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Engineering Economics Class9

The document discusses profit maximization in perfectly competitive markets, highlighting that firms produce where price equals marginal cost (P = MC) to maximize profits. It explains the concepts of total revenue, marginal revenue, and the conditions under which firms should operate or shut down based on their revenue relative to variable costs. Additionally, it covers long-run adjustments and the implications of economies and diseconomies of scale on average costs.

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RUPESH KUMAR
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4 views

Engineering Economics Class9

The document discusses profit maximization in perfectly competitive markets, highlighting that firms produce where price equals marginal cost (P = MC) to maximize profits. It explains the concepts of total revenue, marginal revenue, and the conditions under which firms should operate or shut down based on their revenue relative to variable costs. Additionally, it covers long-run adjustments and the implications of economies and diseconomies of scale on average costs.

Uploaded by

RUPESH KUMAR
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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PROFIT

MAXIMIZATIO
N IN
PERFECTLY
COMPETITIVE
MARKET
Output Decisions: Revenues, Costs, and Profit
Maximization
Perfect Competition

perfect competition An industry structure in which there are


many firms, each small relative to the industry, producing
identical products and in which no firm is large enough to have
any control over prices. In perfectly competitive industries,
new competitors can freely enter and exit the market.

homogeneous products Undifferentiated products; products


that are identical to, or indistinguishable from, one another.
 FIGURE 8.9 Demand Facing a Single Firm in a Perfectly Competitive Market

If a representative firm in a perfectly competitive market


raises the price of its output above $5.00, the quantity
demanded of that firm’s output will drop to zero.
Each firm faces a perfectly elastic demand curve, d.
Total Revenue and Marginal
totalRevenue
revenue (TR) The total amount that a firm takes in from
the sale of its product: the price per unit times the quantity of
output the firm decides to produce (P x q).

total revenue price quantity


TR P  q

marginal revenue (MR) The additional revenue that a firm


takes in when it increases output by one additional unit. In
perfect competition, P = MR.

The marginal revenue curve and the demand curve facing a


competitive firm are identical. The horizontal line in Figure
8.9(b) can be thought of as both the demand curve facing the
firm and its marginal revenue curve:
The Profit-Maximizing Level of
Output
As long as marginal revenue is greater than marginal cost,
even though the difference between the two is getting smaller,
added output means added profit. Whenever marginal revenue
exceeds marginal cost, the revenue gained by increasing
output by 1 unit per period exceeds the cost incurred by doing
so.
The profit-maximizing perfectly competitive firm will produce
up to the point where the price of its output is just equal to
short-run marginal cost—the level of output at which P* = MC.

The profit-maximizing output level for all firms is the output level
where MR = MC.
In perfect competition, however, MR = P, as shown earlier.
Hence, for perfectly competitive firms, we can rewrite our profit-
maximizing condition as P = MC.

Important note: The key idea here is that firms will produce as
long as marginal revenue exceeds marginal cost.
The Short-Run Supply Curve

At any market price, the marginal cost curve shows the output
level that maximizes profit.
Thus, the marginal cost curve of a perfectly competitive profit-
maximizing firm is the firm’s short-run supply curve.
Minimizing Losses

■ If total revenue exceeds total variable cost, the excess revenue


can be used to offset fixed costs and reduce losses, and it will pay
the firm to keep operating.
■ If total revenue is smaller than total variable cost, the firm that
operates will suffer losses in excess of fixed costs. In this case, the
firm can minimize its losses by shutting down.

Producing at a Loss to Offset Fixed Costs

shutdown point The lowest point on the average variable cost curve.
When price falls below the minimum point on AVC, total revenue is
insufficient to cover variable costs and the firm will shut down and
bear losses equal to fixed costs.
 FIGURE 9.2 Short-Run Supply Curve of a Perfectly Competitive Firm

At prices below average variable cost, it pays a firm to shut down rather than
continue operating.
Thus, the short-run supply curve of a competitive firm is the part of its
marginal cost curve that lies above its average variable cost curve.
Long-Run Directions: A Review

TABLE 9.2 Profits, Losses, and Perfectly Competitive Firm Decisions in the Long and
Short Run
Short-Run Condition Short-Run Decision Long-Run Decision
Profits TR > TC P = MC: operate Expand: new firms enter
Losses 1. TR  TVC P = MC: operate Contract: firms exit
(loss < total fixed cost)
2. TR < TVC Shut down: Contract: firms exit
loss = total fixed cost
U-Shaped Long-Run Average Costs

 FIGURE 9.5 A Firm Exhibiting Economies and Diseconomies of Scale


Economies of scale push this firm’s average costs down to q*.
Beyond q*, the firm experiences diseconomies of scale;
q* is the level of production at lowest average cost, using optimal
scale.

optimal scale of plant The scale of plant that minimizes average


cost.
Long-Run Adjustments to Short-Run Conditions
Short-Run Profits: Moves In and Out of
Equilibrium

 FIGURE 9.6 Equilibrium for an Industry with U-shaped Cost Curves


In equilibrium, each firm has

SRMC = SRAC = LRAC

Firms make no excess profits so that

P = SRMC = SRAC = LRAC

and there are enough firms so that supply equals demand.


 FIGURE 15.1 Characteristics of Different Market Organizations

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