MicroEconomics theory and application 12th by browning an zupan chapter 09

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 9: Profit Maximization in Perfectly
Competitive Markets
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives
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Outline the conditions that characterize perfect competition.
Explain why it is appropriate to assume profit maximization
on the part of firms.
Show why the fact that a competitive firm is a price taker
implies that the demand curve for the firm is perfectly
horizontal.
Explain a competitive firm’s optimal output choice in the
short run and how the firm’s shortrun supply curve may be
derived through this output selection.
Describe the firm’s short-run supply curve.

(continued)

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Learning Objectives
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(continued)

Explain how the short-run industry supply curve is derived.
Define the conditions characterizing long-run competitive
equilibrium.
Understand how the long-run industry supply curve
describes the relationship between price and industry output
over the long run, taking into account how input prices may
be affected by an industry’s expansion/contraction.
Analyze the extent to which the competitive market model
applies.
Delineate the mathematics behind perfect competition.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Outline the conditions that characterize perfect competition.

9.1 THE ASSUMPTIONS OF PERFECT
COMPETITION

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The Assumptions of Perfect
Competition
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Large numbers of buyers and sellers
Free entry and exit
Product Homogeneity
Perfect information

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Explain why it is appropriate to assume profit maximization on the part of
firms.

9.2 PROFIT MAXIMIZATION

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Profit Maximization



Assumption: firms select an output level so as to maximize
profit, defined as the difference between revenue and cost
“Survivor Principle” – the observation that in competitive
markets, firms that do not approximate profit-maximizing
behavior fail, and that survivors are those firms that,
intentionally or not, make the appropriate profit-maximizing
decisions.

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Show why the fact that a competitive firm is a price taker implies that the
demand curve for the firm is perfectly horizontal.

9.3 THE DEMAND CURVE FOR A
COMPETITIVE FIRM

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The Demand Curve for a Competitive Firm
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Price taker – a firm that takes prices as given and does not
expect its output decisions to affect price
=>horizontal demand curve

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Total revenue (TR) – price times the quantity sold
Average revenue (AR) – total revenue divided by output
Marginal revenue (MR) – the change in total revenue
when there is a one-unit change in output

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Figure 9.1 - The Competitive Firm’s
Demand Curve

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Explain a competitive firm’s optimal output choice in the short run and
how the firm’s shortrun supply curve may be derived through this output
selection.

9.4 SHORT-RUN PROFIT
MAXIMIZATION

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Short-Run Profit Maximization


Total profit (π) – the difference between total revenue and
total cost

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TR rises in proportion to output since the price is constant.
TC rises slowly at first and then more rapidly as the plant

facility becomes more fully utilized and MC rises.
Total profit tends to increase and then decrease as more is
produced.

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Table 9.1

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Figure 9.2 - Short-Run Profit
Maximization: Total Curves

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Short-Run Profit Maximization
Using Per-unit Curves
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Average profit per unit (π/q) – total profit divided by
number of units sold

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Profit is maximized at the output level where MR=MC.
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If MR>MC, profits would increase if output were increased.
If MR
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Figure 9.3 - Short-Run Profit
Maximization Using Per-unit Curves

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Operating at a Loss in the Short-Run

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If ATC<AR at the output-level where MC=MR => profit is
negative

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Two choices:
 Temporarily shut-down
 Permanently go-out-of-business

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Question: Which choice will yield smaller loss?

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Figure 9.4 - Operating at a Loss in the
Short-Run

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Describe the firm’s short-run supply curve.

9.5 THE PERFECTLY COMPETITIVE
FIRM’S SHORT-RUN SUPPLY CURVE

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The Perfectly Competitive Firm’s Short-Run
Supply Curve
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Short-run firm supply curve – a graph of the systematic
relationship between a product’s price and a firm’s most
profitable output level
Supply curve = MC curve where MC > minimum point
on AVC curve

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Identifies most profitable output for each possible price

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Shutdown point – the minimum level of average variable
cost below which the firm will cease operations

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Figure 9.5 - A Competitive Firm’s
Short-Run Supply Curve

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Output Response to a Change in Input
Prices
Question: What is the impact of a change in input price,
holding product price constant?
1) MC will shift
2) Firm will adjust output until MC=MR

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Figure 9.6 – How a Firm Responds to
Input Prices Changes

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Explain how the short-run industry supply curve is derived.

9.6 THE SHORT-RUN INDUSTRY
SUPPLY CURVE

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The Short-Run Industry Supply Curve


Short-run industry supply curve – add the quantities produced by
each firm by summing the individual firms’ marginal cost curves
horizontally

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Assumption – variable input prices remain constant at all levels of
industry output

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Curve slopes upward due to law of diminishing marginal returns

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Market price and output: determined by interaction between short-run
industry supply curve and the market demand curve

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