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Chapter 11

Chapter 11 discusses the characteristics of perfect competition, highlighting the roles of price takers, economic profit, and revenue structures. It outlines the decision-making process for firms in both the short and long run to maximize economic profit, emphasizing the importance of marginal analysis. The chapter also explains how to determine profit or loss based on total revenue and total cost, as well as the relationship between market price and average total cost.

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15 views15 pages

Chapter 11

Chapter 11 discusses the characteristics of perfect competition, highlighting the roles of price takers, economic profit, and revenue structures. It outlines the decision-making process for firms in both the short and long run to maximize economic profit, emphasizing the importance of marginal analysis. The chapter also explains how to determine profit or loss based on total revenue and total cost, as well as the relationship between market price and average total cost.

Uploaded by

sudip.paul
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER 11

What is Perfect Competition


An industry which consists of:
• Many sellers and buyers
• Identical goods are being sold
• No barriers to entry in the markets
• There is no hidden information
• All buyers and sellers are price takers
Price Taker
• Buyers & sellers in a perfectly competitive markets are price takers
• They cannot influence the market price
• That does not mean the price will not change
• The price will change but the buyers/ sellers take that as given
Economic Profit & Revenue
• A firm’s goal is to maximize economic profit, which is equal to total
revenue minus total cost. (Profit= TR-TC)
• A firm’s total revenue equals the price of its output multiplied by the
number of units of output sold (price × quantity).
• Marginal revenue is the change in total revenue that results from a
one-unit increase in the quantity sold. Marginal revenue is calculated by
dividing the change in total revenue by the change in the quantity sold.
To see how a firm maximises its profit, we first consider the revenue structure of a competitive firm.

For competitive firms,


AR= MR= PRICE
The firm's decision in a PC market
• What is the goal of a PC firm?
• To make economic profit
• To achieve this objective, a firm must make four key decisions, two in the short run and two
in the long run.
• Two key decisions that a firm make in the short run are:
Whether to produce or to temporarily shut down
If the decision is to produce, what quantity to produce

• Two key decisions that a firm make in the long run are:

Whether to increase or decrease their plants size


Whether to remain in an industry or leave it
Profit maximizing output
• A perfectly competitive firm maximizes economic profit by choosing its
output level
• How to find the output level that maximizes economic profit of a firm?
(Remember, economic profit=TR-TC)
Study a firm’s total revenue and total cost curves and find the output level
at which total revenue exceeds total cost by the largest amount
TR, TC, & Economic profit
Looking back at the graphs, which level of output will the firm produce to
maximize profit?
- The profit curve is at its highest when the distance between the total revenue
and total cost curves is greatest.
- Profit maximization occurs at an output of 9 jumpers a day. At this output, Neat
Knits makes an economic profit of £42 a day
- At which level of output is the firm making zero profit? Does the firm
still operate at that level?
- Within which level, will the firm decide to not operate?
Marginal Analysis
• Another way of finding the profit-maximizing output is to use marginal
analysis, by comparing marginal cost, MC, with marginal revenue, MR
• As output increases, marginal revenue remains constant but marginal cost
changes
• If MR > MC, then the extra revenue from selling one more unit exceeds the
extra cost incurred to produce it. The firm makes an economic profit on the
marginal unit, so economic profit increases if output increases
• If MR < MC, then the extra revenue from selling one more unit is less than
the extra cost incurred to produce it. The firm incurs an economic loss on
the marginal unit, so its economic profit decreases if output increase
• If MR = MC, the firm makes maximum economic profit. The rule MR = MC is
an example of marginal analysis.
Does this mean that the price-taking firm’s production decision can be
entirely summed up as “produce up to the point where the marginal cost of
production is equal to the price”
Before applying the principle of marginal analysis to determine how much
to produce, a potential producer must as a first step answer an “either–or”
question: should it produce at all?
• We need to determine whether it is profitable or unprofitable to produce
at all
Profits & Losses in the SR
We know, Economic Profit=TR – TC
• If the firm produces a quantity at which TR > TC, the firm is profitable
• If the firm produces a quantity at which TR = TC, the firm breaks even
• If the firm produces a quantity at which TR < TC, the firm incurs a loss
To calculate profit per unit of output, divide by the number of units of
output, Q, produced:
Profit/Q = TR/Q − TC/Q
Profit Averag Averag
per unit e Total e Total
of outp Revenu Cost
ut e
• Profit/Q = TR/Q − TC/Q
• Average revenue=Marginal Revenue = Market price (Calculate AR from the
previous table)
• Profit per unit = P − ATC
• Economic profit (or loss)= (P – ATC) * Q
• How can you determine a firm's profit outcome from the market price?
• If the firm produces a quantity at which P > ATC, the firm is profitable
• If the firm produces a quantity at which P = ATC, the firm breaks even
• If the firm produces a quantity at which P < ATC, the firm incurs a loss.

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