Chapter11 fi 2010

Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/IrwinManagerial Economics, 9e

Managerial Economics ThomasMauriceninth edition

Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/IrwinManagerial Economics, 9e

Managerial Economics ThomasMauriceninth edition

Chapter 11

Managerial Decisions in Competitive Markets

Managerial EconomicsManagerial Economics

11-2

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


11-3

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


11-4

D

S

Quantity

Pri

ce (

dolla

rs)

Quantity

Pri

ce (

dolla

rs)

P0

Q0

Panel A – Market

Panel B – Demand curve facing a price-taker

Demand for a Competitive Price-Taking Firm (Figure 11.2)

0 0

P0D = MR


11-5

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 TR TC Profit =


11-6

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)

( P ATC )Q

Q Q

Average profit

P ATC Profit margin


11-7

Short-Run Output Decision

• Firm’s manager will produce output where P = MC as long as:• TR TVC• or, equivalently, P AVC

• If price is less than average variable cost (P AVC), manager will shut down• Produce zero output• Lose only total fixed costs• Shutdown price is minimum AVC


11-8

Total revenue =$36 x 600 = $21,600

Profit = $21,600 - $11,400

= $10,200

Total cost = $19 x 600 = $11,400

Profit Maximization: P = $36 (Figure 11.3)


11-9

Short-Run Loss Minimization: P = $10.50 (Figure 11.5)

Total cost = $17 x 300 = $5,100

Total revenue = $10.50 x 300 = $3,150

Profit = $3,150 - $5,100 = -$1,950


11-10

Irrelevance of Fixed Costs

• Fixed costs are irrelevant in the production decision• Level of fixed cost has no effect on

marginal cost or minimum average variable cost

• Thus no effect on optimal level of output


11-11

• 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

Summary of Short-Run Output Decision

• ( P ATC )Q


11-12

Short-Run Supply Curves

• For an individual price-taking firm• Portion of firms’ 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


11-13

Short-Run Firm & Industry Supply (Figure 11.6)


11-14

Long-Run Profit-Maximizing Equilibrium (Figure 11.7)

Profit = ($17 - $12) x 240 = $1,200


11-15

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


11-16

Long-Run Competitive Equilibrium (Figure 11.8)


11-17

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


11-18

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


11-19

Long-Run Industry Supply for a Constant Cost Industry (Figure 11.9)


11-20

Long-Run Industry Supply for an Increasing Cost Industry (Figure 11.10)

Firm’s output


11-21

Profit-Maximizing Input Usage

• Profit-maximizing level of input usage produces exactly that level of output that maximizes profit


11-22

Profit-Maximizing Input Usage• Marginal revenue product (MRP)• MRP of an additional unit of a variable input

is the additional revenue from hiring one more unit of the input

• If choose to produce:• If the MRP of an additional unit of input is

greater than the price of input, that unit should be hired

• Employ amount of input where MRP = input price

TRMRP P MP

L


11-23

Profit-Maximizing Input Usage

• Average revenue product (ARP)• Average revenue per worker

• Shut down in short run if ARP < MRP• When ARP < MRP, TR < TVC

TRARP P AP

L


11-24

Profit-Maximizing Labor Usage (Figure 11.12)

Chapter11 fi 2010

Business