in price results in increase in Q, decrease in MC (say caused by declines in prices of inputs or changes in technology) lead to increase in Q. V. Short-Run Supply, Competitive Industry A. If prices of inputs do not change as the output of the industry expands or contracts, the short-run supply curve of the industry is the horizontal sum of the short-run supply curves of individual firms. If prices of inputs do change as the output of the industry expands or contracts, then the industry supply curve will be steeper than the horizontal sum of the short-run supply curves of individual firms. B. If the industry is large relative to the size of the economy, then prices of inputs will increase as the industry expands. Thus, the true short-run supply curve to the industry is steeper than the simple sum of the firm’s marginal cost curves. © Bryan L. Boulier, 2011. All rights reserved. ...
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