chp8 - ECON 300B Intermediate Microeconomics Chapter...

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ECON 300B Lei Intermediate Microeconomics Winter 2011 1 Chapter 8 Chapter 8 – Competitive Firms and Markets Competitive Firms and Markets Competitive Firms and Markets Competitive Firms and Markets 5 levels of a firm’s decision: 5 levels of a firm’s decision: i. short-run output decision ii. short-run shutdown decision iii. long-run output decision iv. long-run shutdown/exit decision v. long-run entry decision i. Short i. Short-run output decision run output decision run output decision run output decision A firm chooses output level to maximize profit. The profit maximization problem is: max {g} G ±² ³´µ = ¶³´µ − · ±² ³´µ where: - ´ is output of the firm. - ¸ is the price of the good. - ¶³´µ is the_______________________________. If the firm is a price taker , ¸ is taken as given (exogenous variable), so ¶³´µ = ¸´ . If the firm has control power over price, ¸ depends on the output chosen by the firm, so ¸ = ¸³´µ and ¶³´µ = ¸³´µ´ . - · ±² ³´µ is short-run total (economic) cost, that equals ¹·³´µ + º - Revenue minus economic cost equals G , _______________________________. 1 Marginal revenue (MR) Marginal revenue (MR) Marginal revenue (MR) ~ the change of revenue when additional output is sold: »¶³´µ = ¼¶³´µ ¼´ Marginal profit Marginal profit ~ the change in profit when additional output is sold: ¼G³´µ ¼´ Solution Solution Solution NFOC: ¼G ±² ³´µ ¼´ = 0 Thus marginal profit equals zero when profit is maximized. Graphically, the profit is at peak only when its slope, marginal profit, equals zero. (See Figure 8.2.) 1 In contrast, revenue minus accounting cost equals business profit.
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ECON 300B Lei Intermediate Microeconomics Winter 2011 2 The NFOC can be written as: g gG ±²±G³ − ´ µ¶ ±G³³ = 0 g²±G³ gG µ¶ ±G³ gG = 0 g²±G³ gG = µ¶ ±G³ gG With the definition of marginal revenue and marginal cost, ·²±G³ = ¸²·´±G³ If ·² > ·´ , the last unit sold has higher revenue than cost. The firm will earn profit by selling more, so the current output level is not optimal. If ·´ > ·² , the last unit sold has higher cost than revenue. The firm will lose less by selling less, so the current output level is not optimal. Only when ·² = ·´ will the firm have no incentive to change its current output, which is at optimal level. If G solves the NFOC, the firm sets G = G , thus the optimality condition for profit maximization is: ·²±G ³ = ¸²·´±G ³ And maximum profit is: ¹ µ¶∗ ≡ ²±G ³ − ´ µ¶ ±G ³ ii. Short ii. Short-run shutdown decision run shutdown decision run shutdown decision If the profit-maximizing output yields negative economic profit, the firm has the option of shutting the business down. When it shuts down, it does not have to incur the economic loss of production. However, it still has to pay for the fixed cost of the fixed input in the short run. Thus the firm shuts down in the short run if the economic loss is greater than the loss of the fixed cost: ¹ µ¶∗ < −º
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ECON 300B Lei Intermediate Microeconomics Winter 2011 3 Since
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This note was uploaded on 03/22/2011 for the course ECON 300 taught by Professor Juzwiak,william during the Spring '07 term at University of Washington.

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chp8 - ECON 300B Intermediate Microeconomics Chapter...

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