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Lecture Managerial economics (9th edition): Chapter 11A – Thomas, Maurice

Chapter 11 - Managerial decisions in competitive markets. In this chapter you will: Discuss three characteristics of perfectly competitive markets; apply the basic principles of marginal analysis to determine either (1) the profitmaximizing (or loss-minimizing) level of output, or (2) the profit-maximizing (or loss-minimizing) level of input usage; Explain why the demand curve facing an individual firm in a perfectly competitive industry is perfectly elastic, and why this demand curve is also the marginal revenue curve for a competitive firm;. | Chapter 11 Managerial Decisions in Competitive Markets Perfect Competition Firms are price-takers Each produces only a very small portion of total market or industry output All firms produce a homogeneous product Entry into & exit from the market is unrestricted 11- Demand for a Competitive Price-Taker Demand curve is horizontal at price determined by intersection of market demand & supply Perfectly elastic Marginal revenue equals price Demand curve is also marginal revenue curve (D = MR) Can sell all they want at the market price Each additional unit of sales adds to total revenue an amount equal to price 11- D S Quantity Price (dollars) Quantity Price (dollars) P0 Q0 Panel A – Market Panel B – Demand curve facing a price-taker Demand for a Competitive Price-Taking Firm (Figure 11.2) 0 0 P0 D = MR 11- Profit-Maximization in the Short Run In the short run, managers must make two decisions: Produce or shut down? If shut down, produce no output and hires no variable inputs . | Chapter 11 Managerial Decisions in Competitive Markets Perfect Competition Firms are price-takers Each produces only a very small portion of total market or industry output All firms produce a homogeneous product Entry into & exit from the market is unrestricted 11- Demand for a Competitive Price-Taker Demand curve is horizontal at price determined by intersection of market demand & supply Perfectly elastic Marginal revenue equals price Demand curve is also marginal revenue curve (D = MR) Can sell all they want at the market price Each additional unit of sales adds to total revenue an amount equal to price 11- D S Quantity Price (dollars) Quantity Price (dollars) P0 Q0 Panel A – Market Panel B – Demand curve facing a price-taker Demand for a Competitive Price-Taking Firm (Figure 11.2) 0 0 P0 D = MR 11- Profit-Maximization in the Short Run In the short run, managers must make two decisions: Produce or shut down? If shut down, produce no output and hires no variable inputs If shut down, firm loses amount equal to TFC If produce, what is the optimal output level? If firm does produce, then how much? Produce amount that maximizes economic profit Profit = 11- Profit Margin (or Average Profit) Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) Managers should ignore profit margin (average profit) when making optimal decisions 11- Short-Run Output Decision Firm’s manager will produce output where P = MC as long as: TR TVC or, equivalently, P AVC If price is less than average variable cost (P AVC), manager will shut down Produce zero output Lose only total fixed costs Shutdown price is minimum AVC 11- Total revenue =$36 x 600 = $21,600 Profit = $21,600 - $11,400 = $10,200 Total cost = $19 x 600 = $11,400 Profit Maximization: P = $36 (Figure 11.3) 11- Profit Maximization: P = $36 (Figure 11.4) Panel A: Total revenue & total cost Panel B: Profit curve when P =