Chapter 6.Tutorial

7/24/2019 Chapter 6.Tutorial

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Chapter 6Perfectly Competitive

Supply:The cost side of the

marketEven-numbered Qs. and #3 #9

4 additional questions


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Proft-maximizing frm

- Goal is to maximize proft,

- Proft = Total Revenue Total Cost- Total costs include explicit and implicit costs

Perectly Competitive ar!et

- "irms in t#is mar!et ma!e many decisions$ %ut one t#ingt#ey do not decide is t#epriceat ic# to sell t#eir output

- "irms in perect competition are said to %eprice taker

- Price taker a frm t#at cannot in'uence t#e price o agood or service

- (t t#e mar!et price, individual frm can sell as muc# or aslittle )uantity as it &is#es

- *ndividual frm+s demand curve is perectly elastic


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Five conditions of Perfectly competitive market:1) All firms are price-taker

2) All firms sell the same standardized product to many buyers- %uyers are a%le to s&itc# rom one seller to anot#er i t#e price o

t#e good is lo&er

- su%stitution goods are availa%le

3) The market has many buyers and sellers, they have a relatively smallmarket share of the total quantity echan!ed

- individual+s decision &ill #ave no impact on t#e mar!et price

") #roductive resources are mobile

- ree to enter or exit t#e mar!et

$) %uyers and sellers are &ell informed about product bein! sold and theprices char!ed by each firm

- uyers are a%le to see! or t#e lo&est price

- ellers are a%le to see! or t#e .most-proft earning/ opportunities


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"actors o Production0

- inputs used in production

- it can %e varia%le or fxed

1aria%le actor o production

- input can %e varied in t#e s#ort run

- i2e2 la%or frms can increase production simply %y #avingla%ors &or!ing overtime in a s#ort notice

"ixed actor o production

- input cannot %e varied in t#e s#ort run- i2e2 mac#inery, a actory it ta!es time to install a ne&e)uipment, train la%ors to use it$ and it ta!es time to planand %uild a ne& actory


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#ort run vs2 3ong run

#ort run- at least one input is fxed and t#e ot#er inputs arevaria%le

- it is impossi%le to add anot#er actory or install a

mac#ine in a s#ort period o time

3ong run

- all inputs are varia%le

- it is su4cient to add anot#er actory or install amac#ine in a long period o time

T#e s#ort run and long run distinction varies rom

one industry to anot#er


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Law of Diminishing Returns - as adding more varia%le inputs, t#e marginal production

gro&s, 5increasing marginal returns6$ %ut %eyond somepoint, t#e marginal production starts to diminis#5decreasing marginal returns6

- it only applies to t#e s#ort run, at least one input is fxedand t#e ot#er inputs can %e varied

arginal Product0 t#e c#ange in total product7t#e c#ange invaria%le input

- i2e2, a frm #ires some additional la%ors in t#e car

production and t#e amount o mac#inery stays t#e same,t#en, t#e used o t#e mac#ine &ould %e overcro&ded2 T#emarginal productivity gro&s only or t#e frst e& units ola%ors, t#en it starts to diminis#2 T#ereore, marginalproductivity actually decreases


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arginal Cost: t#e c#ange in total cost 5total varia%lecost67t#e c#ange in )uantity

- C at frst decreases s#arply, it reac#es a min2 point, t#enagain, starts to increase

- T#is re'ects t#e act t#at 1C, or TC increases %y adecreasing amount and t#en TC increases %y an increasingamount

- T#e s#ape o t#e C curve is a conse)uence o t#e 3a& o

8iminis#ing Return MC

Quantity

MC

Law of diminisin! returns


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Law of Diminishing Returns

it only applies to t#e s#ort run, at least one inputis fxed and t#e ot#er inputs can %e varied

*n t#e #ort run, C curve is 9-s#ape

in t#e 3ong run, C curve is #orizontal

in t#e long run, all inputs are varia%le2 T#e frmcan oten dou%le its production %y simply dou%lingt#e amount o eac# input t#ey use

T#us, cost is proportional to output

T#ereore, C in t#e long run is #orizontal, notup&ard sloping


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"or a perectly competitive frm, it c#ooses toproduce at a point ere P=C

* P : C0 "irm can increase its proft %y increasingoutput

* P ; C0 "irm can increase its proft %y decreasingoutput

!irms earn pro"t P # $TC where % is at optimallevel of output

!irms su&er loss P ' $TC where % is at optimal

level of output

!irms (reak)even* TR +TC* earning ,ero-conomic pro"t

P + $TCwhere % is at optimal

level of output!irms shutdown point P + min. $/C!irms should shutdown P ' min. $/C* loss +

"0ed cost


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To ummarize0

* P : (TC : min2 (1C

"irms earn proft and stay in t#e mar!et

* (TC : P : min2 (1C

"irms su


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>6 ?#ic# o t#e ollo&ing is @AT true o a perectly

competitive frmB

(6 *t aces a perectly elastic demand curve2

6 *t is una%le to in'uence t#e mar!et price o t#e

good it sells2

C6 *t see!s to maximize revenue2

86 Relative to t#e size o t#e mar!et, t#e frm issmall2

6 T#e frm+s only decision is #o& muc# output toproduce2

Additional Question #1

Ans: C


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5(6 is correct2 ac# frm in a perectly competitivemar!et is acing a #orizontal demand or its

products2

T#e demand is perectly elastic %ecause frms areselling #omogeneous goods2 *t is very easy or

t#e customers to fnd su%stitutes2

@ote t#at t#e (RDT 8(@8 is not #orizontal2Anly t#e demand or individual frms+ products is

perectly elastic2


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56 and 586 are t#e eatures o a perectlycompetitive mar!et2

*n a perectly competitive mar!et, t#ere is a #ugenum%er o frms and eac# frm is o a minusculesize 5compared to t#e ole mar!et6

ecause eac# frm is so small, none o its actioncan in'uence t#e mar!et2 T#e frm &ill su


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56 is also true2 *ndeed, en eac# frm is acinga given mar!et price, at it can do is to

determine #o& muc# output it is going to supply2

T#e decision on output is made %ased on t#efrm+s cost unction2

( rational economic agent &ill al&ays aim atmaximising profts2


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1s ma0imi,ing pro"t the same as minimi,ingcost2

?#at is t#e output level at ic# cost oproduction is minimizedB

Eero output FF

T#us maximizing proft is not t#e same asminimizing costFF


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(s mentioned ust no&, frms al&ays aim atmaximising PRA"*T2

Ho&ever, it does not mean t#at t#ey aim atmaximising R1@92 5Proft is t#e di


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I6 T#e 3a& o 8iminis#ing arginalReturnsJ

(6 *s a 3ong Run concept2

6 (pplies only to small and medium sizedfrms2

C6 *s a #ort and 3ong Run concept2

86 (pplies only to large frms2

6 *s a s#ort run concept2


Ans: E


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T#e 3a& o 8iminis#ing arginal Returns statest#atJ

*n a production ere t#ere are fxed and varia%leactors,

en more varia%le actors are added, additional

output yielded %y eac# marginal unit o inputdrops eventually2


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8oes t#e 3a& o 8iminis#ing arginal Returns#ave anyt#ing to do &it# frm sizeB

@AF

38R #olds enever a frm #as %ot# fxed and

varia%le actors o production, regardless o size2

"irms o any size can %e using 5or not using6 %ot#fxed and varia%le actor input2

Hence, 56 and 586 can %e eliminated %ecauset#ey are &rong2


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5(6, 5C6 and 56 are all a%out 3ong 7 #ort Run2

?#at is #ort RunB ?#at is 3ong RunB

"ort un Lon! un

$i%ed $a&tor ' '

(ariable $a&tor ' '

Yes

Yes Yes

No


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Recall t#at 38R descri%es a situation at ic#%ot# fxed and varia%le actors are in used2

o is it reerring to 3ong Run or #ort RunB

#ort Run

T#ereore, t#e ans&er is 562


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K6 uppose a frm is collecting L>MMM in Total

Revenue and t#e Total Cost o its fxed actors oproduction alls rom LNOO to LOO2 Ane canspeculate t#at t#e frm &illJ

(6 xpand output26 3o&er Price2

C6 arn greater profts or smaller losses2

86 Contract output2

6 arn smaller profts or great losses2


Ans: C


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"irst o all, #o& are production decisions made %yfrms in economicsB

"irms ma!e production decisions %ased on auniversal rule0 C=R

"or a price ta!er, its marginal revenue is al&ayse)ual to t#e price 5R=P6

T#ereore, t#e frm only #as to determine itsoutput level2 T#e optimal level o output is ere

C = R2


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@o& t#at t#e fxed cost o production #asdecreased2

*s t#e arginal Cost 5C6 sc#edule a


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T#ereore, 5(6 and 586 can %e eliminated as t#eyare t#e &rong ans&ers2

Autput level is not a


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Ho& a%out option 56B

ince &e are tal!ing a%out Perect Competition5Price Ta!er6J

8oes t#e frm #ave any say on its priceB

@oF

T#ereore, 56 is also not t#e ans&er2


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T#at leaves us &it# options 5C6 and 5862

Recall t#at Proft = Revenue Costs

@o& t#at 5"ixed6 Costs #ave droppedJ

?#at #appens to ProftB

*ncreasesF

Hence 5C6 is t#e correct ans&er2


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Chapter 6 Pro(lem 3( price-ta!ing frm ma!es air conditioners2 T#e

mar!et price o one o t#eir ne& air conditionersis L>IO2 *ts total cost inormation is given in t#eta%le %elo&0

Ho& many air conditioners s#ould t#e frmproduce per day i its goal is to maximize its

$ir conditioners perday

Total cost 45 per day

> >OOI >NO

K IIO

K>O

N ON

Q N>O

QNO

S SOO


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To decide #o& many air conditioners s#ould produce in orderto maximize its proft, &e can

>6 (pply t#e cost-%eneft principle ,or,

I6 Calculate t#e proft levels and c#oose t#e production levelt#at gives t#e largest proft


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et#od >0

T#e cost %eneft principle, &e !no& t#at frm s#ould

continue to produce an additional unit o goods as long ast#e additional %eneft to produce t#e good is at least asgreat as t#e additional cost to produce t#e same good2

T#at is, : C

(t t#e mar!et price o L>IO or one air conditioner,perectly competitive frm can sell as many air conditionersas t#ey &is# in order to maximize its proft2

T#e rom selling an additional air conditioner is L>IO2

l l #


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To calculate t#e C0

y comparing t#e 5L>IO6 and t#e C, t#e optimal output

or t#is frm to produce is Q air conditioners per day2

T#e C o eac# o t#e frst Q air conditioners produced eac#day is L>ON, ic# is less t#an t#e o L>IO2 5L>IO6 :C 5L>ON6

$irconditioners7day

Total Cost457day

C 457day

8 899 899

3 89 9

; 339 9

=9 >

6 89 89

< 69 8=9

? ?99 89


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et#od I6 Calculate t#e proft0

Proft = TR TC

*n order to maximize its proft, t#is frm s#ould produce Q airconditioners per day, since it yields t#e largest proft amongt#e ot#ers, LI>O7day2

ame result as %y applying t#e cost-%eneft principle2

$irconditioners7

day

Total Cost457day

TotalRevenue457day

Pro"t457day

8 899 839 39

3 89 3=9 >9

; 339 ;69 8=9

= ;89 =?9 8

6 89 9

? ?99 >69 869


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Chapter 6* Pro(lem ; )e *adu&a "lu!!er Com+any ma,es baseball bats out of

lumber su++lied to it by &me "+ortin! oods/ wi& +ays*adu&a 012 for ea& finised bat. *adu&as only fa&tors of+rodu&tion are late o+erators and a small buildin! wit alate. )e number of bats +er day it +rodu&es de+ends on tenumber of em+loyee-ours +er day/ as sown in te table

below. # of bats per day # of employee-hours per day

2 2

1

12 5

1 4

52 6

5 11

32 17

3 55


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a6 * t#e &age is L>N per #our and Paduca#+s dailyfxed cost or t#e lat#e and %uilding is LQO, atis t#e proft-maximizing )uantity o %atsB

Quantity(batsday!

"otale$enue(%day!

"otal labor &ost(hours ' a)e!

"otal &ost(labor &ost *fi+ed &ost!

,rofit (%day!(re$enue

&ost!

. . . /10 %. . * . %. )569

0 0. 1 /10 %10 10 * . %0 )53

1. 1.. 2 /10 %3. 3. * . %4. 589

10 10. 5 /10 %. . * . %12. 5;9

2. 2.. / 10 %1.0 1.0 * . %10 5;

20 20. 11 /10 %10 10 * . %220 53

3. 3.. 1 /10 %25. 25. * . %3.. 59

30 30. 22 /10 %33. 33. * . %34. )5=9


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%6 * t#e frm+s fxed cost decreases rom LQO to LKO,at is t#e proft maximizing )uantity o %atsB

8ecrease in fxed cost &ill increase t#e profts across

di


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Chapter 6 Pro(lem =

*n t#e preceding pro%lem 5K6, #o& &ould Paduca#+s proft-maximizing level o output %e aO per day on t#e companyB 5Hint0T#in! o t#is tax as e)uivalent to a L>O increase in fxedcost26 ?#at &ould Paduca#+s proft-maximizing level o

output %e i t#e government imposed a tax o LI per %atB5Hint0 T#in! o t#is tax as a LI-per-%at increase in t#e frm+smarginal cost26 ?#y do t#ese t&o taxes #ave suc# di


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"ixed cost0

Cost on all fxed "actor o Production, ex2, lease payment onmac#ines, %uildings

@ot depends on frm+s output

( sun! cost

1aria%le cost0

Cost on all varia%le "actor o Production, e2g2, la%or cost,

input cost 8epends on frm+s output

1aried &it# num%er o products t#at frm produces


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@overnment imposed a ta0 of 589 per day 4increasein "0ed cost

?ill t#is tax aO perday at every level o output2

T#e proft-maximizing level o output &ould still %e IO %atsper day 5rom K6

T#is tax does not depends on t#e output, li!e a fxed cost ora sun! cost2

* "ixed cost c#anges, and C &ill not %e a


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Tax o L>O decreases its proft %y L>O per day at every level ooutput2*t+s proft-maximizing output level is still at IO %ats per day2Fixed cost is independent o output

@overnment imposed a ta0 of 589 per day

Quantity(batsday!

"otale$enue(%day!

"otal labor &ost(hours ' a)e!

"otal &ost (labor&ost * fi+ed

&ost!

,rofit (%day!(re$enue

&ost!

. . . /10 %. . * . *1. %. -%.

0 0. 1 /10 %10 10 * . *1. %60 -%30

1. 1.. 2 /10 %3. 3. * . *1.%1..

%.

10 10. 5 /10 %. . * . *1.%13. %2.

2. 2.. / 10 %1.0 1.0 * . *1.%10

%20

20 20. 11 /10 %10 10 * . *1.%230

%10

3. 3.. 1 /10 %25. 25. * . *1.%31.

%-1.

30 30. 22 /10 %33. 33. * . *1.%5..

-%0.


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@overnment imposed a ta0 of $2 per bat (increase inmarginal cost)

?ill t#is tax a


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Tax o LI per %at, t#e proft-maximizing output level alls to>N %ats per day, &it# proft = LO2Variable cost depends on output.

@overnment imposed a ta0 of $2 per bat

Quantity(batsday!

"otale$enue(%day!

"otal labor &ost(hours ' a)e! * %2

per bat

"otal &ost (labor&ost * fi+ed &ost!

,rofit (%day!(re$enue &ost!

. . . /10 * 2/. %. . * . %. -%.

0 0. 1 /10 * 2/0 %20 20 * . %60 -%30

1. 1.. 2 /10 *2/1. %0. 0. * . %11. -%1.

10 10. 5 /10 * 2/10 %4. 4. * . %10. %.

2. 2.. / 10 *2/2.%150 150 * . %2.0 -%0

20 20. 11 /10 *2/20 %210 210 * . %20 -%20

3. 3.. 1 /10 *273. %3.. 3.. * . %3. -%.

30 30. 22 /10 *2/30 %5.. 5.. * . %5. -%11.

Aith T f 589 d 4i i " d t


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Aith Ta0 of 589 per day 4increase in "0ed cost

Proft-maximizing level o output stays t#e same

Aith Ta0 of 53 per (at 4increase "rmBs C

Proft-maximizing level o output alls

T#e di


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government imposed a tax o LIO per %at 5t#in! o t#is tax ase)uivalent to increase in marginal cost26

TR ; 1C or all level o 2

* t#is frm continues to operate, it &ould su


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Chapter 6 Pro(lem 6

Calculate daily producer surplus or t#e mar!etor pizza ose demand and supply curves ares#o&n in t#e grap#2

>I

Price5L7slice6

uantity 5>,OOOso slices7day6

K

Q

O I

8


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Producer Surplus:

T#e economic surplus received %y sellers2

* t#e price exceeds C, t#e frm receives a producer surplus2

*t is t#e di


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Producer surplus0

T#e area o t#e s#aded triangle0

5LK7slice6 5>I,OOO slices7day6 5>7I6 = L>S,OOOslices 7day

Price5L7slice6

Q

I

O

K

uantity >OOOssliceper day

>I

8


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Chapter 6 Pro(lem ?

"or t#e pizza seller ose marginal, averagevaria%le, and average total cost curves are s#o&nin t#e accompanying diagram, at is t#e proft-maximizing level o output and #o& muc# proft&ill t#is producer earn i t#e price o pizza is

LO2SO per sliceB

Price

5L7slice6

Quantity 8sli&esday:

MC

)C

(C

372

1.23

2.;2

2


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(ssume it is a perectly competitive mar!et

"irms are price ta!er

*t is a proft-maximizing frm

Goal is to maximize t#e amount o proft it earns

T#e optimal level o output t#at maximizes proft, en,P + C

"irms earn proft en,

P # $TCere is at optimal level o output

"irm+s #ort-run s#utdo&n condition0

P ' in. $/C


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T#is frm is su


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Price5L7slice6


MC

)C

(C

372

1.23

2.;2

2

Loss


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Chapter 6* Pro(lem >"or t#e pizza seller ole marginal, averagevaria%le, and average total cost curves are s#o&nin t#e accompanying diagram, at is t#e proft-maximizing level o output and #o& muc# proft&ill t#is producer earn i t#e price o pizza is

LO2NO per sliceB


*ri&e

809sli&e:

2

)C

(C

MC

572

2.22.7;

1.1;


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T#e frm s#utdo&n point is at P = LO2QS per slice

!"ere P = #VC$

T#e frm s#ould s#utdo&n at any point %elo&LO2QS

* a slice o pizza is sold or only LO2NO, t#e frm&ill defnitely not produce any pizza and s#utdo&n

ecause price is less t#an t#e minimum value o(1C, t#is producer &ill s#ut do&n in t#e s#ort run2


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* t#e frm s#uts do&n, t#ere &ill %e no 5average6varia%le cost

y s#utting do&n t#e plant, t#e frm &ill #ave anegative proft t#at is exactly e)ual to t#e fxedcost

"ixed cost = Total cost varia%le cost

Total cost< (TC U

< L>2>S 7 slice U IQO slices = LKOQ2SO 7 day

1aria%le cost

< (1C U < LO2QS 7 slice U IQO slices = L>Q2SO 7 day


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"ixed cost = LKOQ2SO7day - L>Q2SO7day=L>KO7day

T#us, %y s#utting do&n t#e plant in t#e s#ort run,t#e frm &ill loss L>KO a day

*n ot#er &ords, t#e frm earns a proft o -L>KOper day i t#e price or a slice o pizza is ustLO2NO


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Chapter 6 Pro(lem 89

"or t#e pizza seller ose marginal, average varia%le, andaverage total cost curves are s#o&n in t#e accompanyingdiagram 5o is t#e same seller as in pro%lem M6, at ist#e proft-maximizing level o output and #o& muc# proft&ill t#is producer earn i t#e price o pizza is L>2>S persliceB

MC


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Price5L7slice6


MC)C

(C

43

1.1;2.66

2.7;2.2

572

2

T#is frm &ill sell KN slices per day to maximize it+s proft2


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T#is frm is ma!ing proft0

P : (TC

T#e proft-maximizing output is KN slices i priceo pizza is L>2>S per slice

Total proft0 Pro"t + TR TC

TR = P x

TC = (TC x

Proft = 5P - (TC6 x

MC


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Price5L

7slice6


MC)C

(C

43

1.1;

2.662.7;

2.2

572

2

T#is frm &ill sell KN slices per day to maximize it+s proft2


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(TC at t#e proft-maximizing level o output0

Recall, TC = "C 1C

(t t#e optimal level o output, KN slices, (1C e)ualsto LO2 per slice

1C = (1C x

1C = LO2 x KN slices

1C = LKK2MN

Recall rom M, t#e frm+s "C = L>KO per day

Total cost0

L>KO LKK2MN = LQ2MN

Total proft at price o L> >S per slice and output KN


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Total proft at price o L>2>S per slice and output KNslices0

Pro"t + TR TC

TR = P x

= L>2>S x KN slices

= LN>K2K

Pro"t + 58;.;7day ) 5=6=.>7day + 5=?.;

dditi l Q ti #4


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P

rice5L7s&eater6

Quantity 8sweaterday:

MC)C

(C

;

052

2

(ccording to t#e grap# %elo&, i mar!et price o s&eater isLIO2 ?#at is t#e proft-maximizing outputB Ho& muc#

proft &ill t#is frm ma!eB ?#at s#ould %e t#e s#utdo&npoint or t#is frmB

dditional Question #4

16

1

7


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(t price LIO, t#e proft-maximizing output is Ss&eaters per day

(t price LIO, P = C = (TC

T#is is t#e frm+s %rea!even point, total revenue

e)uals total cost *t earns zero economic proft

conomic proft = Total Revenue xplicit Costs *mplicit Costs5ore on C#apter SJ6


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Shutdown point: t#e output and price at ic# t#e frm ust covers its totalvaria%le cost2 "irm is indi, P = min2 (1C,

ot# price and (1C e)ual L>, t#e frm ust covers its T1C

T#e frm is indi


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P

rice5L7s&eater6

Quantity 8sweaterday:

MC)C

(C

;

052

2

;rea


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