BEC 30325 Managerial Economics Managerial Decisions in Competitive

BEC 30325 Managerial Economics Managerial Decisions in Competitive Markets

Perfect Competition • Firms are price-takers – Each produces only a very small portion of total market or industry output • All firms produce a homogeneous product • Entry into & exit from the market is unrestricted

Demand for a Competitive Price-taker • Demand curve is horizontal at price determined by intersection of market demand & supply – Perfectly elastic • Marginal revenue equals price – Demand curve is also marginal revenue curve (D = MR) • Can sell all they want at the market price – Each additional unit of sales adds to total revenue an amount equal to price

Demand for a Competitive Price-taking Firm Price (dollars) S P 0 D = MR D 0 Q 0 0 Quantity Market Demand curve facing a price -taker

Profit-Maximization in the Short-run • In the short run, managers must make two decisions: 1. Produce or shut down? • If shut down, produce no output and hires no variable inputs • If shut down, firm loses amount equal to TFC 2. If produce, what is the optimal output level? • • If firm does produce, then how much? Produce amount that maximizes economic profit Profit = π = TR - TC

Profit-Maximization in the Short-run • In the short run, the firm incurs costs that are: – Unavoidable and must be paid even if output is zero – Variable costs that are avoidable if the firm chooses to shut down • In making the decision to produce or shut down, the firm considers only the (avoidable) variable costs & ignores fixed costs

Profit Margin (or Average Profit) • Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) – Managers should ignore profit margin (average profit) when making optimal decisions

Profit Maximization: P = $36

Profit Maximization: P = $36

Profit Maximization: P = $36 Break-even point Panel A: Total revenue & total cost Break-even point Panel B: Profit curve when P = $36

Short-run Loss Minimization: P = $10. 50 Profitcost = $3, 150 Total = $17 -x$5, 100 300 = -$1, 950 = $5, 100 Total revenue = $10. 50 x 300 = $3, 150

Summary of Short-run Output Decision • AVC tells whether to produce – Shut down if price falls below minimum AVC • SMC tells how much to produce – If P minimum AVC, produce output at which P = SMC • ATC tells how much profit/loss if produce π = (P – ATC)Q

Short-run Supply Curves • For an individual price-taking firm – Portion of firm’s marginal cost curve above minimum AVC – For prices below minimum AVC, quantity supplied is zero • For a competitive industry – Horizontal sum of supply curves of all individual firms; always upward sloping – Supply prices give marginal costs of production for every firm

Short-run Firm & Industry Supply

Short-run Producer Surplus • Short-run producer surplus is the amount by which TR exceeds TVC – The area above the short-run supply curve that is below market price over the range of output supplied – Exceeds economic profit by the amount of TFC

Long-run Competitive Equilibrium • All firms are in profit-maximizing equilibrium (P = LMC) • Occurs because of entry/exit of firms in/out of industry – Market adjusts so P = LMC = LAC

Long-run Profit-Maximizing Equilibrium Profit = ($17 - $12) x 240 = $1, 200

Long-run Competitive Equilibrium

Long-run Industry Supply • Long-run industry supply curve can be flat (perfectly elastic) or upward sloping – Depends on whether constant cost industry or increasing cost industry • Economic profit is zero for all points on the long-run industry supply curve for both types of industries

Long-run Industry Supply • Constant cost industry – As industry output expands, input prices remain constant, & minimum LAC is unchanged – P = minimum LAC, so curve is horizontal (perfectly elastic) • Increasing cost industry – As industry output expands, input prices rise, & minimum LAC rises – Long-run supply price rises & curve is upward sloping

Long-run Industry Supply for a Constant Cost Industry

Long-run Industry Supply for an Increasing Cost Industry Firm’s output

Economic Rent • Payment to the owner of a scarce, superior resource in excess of the resource’s opportunity cost • In long-run competitive equilibrium firms that employ such resources earn zero economic profit – Potential economic profit is paid to the resource as economic rent – In increasing cost industries, all long-run producer surplus is paid to resource suppliers as economic rent

Economic Rent in Long-run Competitive Equilibrium