AGENDA Mon 10/12. Economics in Action Review QOD #21: Competitive Farming HW Review Pure Competition MR = MC HW: Read pp Q #7

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1 AGENDA Mon 10/12 Economics in Action Review QOD #21: Competitive Farming HW Review Pure Competition MR = MC HW: Read pp Q #7

2 QOD #21: Competitive Farming A purely competitive wheat farmer can sell any wheat he grows for \$10 per bushel. His five acres of land show diminishing returns, because some are better suited for wheat production than others. The first acre can produce 1000 bushels of wheat, the second acre 900, the third 800, and so on. Draw a table with multiple columns to help you answer the following questions. 1.How many bushels will each of the farmer s five acres produce? 2.How much revenue will each acre generate? 3.What are the TR and MR for each acre? 4.If the marginal cost of planting and harvesting an acre is \$7000 per acre for each of the five acres, how many acres should the farmer plant and harvest?

3 QOD #21: Competitive Farming Solution 1. How much revenue will each acre generate? (\$10 x Production) 2. What are the TR and MR for each acre? (MR = TR 2 TR 1 ) 3. If the marginal cost of planting and harvesting an acre is \$7000 per acre for each of the five acres, how many acres should the farmer plant and harvest? (MR = MC which is at 4 acres \$7000 = \$7000) Acre Production on the acre Total Revenue Marginal Revenue \$10, \$19,000 \$9, \$27,000 \$8, \$34,000 \$7, \$40,000 \$6,000

4 LO1 8-4 Four Market Models Pure competition Pure monopoly Monopolistic competition Oligopoly Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Market Structure Continuum

5 Four Market Models Characteristics of the Four Basic Market Models Characteristic Number of firms Pure Competition A very large number Monopolistic Competition Oligopoly Monopoly Many Few One Type of product Standardized Differentiated Standardized or differentiated Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Unique; no close subs. Considerable Conditions of entry Nonprice Competition LO1 Very easy, no obstacles None Relatively easy Considerable emphasis on advertising, brand names, trademarks Examples Agriculture Retail trade, dresses, shoes Significant obstacles Typically a great deal, particularly with product differentiation Steel, auto, farm implements Blocked Mostly public relation advertising Local utilities 8-5

6 Pure Competition

7 Characteristics of Pure Competition Many sellers. All firms sell standardized (identical) goods. Buyers and sellers have all relevant information about prices, product quality, and sources of supply. There is easy entry into the market and easy exit out of the market.

8 Price Takers A price taker is a seller that can only sell its output at equilibrium price. A firm produces Q at which MR = MC at E Q (equilibrium price) Price takers will not sell for less than equilibrium.

9

10 What does a purely competitive firm do? It produces where marginal revenue equals marginal cost. MR = MC It must sell its product at equilibrium since it is a price taker.

11 Profit in a purely competitive market Profit acts as a signal to firms not in the market to enter the market. As new firms enter the market, they increase the supply of the good that is earning profit, and thus lower its price.

12 LO Pure Competition: Characteristics Perfectly elastic demand Firm produces as much or little as they want at the price Demand graphs as horizontal line

13 LO Average, Total, and Marginal Revenue Average Revenue Revenue per unit AR = TR/Q = P Total Revenue TR = P X Q Marginal Revenue Extra revenue from 1 more unit MR = ΔTR/ΔQ

14 LO Average, Total, and Marginal Revenue Firm s Demand Schedule (Average Revenue) Firm s Revenue Data P Q D TR MR TR \$ \$ ] ] ] ] ] ] ] ] ] ] \$ D = MR = AR

15 LO Profit Maximization: TR TC Approach Three questions: Should the firm produce? If so, what amount? What economic profit (loss) will be realized?

16 LO Profit Maximization: TR TC Approach The Profit-Maximizing Output for a Purely Competitive Firm: Total Revenue Total Cost Approach (Price = \$) (1) Total Product (Output) (Q) (2) Total Fixed Cost (TFC) (3) Total Variable Costs (TVC) (4) Total Cost (TC) (5) Total Revenue (TR) (6) Profit (+) or Loss (-) 0 \$100 \$0 \$100 \$0 \$

17 LO3 Total Economic Profit Total Revenue and Total Cost 8-17 Profit Maximization: TR TC Approach \$ Total Revenue, (TR) Maximum Economic Profit \$299 P=\$ Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) Total Cost, (TC) \$ Quantity Demanded (Sold) Total Economic Profit \$ Quantity Demanded (Sold)

18 LO Profit Maximization: MR-MC Approach The Profit-Maximizing Output for a Purely Competitive Firm: Marginal Revenue Marginal Cost Approach (Price = \$) (1) Total Product (Output) (2) Average Fixed Cost (AFC) (3) Average Variable Costs (AVC) (4) Average Total Cost (ATC) (5) Marginal Cost (MC) (5) Price = Marginal Revenue (MR) (6) Total Economic Profit (+) or Loss (-) 0 \$ \$ \$90.00 \$190 \$90 \$

19 LO3 Cost and Revenue 8-19 Profit Maximization: MR-MC Approach \$ MR = MC MC P=\$ 100 Economic Profit MR = P ATC AVC A=\$ Output

20 LO Loss-Minimizing Case Loss minimization Still produce because P > minavc Losses at a minimum where MR=MC

21 LO3 Cost and Revenue 8-21 Loss-Minimizing Case \$ MC 100 P=\$81 A=\$91.67 Loss ATC AVC MR = P 50 V = \$ Output

22 LO3 Cost and Revenue 8-22 Shutdown Case \$ MC 100 P=\$71 50 V = \$74 ATC AVC MR = P Short-Run Shut Down Point P < Minimum AVC \$71 < \$ Output

23 LO Three Production Questions Output Determination in Pure Competition in the Short Run Question Should this firm produce? Answer Yes, if price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost. What quantity should this firm produce? Will production result in economic profit? Produce where MR (=P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized. Yes, if price exceeds average total cost (TR will exceed TC). No, if average total cost exceeds price (TC will exceed TR).

24 LO Firm and Industry: Equilibrium Firm and Market Supply and the Market Demand (1) Quantity Supplied, Single Firm (2) Total Quantity Supplied, 1000 Firms (3) Product Price (4) Total Quantity Demanded 10 10,000 \$151 4, ,000 6, , , , , , , , ,000

25 LO Firm and Industry: Equilibrium Economic Profit s = MC ATC d \$111 \$111 AVC S = MC s D

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