Comptetitive firms & markets (weeks 4-6)

Comptetitive firms & markets (weeks 4-6) -...

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:KHUH ZH DUH« ± Technology ± Cost-minimization ± Major question for firm: ² How much do we produce? ² How will this affect my prices? ± Depends on type of market and firm ² If firm is small, it has little or no effect on market prices (Pricetaker) ² If firm is large, it has a large effect on market prices (Pricesetter) 1 3HUIHFWO\ &RPSHWLWLYH 0DUNHWV ± Consumers believe that all firms sell identical products ± Firms freely enter and exit the market ± Buyers and sellers know the prices charged by firms ± Low transaction costs ± If firm raises prices from market prices, loses all consumers ² Other consumers know they can find product for cheaper ² No transaction cost to shifting to another supplier ± Reasonable to think of many markets as very competitive ² Large markets, many buyers and sellers ² Easy benchmark to contrast with more monopolistic markets 2
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3URILW 0D[LPL]DWLRQ LQ 3&0 where S is profit, R is total revenue, and C is total cost. Each firm faces 2-step decision process: Step 1 : If the firm produces, what output level, q* maximizes profits (or minimizes losses) Step 2 : At q*, does the firm make a profit, or would they be better off shutting down? 3 0D[LPL]LQJ 3URILWV 4
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+RZ WR 0D[LPL]H 3URILWV 3 ways: Method 1 : Set output to where profit is maximized Method 2 : Set output to where marginal profit = 0 Method 3 : Set output to where MR(q) = MC(q) Each method yields same optimum 2 nd order cond has to be satisfied to ensure a maximum! 5 0HWKRG ±² 6
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0HWKRG ± ± q* maximizes S (q) is the same as if the following (2 nd order condition) condition is satisfied Can see this from picture 7 0HWKRG ² First-order condition (f.o.c.) Second-order condition (s.o.c.) 8
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6KXW±GRZQ UXOH Does a firm that is making a loss always shut down? ± It depends! ± In short-run , it depends on level of fixed / sunk costs and variable costs; if revenue exceed short-run costs, better to have production ± In long-run , there are no fixed costs, so all loss making firms would be better off producing 0 9 6KXWGRZQ 5XOH LQ 6KRUW 5XQ ± Suppose we were to calculate q* and find that q* = 100 R(q*) = $2000 VC(q*) = $1500 Fixed = $1000 Then, S (q*) = S (0) = Firm is better off by running; shutting down doesn’t avoid fixed cost. 10
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6KXWGRZQ 5XOH LQ 6KRUW 5XQ ± Suppose we were to find that for all q > 0 R(q) - VC(q) < 0 Then for all q > 0 S (q) = R(q) – VC(q) – F S (0) = -F Firm is better off by shutting down since revenues do not exceed avoidable costs. 11 6KXW±GRZQ UXOH Does a firm that is making a loss always shut down? ± It depends! ± In short-run , it depends on level of fixed / sunk costs and variable costs; if revenue exceed short-run costs, better to have production ± In long-run , there are no fixed costs, so all loss making firms would be better off producing 0 Punchline: Shut down only if revenue is less than avoidable costs.
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Comptetitive firms &amp;amp; markets (weeks 4-6) -...

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