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Prinecomi lectureppt ch09

Jun 20, 2015

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PPT

  • 1. Firms in a Competitive Market9

2. Previously Economists break cost into two components Explicit costs (can be easily calculated) Implicit costs (are hard to calculate) Costs are defined in a number of ways, but marginal cost plays the most crucial role in a firms cost structure The MC curve always leads the ATC and AVC curves Long run costs are a reflection of scale 3. Big Questions 1. How do competitive markets work? 2. How do firms maximize profits? 3. What does the supply curve look like in perfectly competitive markets? 4. Competitive Markets Competitive markets Many buyers and sellers Similar (if not identical) goods Free entry and exit Firms are price takers Price taker Has no control over the market price takes the price as given 5. Are these Markets Really Perfectly Competitive? Example How It Works Reality Check Stock market Buyers and sellers have real-time information about prices. Most of the traders make up only a small share of the market. Large institutional investors are big enough to be able to influence the market price. Farmers markets Sellers are free to come and go without having to pay a fee. Many buyers are also present. The market price for similar products will converge to a single price. Many produce markets do not have enough sellers to achieve perfect competition. Higher- quality produce sellers can set their prices higher. 6. Are these Markets Really Perfectly Competitive? Example How It Works Reality Check Online ticket auctions The resale market for tickets to major events involves many buyers and sellers. The prices for seats in identical sections end up converging quickly to a narrow range. Some ticket companies and fans get special privileges that enable them to buy and sell blocks of tickets before others can enter the market. Currency trading Currency is a homogeneous good. There are hundreds of thousands of traders around the globe. All traders have real-time information and currency trades in different parts of the world converge toward the same price. Currency markets are subject to intervention on the part of governments that might wish to strategically alter the prevailing price of their currency. 7. Economics in Two and a Half Men Alan tries to earn money by entering the competitive industry of personal massage 8. Production and Profits for the Firm Goal of a firm: Maximize profits This is true whether the firm is competitive or not A profit maximizing firm needs to consider Revenues Costs 9. Profit Maximizing Rule Quantity (Q) How many driveways did Mr. Plow clear? Price (P) Price charged per driveway Total Revenue (TR) TR = P Q Total Costs (TC) Sum of all production costs at a certain level of output Profit () = TR TC 10. Profit Maximizing Rule Marginal Revenue (MR) MR = TR Q = change in For a competitive firm, MR = P Marginal Cost (MC) MC = TC Q Additional costs of producing additional units 11. Profit Maximizing Rule Change in Profit Profit = MR MC Profit maximizing rule: To maximize profits, the firm should use a marginal analysis Profit is maximized by choosing the level of output such that MR = MC 12. Profit Maximizing Rule Profit is maximized by choosing the level of output such that MR = MC If MR > MC The firm can increase profits by producing more Q If MR < MC The firm has produced too much Q, and profits are not maximized 13. Calculating Profits Quantity TR P Q TC Profit TR TC MR TR Q MC TC Q Change in Profit MR MC TR Q 0 $0 $250 -$250 10 100 340 -240 $100 $90 10 20 200 410 -210 100 70 30 30 300 460 -160 100 50 50 40 400 490 -90 100 30 70 50 500 510 -10 100 20 80 60 600 540 60 100 30 70 70 700 600 100 100 60 40 80 800 700 100 100 100 0 90 900 950 -50 100 250 -150 100 1000 1250 -250 100 300 -200 14. Deciding How Much to Produce Mr. Plow is a price taker Cannot set his own price, and must charge the price that is determined by overall supply and demand Recall Cost curves (ATC, AVC, and MC) are U-shaped In perfect competition, P = MR Profits are maximized at the level of output Q where MR = MC 15. Profit Maximization 16. Calculating Profit To find profit, we need to know revenues and costs For a perfectly competitive firm, revenues can be found by looking at the price (determined by the market) and the quantity sold Costs are determined by the quantity sold For the firm, Intuition: Profit = (units sold) (average profit per unit) ( )ATCPq = 17. The Decision to Shut Down in the Short Run Firms cant always make a profit Ski resort in summer Surf shop in winter Shutting down Firm will shut down if it cannot cover variable costs Shutting down is not the same as going out of business and exiting the industry 18. Signaling Profits and losses act as signals to firms Signals Convey information about the profitability of various markets Positive profits A signal of profitability. More firms will enter the industry. Negative profits (losses) A signal that resources could be doing better elsewhere. Firms will exit the industry. 19. When to Operate or Shut Down 20. Profit and Loss in the Short Run Condition Outcome P > ATC The firm makes a profit ATC > P > AVC The firm will operate to minimize loss AVC > P The firm will temporarily shut down 21. Short Run Supply Curve 22. Long Run Supply Curve 23. Long Run Shut Down Criteria Condition Outcome P > ATC The firm makes a profit P < ATC The firm should shut down 24. Sunk Costs Sunk costs Costs that have been incurred as a result of past decisions Unrecoverable Sunk-cost fallacy Considering sunk costs when making new decisions at the margin Can lead to using out-of-date facilities and incurring large opportunity costs 25. Sunk-Cost Fallacies in Your Life Waiting in line at food court restaurant A while there is no line at restaurant B We might as well stay in line. Weve already been waiting for 15 minutes. 26. Sunk-Cost Fallacies in Your Life After one semester of college Im not getting much from my experience at Tech, but Ive already spent time and money for a whole semester here, so I dont want to transfer to State. 27. Short Run Market Supply 28. Long Run Market Supply 29. Economic Profits Why join an industry if you cant maintain long run economic profits? Remember the difference between accounting and economics profits Economics profits Include opportunity costs Zero economic profits means that your opportunity costs are the same as your accounting profits 30. Market in Equilibrium 31. Short Run Adjustment to Demand Decrease 32. Long Run Adjustment to Demand Decrease 33. Animated Analysis Recall that for a competitive industry in the long run: If firms are making positive profits, then new firms will enter Profits are a signal for the entry of new firms. The industry will expand Market supply shifts right and price will fall until profits are zero 34. Animated Analysis Firm entry caused by positive profits Cost, Price Price QuantityQuantity Single Firm Market D S1MC ATC S2 P2P1 Q1Q2 35. Animated Analysis Recall that for a competitive industry in the long run: If firms are making negative profits, then existing firms will exit Losses are a signal for the exiting of firms. The industry will contract (shrink) Market supply shifts left and price will rise until profits are zero 36. Animated Analysis Firm exit caused by negative profits Cost, Price Price QuantityQuantity Single Firm Market D S1 MC ATC S2 P2P1 Q1 Q2 37. Animated Analysis Summary Free entry means that anyone can enter the industry in response to profit opportunities. Thus, if the industry is profitable, new firms will enter. This increases supply and decreases prices, lowering profits. If the industry is experiencing losses, firms will exit. This decreases supply and increases prices, increasing profits for remaining firms. As long as firms are entering and exiting, we are not in long run equilibrium. In perfect competition, we move toward zero economic profit over time. 38. Long Run Supply Previous graph showed LR supply as horizontal LR supply may be upward-sloping because Resources may be limitedthink about land for farming Opportunity costs of labor. When expanding production, may have to increase wages to attract more workers 39. Practice What You Know Short Run or Long Run? Answer the following questions by making sounds for the following answers: Short run: clap Long run: snap Either/both: stomp your feet 40. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: dtomp your feet Daves Bar & Grill is producing output, but Dave is doing so with a fixed level of capital Short runcapital is fixed in the short run 41. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: stomp your feet Jaime owns a firm in a perfectly competitive industry. She is making positive economic profits. Short runin PC industries, profits can be positive in the SR, but will be zero in long run equilibrium 42. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: stomp your feet Pizza Barn builds a new restaurant Long runchanging levels of capital 43. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: stomp your feet A new competitor enters the industry Long runentering or exiting involves changing levels of capital 44. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: stomp your feet Kyle is producing output, and can cover his VC, but not his FC expenses Short runin the long run we dont have FC expenses 45. Practice What You Know Short Run or Long Run? Short run: clap Long run: snap Either/both: stomp your feet Eric is a farmer. Given t

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