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Chapter 8
Chapter 8
Chapter 8
Chapter 8
pp.
262-8
Cost,
Revenue,
Profit
($s per
year)
C(q)
A
R(q)
Profits are
maximized
where R(q)
C(q) is
maximized
q0
q*
Chapter 8
Output
(q)
5
Chapter 8
= RC
R C
=
=0
q q q
MR MC = 0
MR = MC
2005 Pearson Education, Inc.
Chapter 8
Chapter 8
Chapter 8
Firm
Price
$ per
bushel
Industry
S
$4
$4
D
100
2005 Pearson Education, Inc.
200
Output
(bushels)
Chapter 8
100
Output
(millions
of bushels)
10
MC (q ) = MR = P = AR
2005 Pearson Education, Inc.
Chapter 8
11
pp.
262-8
Cost,
Revenue,
Profit
($s per
year)
C(q)
R(q)
=pq
q*
Profits are
maximized
where R(q)
C(q) is
maximized
Output
(q)
2005 Pearson Education, Inc.
Chapter 8
12
pp. 268-73
Chapter 8
13
Price
Lost Profit
for q2>q*
Lost Profit
for q2>q*
50
40
AR=MR=P
ATC
AVC
30
q1 : MR > MC
q2: MC > MR
q*: MC = MR
20
10
0
q1
2005 Pearson Education, Inc.
Chapter 8
q* q2
10
11
Output
14
pp. 268-73
Chapter 8
15
Total
Profit =
ABCD
50
40
MC
AR=MR=P
ATC
Profit per
unit = PAC(q) =
A to B
30 C
Profits are
determined
by output per
unit times
quantity
AVC
20
10
0
q1
2005 Pearson Education, Inc.
Chapter 8
q* q2
10
11
Output
16
Chapter 8
17
pp. 268-73
MC
Price
ATC
C
D
P = MR
q*:
At
MR =
MC and P <
ATC
Losses =
(P- AC) x q*
or ABCD
AVC
q*
2005 Pearson Education, Inc.
Chapter 8
Output
18
Continue producing
Shut down temporarily
Will compare profitability of both choices
Chapter 8
19
Chapter 8
20
pp. 268-73
MC
Price
ATC
Losses
C
D
P < ATC but
AVC so
firm will
continue to
produce in
short run
P = MR
AVC
q*
2005 Pearson Education, Inc.
Chapter 8
Output
21
Chapter 8
22
A Competitive Firms
Short-Run Supply Curve pp. 273-6
Price
($ per
unit)
Supply is MC
above AVC
MC
P2
ATC
P1
AVC
P = AVC
q1
2005 Pearson Education, Inc.
Chapter 8
q2 Output
23
A Competitive Firms
Short-Run Supply Curve pp. 273-6
Supply is upward sloping due to
diminishing returns
Higher price compensates the firm for the
higher cost of additional output and
increases total profit because it applies to
all units
Chapter 8
24
A Competitive Firms
Short-Run Supply Curve pp. 273-6
Over time, prices of product and inputs
can change
How does the firms output change in
response to a change in the price of an
input?
We can show an increase in marginal costs
and the change in the firms output decisions
Chapter 8
25
MC2
Savings to the firm
from reducing output
MC1
$5
q2
2005 Pearson Education, Inc.
Chapter 8
q1
Output
26
pp. 276-81
Chapter 8
27
$ per
unit
MC2
MC3
The short-run
industry supply curve
is the horizontal
summation of the supply
curves of the firms.
P3
P2
P1
Q
2
2005 Pearson Education, Inc.
7 8
10
Chapter 8
15
21
28
MC
Producer
Surplus
pp. 276-81
AVC
B
P
At q* MC = MR.
Between 0 and q,
MR > MC for all units.
Producer surplus
is area above MC
to the price
q*
2005 Pearson Education, Inc.
Chapter 8
Output
29
Chapter 8
30
Chapter 8
31
MC
Producer
Surplus
pp. 276-81
AVC
B
P
q*
2005 Pearson Education, Inc.
Chapter 8
Producer surplus
is also ABCD =
Revenue minus
variable costs
Output
32
pp. 276-
81
Price
($ per
unit of
output)
P*
Producer
Surplus
Q*
2005 Pearson Education, Inc.
Chapter 8
Output
33
Chapter 8
34
Chapter 8
35
pp. 281-
7
Price
LMC
LAC
SMC
SAC
$40
A
P = MR
$30
In the short run, the
firm is faced with fixed
inputs. P = $40 > ATC.
Profit is equal to ABCD.
q1
2005 Pearson Education, Inc.
Chapter 8
q2
q3
Output
36
pp. 281-
7
In the long run, the plant size will be
increased and output increased to q3.
Long-run profit, EFGD > short run
profit ABCD.
Price
LMC
LAC
SMC
SAC
$40
A
P = MR
G
$30
q1
2005 Pearson Education, Inc.
Chapter 8
q2
q3
Output
37
Long-Run Competitive
Equilibrium pp. 281-7
For long run equilibrium, firms must have
no desire to enter or leave the industry
We can relate economic profit to the
incentive to enter and exit the market
Chapter 8
38
Long-Run Competitive
Equilibrium pp. 281-7
Firm uses labor (L) and capital (K) with
purchased capital
Accounting Profit and Economic Profit
Accounting profit: = R - wL
Economic profit: = R = wL - rK
wl
= labor cost
rk = opportunity cost of capital
Chapter 8
39
Long-Run Competitive
Equilibrium pp. 281-7
Zero-Profit
A firm is earning a normal return on its
investment
Doing as well as it could by investing its
money elsewhere
Normal return is firms opportunity cost of
using money to buy capital instead of
investing elsewhere
Competitive market long run equilibrium
Chapter 8
40
Long-Run Competitive
Equilibrium pp. 281-7
Entry and Exit
The long-run response to short-run profits is
to increase output and profits
Profits will attract other producers
More producers increase industry supply,
which lowers the market price
This continues until there are no more profits
to be gained in the market zero economic
profits
Chapter 8
41
Long-Run Competitive
Equilibrium Profits pp. 281-7
Profit attracts firms: New entrants
Supply increases until profit = 0
$ per
unit of
output
$ per
unit of
output
Firm
Industry
S1
LMC
$40
LAC
P1
S2
P2
$30
D
q2
2005 Pearson Education, Inc.
Output
Chapter 8
Q1
Q2
Output
42
Long-Run Competitive
Equilibrium Losses pp. 281-7
Losses causeexisting firms to leave
Supply decreases until profit = 0
$ per
unit of
output
Firm
LMC
$ per
unit of
output
LAC
Industry
S2
P2
$30
S1
P1
$20
D
q2
2005 Pearson Education, Inc.
Output
Chapter 8
Q2
Q1
Output
43
Long-Run Competitive
Equilibrium pp. 281-7
1. All firms in industry are maximizing
profits
p = MC
3. Market is in equilibrium
QD = Q S
Chapter 8
44
LMC
LAC
A baseball team
in a moderate-sized city
sells enough
tickets so that price
is equal to marginal
and average cost
(profit = 0).
$7
1.0
2005 Pearson Education, Inc.
Chapter 8
Season Tickets
Sales (millions)
45
Chapter 8
46
Chapter 8
47
Chapter 8
48