mr=p mc review: market equilibrium the equilibrium price and quantity are determined by the market...
TRANSCRIPT
MR=P
MC
Review: Market EquilibriumThe equilibrium price and quantity are determined by the market demand and market supply curves.
First Question: Where does the market supply curve come from?The market supply curve is the horizontal sum of each individual firm’s supply curve.
Second Question: Where does an individual firm’s supply curve come from?
Profit Maximization
Marginal Revenue (MR): Change in the firm’s total revenue resulting from a one unit change in the quantity of output produced.
Marginal Cost (MC): Change in the firm’s total cost resulting from a one unit change in the quantity of output produced.
MR > MC
More production increases profit
MR < MC
Less production increases profit
MR = MC
Profit is maximized
Marginal Revenue and Perfect Competition:
MR = P
Marginal Cost Curve:
Upward Sloping
qq*
Individual Firm’s Supply Curve: The individual firm’s supply curve is its marginal cost curve.
q
MR = .50
MC
Second Question: Where does an individual firm’s supply curve come from? That is, how does a firm decide how much output to produce?
Firm A’s supply curve: How many cans of beer would firm A produce, if the price of beer were _____, given that everything else relevant to the supply of beer remains the same?
If P = .50
MR = 1.00If P = 1.00
MR = 1.50If P = 1.50
Profit Maximization: Produce the quantity of
output at which MR = MC.
.501.001.50
It looks like an individual firm’s supply curve is the firm’s marginal cost curve.
P
In fact, we must add one caveat.
S
Review: Short Run versus Long RunShort Run
Firms must meet theirshort run commitments
Terminology: When a firm goes out of business in the short run, we say
that the firm shuts down.
Long Run
Firms can escape theirshort run commitments
Terminology: When a firm goes out of business in the long run we say
that the firm exits the industry.Short Run Shutdown “Rule”
Price andAverage Variable Cost (AVC)
P < AVC
Firm goes out of business
in the short run
The firm shuts down.
Long Run Exit “Rule”Price and
Average Total Cost (ATC)
P < ATC
Firm goes out of businessin the long run
The firm exits the industry.
Rationale for the Caveat and the Long Run Behavior of an Individual FirmQuestion: How does the owner of a firm decide to
Continue to operate
Owner’s income when operating the firm
Go out of business
Owner’s income if he/she goes out of business and works for someone else
Answer: Compareor
with
q
MCP
Individual Firm’s Supply Curve: The individual firm’s supply curve is its marginal cost curve until the price is very low and falls below average variable cost. When the price is less than average variable cost, the firm will shut down and produce nothing.
S
Jeff’s monthly income if he continues to operate his firm
=Total
Revenue
Jeff’s monthly income in the long run if he goes out of business
Opportunity Costs
Accounting Costs
=
Profit of Jeff’s Firm Total Revenue Total Costs=
Total Revenue (Accounting Costs + Opportunity Costs)=
Total Revenue Accounting Costs Opportunity Costs=
(Total Revenue Accounting Costs) Opportunity Costs=
Jeff’s monthly income if he continues to operate his firm
Jeff’s monthly income
in the long run if he goes out of business
=Profit of Jeff’s Firm
Profit of Jeff’s Firm Total Revenue Total Cost=
Pq
ATCq=
Total Revenue = Pq
ATC = Total Cost
Total Cost = ATCq
q
= (P ATC)q
Claim: A firm’s profit depends on price P and average total cost (ATC).
Profit of Jeff’s Firm = (P ATC) q
P < ATC
Jeff’s Jeff’s
income incomewhen < in the long run
operating if he goeshis firm out of business
Jeff earns less income by operating his firm than by working for someone else.
Exit occurs in the long run
P > ATC
Jeff’s Jeff’s
income incomewhen > in the long run
operating if he goeshis firm out of business
Jeff earns more income
by operating his firm than byworking for someone else.
Entry occurs in the long run
P = ATC
Jeff’s Jeff’s
income incomewhen = in the long run
operating if he goeshis firm out of business
Jeff earns the same income by operating his firm or byworking for someone else.
Long run equilibrium
Profit < 0
Profit = 0
Profit > 0
q
MC
ATC
The ATC curve intersects the MC curve at minimum ATC.
MC < ATC ATC falls
MC > ATC ATC rises
ATCMC
P
Scenario 1:P* < Min ATC
P*
q*
Max profit: q = q*
P* < ATC
Profit < 0
Firms exit
in the long run
Supply curve
shifts leftin the long run
Price rises
in the long run
D
S
MR = P*
S’
SummaryP* < Min ATC
Price rises
in the long run
Intersects the marginal cost curve (MC) at minimum
average total cost.
Average Total Cost (ATC) Curve
ATCMC
P
Scenario 2:P* > Min ATC
P*
q*
Max profit: q = q*
P* > ATC
Profit > 0
Firms enter
in the long run
Supply curve
shifts rightin the long run
Price falls
in the long run
D
S
MR = P*
S’
Intersects the marginal cost curve (MC) at minimum
average total cost.
Summary:P* > Min ATC
Price falls
in the long run
Average Total Cost (ATC) Curve
ATCMC
qD
S
Q
P
Scenario 3:P* = Min ATC
P*
q*
Max profit: q = q*
P* = ATC
Profit = 0
Long run
equilibrium
Supply curve will
not shiftin the long run
MR = P*
Summary:P* = Min ATC
Long run
equilibrium
Intersects the marginal cost curve (MC) at minimum
average total cost.
Average Total Cost (ATC) Curve
Price does not change
in the long run
President Clinton’s “Level Playing Field” Claim
On April 7, 1994, President Clinton (Hilary’s husband) held a town meeting at the KCTV television studios in Kansas City, Missouri. He fielded a variety of questions concerning his health care proposal. One question was posed by Herman Cain, president and chief executive officer of Godfather Pizza, Inc. Mr. Cain feared that Clinton’s proposal would raise his costs, hurt his business, and force him to lay off workers. President Clinton agreed that costs would rise, but argued that since the costs of all pizza firms would increase, Godfather would not suffer:
“..., so [for] you [the health proposal] would add about one and one-half percent to the total cost of doing business. Would that really cause you to lay a lot of people off if all your competitors had to do it too? Only if people stop eating out. If all your competitors had to do it, and your cost of doing business went up one and one-half percent, wouldn't that leave you in the same position you are in now? Why wouldn't they all be in the same position, and why wouldn't you all be able to raise the price of pizza two percent? I'm a satisfied customer. I'd keep buying from you.”
President Clinton’s “Level Playing Field” Claim: Since the costs of all pizza firms would increase, an individual firm would not be hurt.
Where does the market supply curve "come from?" What happens to the equilibrium quantity?
What happens to the firm's profit maximizing level of output?
Decreases.What happens to the equilibrium price? Increases.
ATCMC
qD
S
Q
P
P*
q*
MR = P*
Q*
ATCMC
S
P** MR = P**
q**Q**
.10 .10
.10
.10
<.10 <.10
What is the goal of each pizza firm? Profit maximization
A profit maximizing firm produces the level of output at which
In a metropolitan area, there are a large number of small, independent pizza firms; consequently, the pizza market is perfectly competitive:
In a perfectly competitive market,
MR = MC.
MR = Price.
Is the industry is in long run equilibrium?
When an industry is in long run equilibrium,
How is the average total cost curve shaped?
Yes
the price, P*, equals minimum ATC.
ATC curve intersects the MC curve at minimum ATC.
What happens to the typical firm's average total cost curve?
What happens to the typical firm's marginal cost curve?
Horizontal sum of each firms MC curve.
Shifts up by $.10.
Shifts up by $.10.
What happens to the market supply curve? Shifts up by $.10.
What happens to the equilibrium price?
Decreases.
Increases by less than $.10.
How are the price and average total cost related? Price is less than average total cost
Will firms enter or exit? Exit
What happens to the market supply curve? Shifts left.
What happens to the equilibrium quantity? Decreases.
S
P***
Q***
Pizza Market Typical Pizza Firm