Chapter 10

• •  Profit = revenue – cost

  •  Assumption: firms aim to maximise profit

  •  TR = P x Q

  •  Price of the product is dependent on the market structure
• Four different types of market structures:

  Perfect competition(Max degree of competition),

  Monopolistic Competition

  Oligopoly

  Monopoly(Zero degree of competition)

  
• Market structure

  The major organisational features of the market in which a firm sells its products
• The equilibrium conditions(for any firm)

  Two decisions:

  •Should we produce?

  •If yes, how much?
• Shut down rule

  •  The shut-down rule

  –  produce only if total revenue is equal to, or greater than, total variable cost

  –  TR ≥ TVC

  OR

  –  produce only if average total revenue is equal to, or greater than, average total variable cost

  –  AR ≥ AVC
• Profit-maximising rules

  1.  Profits are maximised where the positive difference between total revenue and total cost is the greatest

  2.  Profit is maximised where marginal revenue is equal to marginal cost  MR = MC

  Different possibilities

  •  If MR > MC, output should be expanded

  •  If MR = MC, profits are maximised

  •  If MR < MC, output should be reduced
• Sunk cost = cost incurred that cannot be recovered

  •  Marginal principle: Always look at the marginal costs and marginal benefits of decisions and ignore past or sunk costs

  A) Price=AR

  B) Is it above AC

  C) No

  D) Yes

  E) cont to produce

  F) Above AVC

  G) yes

  H) No

  I) Continue to produce

  J) Shut down

  
• Perfect competition occurs when none of the individual market participants can influence the price of the product
• Perfect competition

  Requirements

  •  Large number of buyers and sellers

  •  No collusion

  •  Identical products (homogeneous)

  •  Complete freedom of entry and exit

  •  Perfect knowledge of market conditions

  •  No government intervention

  •  All factors of production must be perfectly mobile

  In these markets no individual firm has any market power

  – all the firms are price takers.
• Relevance

  Why study perfect competition?

  •  We may apply our knowledge to markets where many of the requirements for perfect competition are met.

  •  A useful starting point for analysing the determination of price and output
• The demand for the product of the firm

  Under perfect competition

  –  Price of a product is determined by supply and demand

  –  The individual  firm is a price taker

  •  The demand curve for the product of the firm is horizontal (perfectly elastic)
• Profit-maximising rules

  • Profits are maximised where the positive difference between total revenue TR and total cost TC is the greatest
  • Profit is maximised where marginal revenue is equal to marginal cost MR = MC
• Demand curve for the product

  • Horizontal (perfectly elastic)
  • Firm is a price taker
  • Firm can only choose the output at which it maximises profits
• Profit maximisation

  1. Where the positive difference between total revenue TR and total cost TC is at a maximum

  2. Where marginal revenue MR is equal to marginal cost MC, provided, of course, that average revenue AR (= P) is at least equal to short-run average variable cost AVC (the shut-down rule)
• Profit maximisation

  A firm maximises its profit where MR = MC
• P = MC
• Marginal cost


  • U-shaped
  • Only the rising part of the MC is relevant to our analysis
• Profits are maximised alongthe rising part of the costcurve

  A) Profits are maximised

  
• At lower levels of production, profit can be increased by expanding production. If more than 4 units of the product are produced, profit starts falling.
• The equilibrium condition of the firm under perfect competition

  Profit is maximised (or loss minimised) when a firm produces an output where marginal revenue equals marginal cost, provided marginal cost is rising and lies above minimum average variable cost.