Chapter 8 Competitive Firms and Markets Competition & Profit Maximization Competition Price taking Economists say that a market is competitive if each firm in the market is a price taker Horizontal demand curve: The firm can sell as much as it wants at the market price, so it has no incentive to lower its price. The firm cannot increase the price because it faces an infinitely elastic demand, A small increase in price results in its demand falling to zero. Why the firm?s demand curve is horizontal Perfectly competitive market Identical products Freely enter and exit the market Buyers and sellers know the prices charged by firms Low transaction cost Why we study perfect competition? Many markets can be reasonably described as competitive. A perfectly competitive market has many desirable properties. Economists use this model as ideal against which real-world markets are compared. Profit Maximization A firm?s profit, ?=R-C. If profit is negative ?<0, the firm makes a loss Business use only explicit costs, Economist use explicit and implicit cost (opportunity cost)=Economic cost Economic profit = Revenue minus economic cost, where economic cost includes any additional opportunity cost Two steps to maximizing profit Firm?s profit function ?(q)=R(q)-C(q) To maximize profit, any firm must answer two questions Output decisions Shutdown decisions Output Rules Output rule 1: The firm sets its output where its profit is maximized. Output rule 2: A firm sets its output where its marginal profit is zero Output rule 3: A firm sets its output where its marginal revenue equals its marginal cost Maximizing Profit Shutdown Rule Shutdown rule 1: The firm shuts down only if it can reduce its loss by doing so. Shutdown rule 2: The firm shuts down only if its revenue is less than its avoidable cost. E.g., R=$2,000, VC=$1,000, F=$3,000, Profit=-$2,000? What if R=$500, VC=$1,000, F=$3,000, Profit=-$3,500? Competition in the short run Short-run competitive profit maximization Where its marginal profit is zero or where its marginal cost equals its marginal revenue A competitive firm can sell as many units of output as it wants, the revenue is R=pq. Because a competitive firm?s marginal revenue equals the market price, a profit maximizing competitive firm produces the output where Mc(q)=p How a Competitive Firm Maximizes Profit Quiz 18 Why each firm in the market is price taker if demand curve of the market is horizontal Quiz 18 Why each firm in the market is price taker if demand curve of the market is horizontal 2. The below figure shows the cost curves for a competitive firm. If the market price is $15 per unit, how much profit the firm will earn? Show your work and explain.
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