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## Chapter 8 Profit Maximization and Competitive Markets

by: Natalie Strawn

12

2

4

# Chapter 8 Profit Maximization and Competitive Markets ECO 420K

Natalie Strawn
UT
GPA 3.66

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These notes cover definitions, examples, and problems for profit maximization and competitive markets.
COURSE
MICROECONOMIC THEORY
PROF.
John Thompson
TYPE
Class Notes
PAGES
4
WORDS
CONCEPTS
Economics, Microeconomics, profit, maximization, competitivemarkets, competition, markets
KARMA
25 ?

## Popular in Economcs

This 4 page Class Notes was uploaded by Natalie Strawn on Wednesday June 29, 2016. The Class Notes belongs to ECO 420K at 1 MDSS-SGSLM-Langley AFB Advanced Education in General Dentistry 12 Months taught by John Thompson in Summer 2016. Since its upload, it has received 12 views. For similar materials see MICROECONOMIC THEORY in Economcs at 1 MDSS-SGSLM-Langley AFB Advanced Education in General Dentistry 12 Months.

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Date Created: 06/29/16
June 20, 2016 Ch 8 Profit Maximization and Competitive Supply Perfect competition The model of perfect competition is stylized to show maximum competition. Assumptions: -many sellers, many buyers -homogeneous product -free entry and exit (in the long run) Result: -price is set by the overall market -firms are price takers – they have no “market power” -firms maximize profits by producing and selling any units whose marginal revenue exceeds marginal cost *MR = MC is a necessary condition for profit maximization (or loss minimization) -for a competitive firm, P = MR, P = MC *max pi (Q) = TR(Q) – TC(Q) (figure 8.3) (d pi/dQ) = MR(Q) – MC(Q) = 0 MR(Q) = MC(Q) The short-run shut down decision: -if P > AVC, keep producing to minimize losses -if P < AVC, shut down (produce no output) to minimize losses Since firms produce where P = MC above AVC, the MC curve is a competitive firm’s supply curve -If price rises (falls), the firm responds by increasing (decreasing) output. -If MC rises (falls), the firm responds by decreasing (increasing) output (figure 8.7) The industry supply curve is the horizontal sum of individual firms’ supply curves. (figure 8.9) As market conditions (demand, cost, # firms, etc.) change, the individual firms’ response leads to the aggregate effect. Producer surplus for a firm is the difference between price and marginal cost. Producer surplus for the market is the difference between price and the market supply curve. (figure 8.11 & 8.12) Is there a difference between consumer surplus and profit? -No, consumer surplus doesn’t account for fixed costs. (Producer surplus – fixed costs = profit) In the long run, firms maximize output by choosing the output where MR = LRMC. (Figure 8.13) Long run competitive equilibrium -In the long run, entry and exit is possible. -Short run economic profits attract entry, and those profits will be competed away in the long run. (Figure 8.14) -Short run economic losses cause exit, and those losses will disappear in the long run. -A long run equilibrium is characterized by the following: -All firms are maximizing profits. -No firm has an incentive to enter or exit because everyone is making zero economic profit. -In the overall market, the price is such that Qs = Qd. The industry’s long run supply curve (SLR) would be characterized by the locus of all long run price/quantity combinations. In a constant cost industry, the SLR is horizontal. In an increasing cost industry, the SLR is positively sloped. (Figure 8.16 and 8.17) June 20, 2016 Ch 8 Profit Maximization and Competitive Supply Perfect competition The model of perfect competition is stylized to show maximum competition. Assumptions: -many sellers, many buyers -homogeneous product -free entry and exit (in the long run) Result: -price is set by the overall market -firms are price takers – they have no “market power” -firms maximize profits by producing and selling any units whose marginal revenue exceeds marginal cost *MR = MC is a necessary condition for profit maximization (or loss minimization) -for a competitive firm, P = MR, P = MC *max pi (Q) = TR(Q) – TC(Q) (figure 8.3) (d pi/dQ) = MR(Q) – MC(Q) = 0 MR(Q) = MC(Q) The short-run shut down decision: -if P > AVC, keep producing to minimize losses -if P < AVC, shut down (produce no output) to minimize losses Since firms produce where P = MC above AVC, the MC curve is a competitive firm’s supply curve -If price rises (falls), the firm responds by increasing (decreasing) output. -If MC rises (falls), the firm responds by decreasing (increasing) output (figure 8.7) The industry supply curve is the horizontal sum of individual firms’ supply curves. (figure 8.9) As market conditions (demand, cost, # firms, etc.) change, the individual firms’ response leads to the aggregate effect. Producer surplus for a firm is the difference between price and marginal cost. Producer surplus for the market is the difference between price and the market supply curve. (figure 8.11 & 8.12) Is there a difference between consumer surplus and profit? -No, consumer surplus doesn’t account for fixed costs. (Producer surplus – fixed costs = profit) In the long run, firms maximize output by choosing the output where MR = LRMC. (Figure 8.13) Long run competitive equilibrium -In the long run, entry and exit is possible. -Short run economic profits attract entry, and those profits will be competed away in the long run. (Figure 8.14) -Short run economic losses cause exit, and those losses will disappear in the long run. -A long run equilibrium is characterized by the following: -All firms are maximizing profits. -No firm has an incentive to enter or exit because everyone is making zero economic profit. -In the overall market, the price is such that Qs = Qd. The industry’s long run supply curve (SLR) would be characterized by the locus of all long run price/quantity combinations. In a constant cost industry, the SLR is horizontal. In an increasing cost industry, the SLR is positively sloped. (Figure 8.16 and 8.17)

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