perfect competition tutorial 8. page 2 firm’s output choice economists assume all firms maximize...
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Page 2
Firm’s Output Choice
Economists assume ALL firms maximize economic profits,
As shown by the cost functions developed in the last chapter, total costs depends on quantity of output of the firm.
To see how a firm’s revenue depends on its output level, we must look at the demand for the firm’s product, which is highly related to the market structure in which the firm is operating.
- Perfect Competition
- Monopoly
- Monopolistic Competition
- Oligopoly
CR
Page 3
Perfect Competition
Characteristics of perfectly competitive markets:
- Large numbers of small buyers and sellers: price takers
- Homogeneous products
- Perfect information
- Free entry and exit
Page 4
Demand Curve facing a Competitive Firm
Q q
p p
D
S
pe
d = p = MR
Market Individual Firm
Qe
Marginal revenue: additional revenue obtained by producing one more unit of output.
Page 5
Short-run Output Decision
Q q
p p
D
S
pe
d = p = MR
Market Individual Firm
Qe
SMC
MC = MR
q1 q2q*
At q1 , p > MC At q2 ,p < MC
Page 6
Short-run Output Decision
To find the profit of the firm:
To show the profit in a per-unit diagram, it is often convenient to represent the profit as
P
q
p = MR
AC*
q*
p*
SAC
SMC
π
TCTR
qACpqq
Cpq )(
Page 7
Short-run Shutdown Decision
What if the firm is making economic loss? - Keep on Production- Shut down
Which one to choose? Depending on market price
Shutdown: Do not produce temporarily. - Loss = TFC
Case 1: When SAC > P > AVCSAC x q > P x q > AVC x qTC > TR > TVCEconomic Loss = TC – TR < TC – TVC (= TFC)
Case 2: When SAC > AVC > PSAC x q > AVC x q > P x qTC > TVC > TREconomic Loss = TC – TR > TC – TVC (= TFC)
The firm will shut down only if its revenues cannot cover its variable cost
Page 9
Firm’s Short-run Supply Curve
The firm’s supply curve shows how much it will produce at various output prices.
The positively-sloped segment of the firm’s SMC curve above the point of minimum AVC, therefore, is the firm’s short-run supply curve.
o For prices below this level, the firm will choose to shut down, so this price level is called the shut-down price.
p($)
qq1
p1
A
BAVC
SMC
C
p0
p2
q2q0
Page 10
Short-run Market Supply Curve
The short-run market supply curve is derived by horizontal summing all the individual firms’ supply curves:
q1
Q
p p
S1
p1
MarketFirm 1
p
S2
SS
q2 q3
p2
q4 q1 + q2 q3 + q4
Firm 2
Page 11
Short-run Competitive Market Equilibrium
The market equilibrium occurs when the quantity demanded by all consumers equals the total quantity supplied by all the firms in the market. That is,
sd QQ
Q q
p p
D
SS
p*
Q*
p = MR
Market Individual Firm
SAC
SMC
q*
Page 12
Long-run Output Choice and Firm’s Supply Curve
In the long run, a firm may adapt all of its inputs, such as adjusting plant size (capital employed), to fit market condition. Therefore, we should use the firm’s long-run cost functions for long-run analysis.
As firm will exit the market if it makes an economic loss in the long run. Therefore, the firm’s long-run supply curve is its long-run marginal cost curve above the minimum of its long-run average cost curve
p($)
q
SAC2
q2
SAC1
LAC
LMCSMC1 SMC2
q1
p1E MR
Page 13
Free Entry and Long-run Competitive Market Equilibrium
In the long run, new firms can enter the industry.- New firms enter when π > 0.- Existing firms exit when π < 0.
Q q
p pSS0
p2
Market Individual Firm
ACSAC
q2 q1
SS1
Q1
p1
D1
Q2
SMC MC
Page 14
Comparative statics analysis
Increase in Demand:
Q q
p p
D1
SS1
p1
Q1
Market Individual Firm
ACSAC
q1q2
SS2
Q2
p2
D2
Q3
SMC
Page 15
Comparative statics analysis: Long run
The long-run market supply curve can be derived indirectly by connecting the long-run equilibrium before and after the increase in market demand.- Why not derive it by horizontal summation of all firms’ long-run supply curve?
p
Q
D1
D2
E2
E1
S
Page 16
Comparative statics analysis: Long run
Long-run Market Supply Curve
Q q
p p
D1
SS1
p1
Q1
Market Individual Firm
ACSAC
q1 q2
SS2
Q2
p2
D2
Q3
SMC
LS
Page 17
Comparative statics analysis: Long run
The long-run market supply curve can be derived indirectly by connecting the long-run equilibrium before and after the increase in market demand.- Why not derive it by horizontal summation of all firms’ long-run supply curve?
The long-run supply curve is horizontal at price equal to the minimum long-run average cost .- Free entry and exit always drive price to this level (zero profit)
- Constant-cost industry: It is assumed that entry of new firms will have no effect on input prices
Page 18
Discussion Question 2: Beijing’s Silk Market (Xiushui Market)
The Silk Street attracts approximately 20,000 visitors daily (from 9am to 9pm) on weekdays and between 50,000 and 60,000 on weekends as of 2006.Many of the stalls have over the years gained local and international reputation for selling counterfeit luxury designer brands at relatively low prices.
Page 19
Discussion Question 2: Beijing’s Silk Market (Xiushui Market)
In an opinion piece published in The Wall Street Journal on 17 June, 2008, Chinese Vice-Premier Wang Qishan mentioned that Beijing’s Silk Market has gone “through rectification and has since become a distribution centre of famous brands”. But in reality, many stalls have carried on selling counterfeit luxury designer brands despite growing pressures from the Chinese government and famous brand name companies.
“True, there is not much shouting or pulling at customers walking down the aisles full of handbag and shoe stalls. But if you are caught looking at a bag for more than two seconds, a saleslady quickly hisses at you: “ Want Gucci?” …”
Page 20
Discussion Question 2: Beijing’s Silk Market (Xiushui Market)
According to the article, the problem persists because of weak enforcement of the intellectual property law.
“In reality the cost of proving a criminal charge is very high,” said National Copyright Administration deputy director – general Xu Chao. “It’s very difficult, hence the limited number of criminal arrests.”
(Source: SCMP, July 7, 2008)
a. Consider the counterfeiters industry, which is highly competitive. Suppose the government runs a confiscation program to arrest the counterfeiters from time to time. The program can only arrest limited number of counterfeiters. What would happen to the profits and prices of the remaining firms, which were not arrested in short run?
b. What would be the long run adjustment in the market after the confiscation program? Is this kind confiscation program an effective way to deal with the piracy problem?
Page 21
Effects of the Confiscation Program
P
Q q
P ($)
LAC
LMC
SAC
SMC
S1
D
q1Q1
P1
Individual FirmMarket
S2
P2
Q2 q2
MR1
MR2
Page 22
Discussion Question 2
c. Many people suggested other measures to be more effective, e.g. educating the youngsters about the importance of protecting the intellectual property rights were more effective ways to deal with piracy in long run. Do you agree?
Page 23
Effects of Successful Education
P
Q q
P ($)
LAC
SAC
SMC
S1
D1
q1Q1
P1
Individual FirmMarket
P2
Q2 q2
D2
MR1
MR2
S2
LMC
Q3
Page 24
Discussion Question 3: Fishermen in HK
A report published in Hong Kong Economics Times on 11 June 2008 concerns the fishing market in Hong Kong. It is reported that the diesel price increased by 2.4 times in a year, which raised the cost of fishing significantly. How would this regulation affect the market and individual fishermen in the short run and long run? (Source: Hong Kong Economic Times, 11 June, 2008)
Page 25
Short-run Effects of Increase in (Variable) Cost
P
Q q
P ($)
SAC2
SMC2
S1
q1Q1
P1
Individual Firm Market
P2
Q2 q2
MR1
SAC1
SMC1
S2
LAC2
LAC1
MR2
D
Page 26
Discussion Question 3: Fishermen in HK
If p < AVC, some fishermen may shutdown
“Because of the high diesel price, some fishermen’s two-day revenues of $4000 can only cover the diesel costs. Therefore, some of them have stopped fishing for some time,” said Mr. Lai.
Page 27
Long-run Effects of Increase in Cost
P
Q q
P ($)
SAC2
SMC2
S1
q1Q1
P1
Individual Firm Market
P2
Q2 q2
MR1
SAC1
SMC1
S2
LAC2
LAC1
MR2
D
MR3
Q3q3
S2
P3
Page 28
Discussion Question 3: Fishermen in HK
Starting from this year, some of the fishermen started to sell their boats to stop losses. Starting from January, 30 boats were sold in this year.
It leads to higher fish prices. Some of the fish prices rise by about 25%.
Page 29
Discussion Question 4
Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Hi-Tech Printing Company employs an extra-ordinary manager that sharply reduces the cost of administrative costs (i.e. fixed cost in the short run). What happens to Hi-Tech’s profits and the price of books in short run? Will it attract new firms to enter the market in long run?
b. Suppose you were the owner of Hi-Tech. What is the maximum amount that you would offer to keep the extra-ordinary manager to your own firm?