AGENDA Mon 10/12

• Economics in Action Review

• QOD #21: Competitive Farming

• HW Review

• Pure Competition

• MR = MC

• HW: Read pp 173-176 Q #7

QOD #21: Competitive Farming

A purely competitive wheat farmer can sell any wheat he grows for $10 per bushel. His five acres of land show diminishing returns, because some are better suited for wheat production than others. The first acre can produce 1000 bushels of wheat, the second acre 900, the third 800, and so on.

Draw a table with multiple columns to help you answer the following questions.

1.How many bushels will each of the farmer’s five acres produce?

2.How much revenue will each acre generate?

3.What are the TR and MR for each acre?

4.If the marginal cost of planting and harvesting an acre is $7000 per acre for each of the five acres, how many acres should the farmer plant and harvest?

QOD #21: Competitive Farming Solution

1. How much revenue will each acre generate? ($10 x Production)

2. What are the TR and MR for each acre? (MR = TR2 – TR1)

3. If the marginal cost of planting and harvesting an acre is $7000 per acre for each of the five acres, how many acres should the farmer plant and harvest? (MR = MC which is at 4 acres $7000 = $7000)

Acre Production on the acre Total Revenue Marginal Revenue

1 1000 $10,000 ---

2 900 $19,000 $9,000

3 800 $27,000 $8,000

4 700 $34,000 $7,000

5 600 $40,000 $6,000

Four Market Models

• Pure competition

• Pure monopoly

• Monopolistic competition

• Oligopoly

LO1

Market Structure Continuum

Pure Competition

Monopolistic Competition

Oligopoly Pure

Monopoly

8-4

Four Market Models

LO1

Characteristics of the Four Basic Market Models

Characteristic

Pure

Competition

Monopolistic

Competition Oligopoly Monopoly

Number of firms A very large

number

Many Few One

Type of product Standardized Differentiated Standardized or

differentiated

Unique; no

close subs.

Control over

price

None Some, but within rather

narrow limits

Limited by mutual

inter-dependence;

considerable with

collusion

Considerable

Conditions of

entry

Very easy, no

obstacles

Relatively easy Significant

obstacles

Blocked

Nonprice

Competition

None Considerable emphasis

on advertising, brand

names, trademarks

Typically a great

deal, particularly

with product

differentiation

Mostly public

relation

advertising

Examples Agriculture Retail trade, dresses,

shoes

Steel, auto, farm

implements

Local utilities

8-5

Pure Competition

Characteristics of Pure Competition

• Many sellers.

• All firms sell standardized (identical) goods.

• Buyers and sellers have all relevant information about prices, product quality, and sources of supply.

• There is easy entry into the market and easy exit out of the market.

Price Takers • A price taker is a seller

that can only sell its

output at equilibrium

price.

• A firm produces Q at

which MR = MC at EQ

(equilibrium price)

• Price takers will not

sell for less than

equilibrium.

What does a purely competitive firm do?

• It produces where

marginal revenue

equals marginal cost.

– MR = MC

• It must sell its product

at equilibrium since it is

a price taker.

Profit in a purely competitive market

• Profit acts as a signal to

firms not in the market to

enter the market.

• As new firms enter the

market, they increase the

supply of the good that is

earning profit, and thus

lower its price.

Pure Competition: Characteristics

• Perfectly elastic demand

• Firm produces as much or little as

they want at the price

• Demand graphs as horizontal line

LO2 8-12

Average, Total, and Marginal Revenue

• Average Revenue

• Revenue per unit

• AR = TR/Q = P

• Total Revenue

• TR = P X Q

• Marginal Revenue

• Extra revenue from 1 more unit

• MR = ΔTR/ΔQ

LO3 8-13

Average, Total, and Marginal Revenue

LO3

Firm’s Demand Schedule (Average Revenue)

Firm’s Revenue

Data

D = MR = AR

TR

P QD TR MR

$131

131

131

131

131

131

131

131

131

131

131

0

1

2

3

4

5

6

7

8

9

10

$0

131

262

393

524

655

786

917

1048

1179

1310

$131

131

131

131

131

131

131

131

131

131

]

] ] ] ]

]

]

]

]

]

8-14

Profit Maximization: TR–TC Approach

• Three questions:

• Should the firm produce?

• If so, what amount?

• What economic profit (loss) will be

realized?

LO3 8-15

Profit Maximization: TR–TC Approach

LO3

The Profit-Maximizing Output for a Purely Competitive Firm: Total Revenue –

Total Cost Approach (Price = $131)

(1)

Total Product

(Output) (Q)

(2)

Total Fixed Cost

(TFC)

(3)

Total Variable

Costs (TVC)

(4)

Total Cost

(TC)

(5)

Total Revenue

(TR)

(6)

Profit (+)

or Loss (-)

0 $100 $0 $100 $0 $-100

1 100 90 190 131 -59

2 100 170 270 262 -8

3 100 240 340 393 +53

4 100 300 400 524 +124

5 100 370 470 655 +185

6 100 450 550 786 +236

7 100 540 640 917 +277

8 100 650 750 1048 +298

9 100 780 880 1179 +299

10 100 930 1030 1310 +280

8-16

1 0 2 3 4 5 6 7 8 9 10 11 12 13 14

1 0 2 3 4 5 6 7 8 9 10 11 12 13 14

$1800

1700

1600

1500

1400

1300

1200

1100

1000

900

800

700

600

500

400

300

200

100

$500

400

300

200

100

To

tal R

eve

nu

e a

nd

To

tal C

os

t To

tal E

co

no

mic

P

rofi

t

Quantity Demanded (Sold)

Quantity Demanded (Sold)

Profit Maximization: TR–TC Approach

LO3

Total Revenue, (TR)

Break-Even Point (Normal Profit)

Break-Even Point (Normal Profit)

Maximum Economic

Profit $299

Total Economic

Profit

$299

P=$131

Total Cost,

(TC)

8-17

Profit Maximization: MR-MC Approach

LO3

The Profit-Maximizing Output for a Purely Competitive Firm: Marginal

Revenue – Marginal Cost Approach (Price = $131)

(1)

Total

Product

(Output)

(2)

Average

Fixed Cost

(AFC)

(3)

Average

Variable

Costs (AVC)

(4)

Average

Total Cost

(ATC)

(5)

Marginal

Cost

(MC)

(5)

Price =

Marginal

Revenue

(MR)

(6)

Total

Economic

Profit (+)

or Loss (-)

0 $-100

1 $100.00 $90.00 $190 $90 $131 -59

2 50.00 85.00 135 80 131 -8

3 33.33 80.00 113.33 70 131 +53

4 25.00 75.00 100.00 60 131 +124

5 20.00 74.00 94.00 70 131 +185

6 16.67 75.00 91.67 80 131 +236

7 14.29 77.14 91.43 90 131 +277

8 12.50 81.25 93.75 110 131 +298

9 11.11 86.67 97.78 130 131 +299

10 10.00 93.00 103.00 150 131 +280

8-18

Profit Maximization: MR-MC Approach

LO3

Co

st

an

d R

even

ue

$200

150

100

50

0 1 2 3 4 5 6 7 8 9 10

Output

Economic Profit MR = P

MC MR = MC

AVC

ATC

P=$131

A=$97.78

8-19

Loss-Minimizing Case

• Loss minimization

• Still produce because P > minAVC

• Losses at a minimum where

MR=MC

LO3 8-20

Loss-Minimizing Case

LO3

Co

st

an

d R

even

ue

$200

150

100

50

0 1 2 3 4 5 6 7 8 9 10

Output

Loss

MR = P

MC

AVC

ATC

P=$81

A=$91.67

V = $75

8-21

Shutdown Case

LO3

Co

st

an

d R

even

ue

$200

150

100

50

0 1 2 3 4 5 6 7 8 9 10

Output

MR = P

MC

AVC

ATC

P=$71

V = $74

Short-Run Shut Down Point P < Minimum AVC

$71 < $74

8-22

Three Production Questions

LO3

Output Determination in Pure Competition in the Short Run

Question Answer

Should this firm produce? Yes, if price is equal to, or greater than,

minimum average variable cost. This

means that the firm is profitable or that

its losses are less than its fixed cost.

What quantity should this firm produce? Produce where MR (=P) = MC; there,

profit is maximized (TR exceeds TC by

a maximum amount) or loss is

minimized.

Will production result in economic

profit?

Yes, if price exceeds average total cost

(TR will exceed TC). No, if average

total cost exceeds price (TC will exceed

TR).

8-23

Firm and Industry: Equilibrium

LO4

Firm and Market Supply and the Market Demand

(1)

Quantity

Supplied,

Single

Firm

(2)

Total

Quantity

Supplied,

1000 Firms

(3)

Product

Price

(4)

Total

Quantity

Demanded

10 10,000 $151 4,000

9 9,000 131 6,000

8 8,000 111 8,000

7 7,000 91 9,000

6 6,000 81 11,000

0 0 71 13,000

0 0 61 16,000

8-24

Firm and Industry: Equilibrium

LO4

Economic

Profit d

ATC

AVC

s = MC

$111 $111

D

S = ∑ MC’s

8 8000

8-25