princ-ch14-presentation

©2009South-Western,apartofCengageLearning,allrightsreservedCHAPTERFirmsinCompetitiveMarketsEconomicsPRINCIPLESOFN.GregoryMankiwPremiumPowerPointSlidesbyRonCronovich14Inthischapter,lookfortheanswerstothesequestions:Whatisaperfectlycompetitivemarket?Whatismarginalrevenue?Howisitrelatedtototalandaveragerevenue?Howdoesacompetitivefirmdeterminethequantitythatmaximizesprofits?Whenmightacompetitivefirmshutdownintheshortrun?Exitthemarketinthelongrun?Whatdoesthemarketsupplycurvelooklikeintheshortrun?Inthelongrun?1FIRMSINCOMPETITIVEMARKETS2Introduction:AScenarioThreeyearsaftergraduating,yourunyourownbusiness.Youmustdecidehowmuchtoproduce,whatpricetocharge,howmanyworkerstohire,etc.Whatfactorsshouldaffectthesedecisions?Yourcosts(studiedinprecedingchapter)HowmuchcompetitionyoufaceWebeginbystudyingthebehavioroffirmsinperfectlycompetitivemarkets.FIRMSINCOMPETITIVEMARKETS3CharacteristicsofPerfectCompetition1.Manybuyersandmanysellers.2.Thegoodsofferedforsalearelargelythesame.3.Firmscanfreelyenterorexitthemarket.Becauseof1&2,eachbuyerandsellerisa“pricetaker”–takesthepriceasgiven.FIRMSINCOMPETITIVEMARKETS4TheRevenueofaCompetitiveFirmTotalrevenue(TR)Averagerevenue(AR)Marginalrevenue(MR):ThechangeinTRfromsellingonemoreunit.∆TR∆QMR=TR=PxQTRQAR==PACTIVELEARNING1CalculatingTR,AR,MR5Fillintheemptyspacesofthetable.$50$105$40$104$103$102$10$101n/a$100TRPQMRAR$10ACTIVELEARNING1Answers6Fillintheemptyspacesofthetable.$50$105$40$104$103$10$10$10$10$102$10$101n/a$30$20$10$0$100TR=PxQPQ∆TR∆QMR=TRQAR=$10$10$10$10$10NoticethatMR=PFIRMSINCOMPETITIVEMARKETS7MR=PforaCompetitiveFirmAcompetitivefirmcankeepincreasingitsoutputwithoutaffectingthemarketprice.So,eachone-unitincreaseinQcausesrevenuetorisebyP,i.e.,MR=P.MR=Pisonlytrueforfirmsincompetitivemarkets.FIRMSINCOMPETITIVEMARKETS8ProfitMaximizationWhatQmaximizesthefirm’sprofit?Tofindtheanswer,“thinkatthemargin.”IfincreaseQbyoneunit,revenuerisesbyMR,costrisesbyMC.IfMRMC,thenincreaseQtoraiseprofit.IfMRMC,thenreduceQtoraiseprofit.FIRMSINCOMPETITIVEMARKETS9ProfitMaximization505404303202101453323159$5$00Profit=MR–MCMCMRProfitTCTRQAtanyQwithMRMC,increasingQraisesprofit.57751–$510101010–2024$6121086$4$10(continuedfromearlierexercise)AtanyQwithMRMC,reducingQraisesprofit.FIRMSINCOMPETITIVEMARKETS10P1MRMCandtheFirm’sSupplyDecisionAtQa,MCMR.So,increaseQtoraiseprofit.AtQb,MCMR.So,reduceQtoraiseprofit.AtQ1,MC=MR.ChangingQwouldlowerprofit.QCostsMCQ1QaQbRule:MR=MCattheprofit-maximizingQ.FIRMSINCOMPETITIVEMARKETS11P1MRP2MR2MCandtheFirm’sSupplyDecisionIfpricerisestoP2,thentheprofit-maximizingquantityrisestoQ2.TheMCcurvedeterminesthefirm’sQatanyprice.Hence,QCostsMCQ1Q2theMCcurveisthefirm’ssupplycurve.FIRMSINCOMPETITIVEMARKETS12Shutdownvs.ExitShutdown:Ashort-rundecisionnottoproduceanythingbecauseofmarketconditions.Exit:Along-rundecisiontoleavethemarket.Akeydifference:IfshutdowninSR,muststillpayFC.IfexitinLR,zerocosts.FIRMSINCOMPETITIVEMARKETS13AFirm’sShort-runDecisiontoShutDownCostofshuttingdown:revenueloss=TRBenefitofshuttingdown:costsavings=VC(firmmuststillpayFC)So,shutdownifTRVCDividebothsidesbyQ:TR/QVC/QSo,firm’sdecisionruleis:ShutdownifPAVCFIRMSINCOMPETITIVEMARKETS14Thefirm’sSRsupplycurveistheportionofitsMCcurveaboveAVC.QCostsACompetitiveFirm’sSRSupplyCurveMCATCAVCIfPAVC,thenfirmproducesQwhereP=MC.IfPAVC,thenfirmshutsdown(producesQ=0).FIRMSINCOMPETITIVEMARKETS15TheIrrelevanceofSunkCostsSunkcost:acostthathasalreadybeencommittedandcannotberecoveredSunkcostsshouldbeirrelevanttodecisions;youmustpaythemregardlessofyourchoice.FCisasunkcost:Thefirmmustpayitsfixedcostswhetheritproducesorshutsdown.So,FCshouldnotmatterinthedecisiontoshutdown.FIRMSINCOMPETITIVEMARKETS16AFirm’sLong-RunDecisiontoExitCostofexitingthemarket:revenueloss=TRBenefitofexitingthemarket:costsavings=TC(zeroFCinthelongrun)So,firmexitsifTRTCDividebothsidesbyQtowritethefirm’sdecisionruleas:ExitifPATCFIRMSINCOMPETITIVEMARKETS17ANewFirm’sDecisiontoEnterMarketInthelongrun,anewfirmwillenterthemarketifitisprofitabletodoso:ifTRTC.DividebothsidesbyQtoexpressthefirm’sentrydecisionas:EnterifPATCFIRMSINCOMPETITIVEMARKETS18Thefirm’sLRsupplycurveistheportionofitsMCcurveaboveLRATC.QCostsTheCompetitiveFirm’sSupplyCurveMCLRATCACTIVELEARNING2Identifyingafirm’sprofit19Determinethisfirm’stotalprofit.Identifytheareaonthegraphthatrepresentsthefirm’sprofit.QCosts,PMCATCP=$10MR50$6AcompetitivefirmACTIVELEARNING2Answers20profitQCosts,PMCATCP=$10MR50$6AcompetitivefirmProfitperunit=P–ATC=$10–6=$4Totalprofit=(P–ATC)xQ=$4x50=$200ACTIVELEARNING3Identifyingafirm’sloss21Determinethisfirm’stotalloss,assumingAVC$3.Identifytheareaonthegraphthatrepresentsthefirm’sloss.QCosts,PMCATCAcompetitivefirm$5P=$3MR30ACTIVELEARNING3Answers22lossMRP=$3QCosts,PMCATCAcompetitivefirmlossperunit=$2Totalloss=(ATC–P)xQ=$2x30=$60$530FIRMSINCOMPETITIVEMARKETS23MarketSupply:Assumptions1)Allexistingfirmsandpotentialentrantshaveidenticalcosts.2)Eachfirm’scostsdonotchangeasotherfirmsenterorexitthemarket.3)Thenumberoffirmsinthemarketisfixedintheshortru