ECON 160ECON 160

Week 10

The Firm in Competition

(Chapter 13)

ReviewReview

• Production is organized within Firms to take advantage of the benefits of Teamwork & Specialization.

• Owners receive Profits to monitor their behavior to Maximize TR and Minimize TC.

• Profits (Π) is increased if MR > MC.• What rate of output, Maximizes Π ?

Alternative Rates of ProductionAlternative Rates of Production

Wks 1 2 3 4 5 6 7 8 9 10

Qty. 10 25 45 62 76 86 91 95 97 98

M.P 10 15 20 17 14 10 5 4 2 1

Marginal ProductMarginal Product

• At first: Teamwork and specialization Increasing marginal product as you add workers.

• Law of Diminishing ReturnsLaw of Diminishing Returns: As you add more of one input to a fixed amount of other inputs, Marginal product declines.

Marginal Product

02

46

810

1214

1618

20

1 2 3 4 5 6 7 8 9 10

3-D Column 1

Workers

Marg.Product

Marginal Cost of ProductionMarginal Cost of Production

Wks 1 2 3 4 5 6 7 8 9 10

Qty. 10 25 45 62 76 86 91 95 97 98

M.P 10 15 20 17 14 10 5 4 2 1

TC 120 140 160 180 200 220 240 260 280 300

M.C. $2.00 $1.33 $1.00 $1.18 $1.43 $2.00 $4.00 $5.00 10.00 20.00

Marginal Cost

0

1

2

3

4

5

10 25 45 62 76 86 91 95 97 98

Marg. Cost

$ MarginalCost

Qtys/Day

Marginal Cost

$ COST

Quantity of Output / Time period

MarginalCost

Average Cost of ProductionAverage Cost of Production

Wks 1 2 3 4 5 6 7 8 9 10

Qty. 10 25 45 62 76 86 91 95 97 98

M.P 10 15 20 17 14 10 5 4 2 1

TC 120 140 160 180 200 220 240 260 280 300

M.C.

$2.00 $1.33 $1.00 $1.18 $1.43 $2.00 $4.00 $5.00 10.00 20.00

A.C. 12.00 5.60 3.55 2.90 2.64 2.56 2.73 2.74 2.89 3.06

Average CostAverage Cost

0

2

4

6

8

10

12

10 25 45 62 76 86 91 95 97 98

Average Cost

$ Cost

Qtys/Day

Average Total Cost

$ COST

Quantity of Output

AverageTotal Cost

Average Total Cost & Marginal Cost

$ COST

Quantity of Output / Time

AverageTotal Cost

MarginalCost

Economies of Scale

$ COST

Quantity of Output

AverageTotal Cost

Economies of ScaleDis-Economies of Scale

Minimum ATC

Demand Facing the Firm

$P $P $P $P

Q Q Q Q

D1

D2

D3 D4

Increasing degrees of Competition Increasing degrees of Market Power

Alternative Market Structures

The Most Competitive Case:

The Price Taker Firm

Market and Firm Demand$P

Q/T

Pe

Qe

$P

Q/T

Pe

Market Firm

D

D

DS

S

Price Taker Firm

$ P

Q/T

Pe D = MR

MCMC

Qe

Profit Maximizing Rate of output

Price = Marginal Price = Marginal RevenueRevenue

Assumptions for a Price Taker

• Large number of buyers & sellers

• Homogeneous products

• Low information costs to buyers & sellers

• Low costs of entry and exit of firms

Total Revenue = Pe x Qe

$ P

Q/T

Pe D

MCMC

Qe

Total RevenueTotal Revenue

$ P

Q/T

Pe D

MC

Qe

AC

Total Cost = AC x Q

AC at Qe

Total CostTotal Cost

Profit = TR - TC$ P

Q/T

Pe D

MC

Q

AC

Market Response to Profits$P

Qx/T

Pe

Qe

D

DSo

SoS’

P’

Q’

Price Taker Firm: Zero Profits

$ P

Q/T

Pe’ D’ = MR

MCMC

Qe

ATC

D

Price Taker Firm: Loss

$ P

Q/T

Pe D = MR

MCMC

Qe

ATC

Loss

Market Response to Losses$P

Qx/T

P’

Q’

D

DS’

S’So

Po

Qo

Price Taker Firm: Zero Profits

$ P

Q/T

Pe’ D’ = MR

MCMC

Qe

ATC

DPo

$ P

Q/T

Pe D = MR

MC

Qe

AC

Profits occur if (P=MC) > AC

Price Taker Firm: Loss but stay in business Short-Run

$ P

Q/T

AVC

MCMC

Qc

ATC

PcDemand

TVC

TFC

Total Revenue

Loss

Shut down Loss

AC

$ P

Q/T

MC

AC

Short Run Firm Supply: MC > AVC

AVC

SR Firm SupplyProfit Range

Min. Loss Range

Long-Run Industry EquilibriumLong-Run Industry Equilibrium$P

Q/T

Pe

Qe

$P

Q/T

Pe

Market Firm

D

D

DS

SMC

ATC

Qe

Implications of Price-Taker Industry

• Demand for the firm is horizontal at the market price

• Efficiency: Price equals marginal cost of production

• Competition drives price to equal Average cost

• Economic profits only exist in the short-run.