Chapter 11

Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Managerial Economics, 9e
Managerial Economics
Thomas
Maurice
ninth edition
Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Managerial Economics, 9e
Managerial Economics
Thomas
Maurice
ninth edition
Chapter 11
Managerial Decisions in
Competitive Markets
Managerial Economics Managerial Economics
11-2
Perfect Competition
Firms are price-takers
Each produces only a very small portion
of total market or industry output
All firms produce a homogeneous
product
Entry into & exit from the market is
unrestricted

11-3
Demand for a Competitive
Price-Taker
Demand curve is horizontal at price
determined by intersection of market
demand & supply
Perfectly elastic
Marginal revenue equals price
Demand curve is also marginal revenue curve
(D = MR)
Can sell all they want at the market price
Each additional unit of sales adds to total
revenue an amount equal to price
11-4
D

S

Quantity
P
r
i
c
e

(
d
o
l
l
a
r
s
)

Quantity
P
r
i
c
e

(
d
o
l
l
a
r
s
)

P
0
Q
0
Panel A
Market
Panel B Demand curve
facing a price-taker
Demand for a Competitive
Price-Taking Firm (Figure 11.2)
0 0
P
0
D = MR

11-5
Profit-Maximization in the
Short Run
In the short run, managers must make
two decisions:
1. Produce or shut down?
If shut down, produce no output and hires no
variable inputs
If shut down, firm loses amount equal to TFC
2. If produce, what is the optimal output
level?
If firm does produce, then how much?
Produce amount that maximizes economic profit
TR TC t =
Profit =
11-6
Profit Margin (or Average Profit)
Level of output that maximizes total
profit occurs at a higher level than the
output that maximizes profit margin (&
average profit)
Managers should ignore profit margin
(average profit) when making optimal
decisions
( P ATC )Q
Q Q
t
= = Average profit
P ATC = = Profit margin
11-7
Short-Run Output Decision
Firms manager will produce output
where P = MC as long as:
TR > TVC
or, equivalently, P > AVC
If price is less than average variable
cost (P < AVC), manager will shut down
Produce zero output
Lose only total fixed costs
Shutdown price is minimum AVC
11-8
Total revenue =$36 x 600
= $21,600
Profit = $21,600 - $11,400
= $10,200
Total cost = $19 x 600
= $11,400
Profit Maximization: P = $36
(Figure 11.3)
11-9
Profit Maximization: P = $36
(Figure 11.4)
Panel A: Total revenue
& total cost
Panel B: Profit curve
when P = $36
11-10
Short-Run Loss Minimization:
P = $10.50 (Figure 11.5)
Total cost = $17 x 300
= $5,100
Total revenue = $10.50 x 300
= $3,150
Profit = $3,150 - $5,100
= -$1,950
11-11
Irrelevance of Fixed Costs
Fixed costs are irrelevant in the
production decision
Level of fixed cost has no effect on
marginal cost or minimum average
variable cost
Thus no effect on optimal level of
output
11-12
AVC tells whether to produce
Shut down if price falls below minimum
AVC
SMC tells how much to produce
If P > minimum AVC, produce output
at which P = SMC
ATC tells how much profit/loss if
produce

Summary of Short-Run Output
Decision
( P ATC )Q t =
11-13
Short-Run Supply Curves
For an individual price-taking firm
Portion of firms marginal cost curve
above minimum AVC
For prices below minimum AVC,
quantity supplied is zero
For a competitive industry
Horizontal sum of supply curves of all
individual firms; always upward sloping
Supply prices give marginal costs of
production for every firm
11-14
Short-Run Producer Surplus
Short-run producer surplus is the
amount by which TR exceeds TVC
The area above the short-run supply
curve that is below market price over
the range of output supplied
Exceeds economic profit by the
amount of TFC
11-15
Computing Short-Run
Producer Surplus (Figure 11.6)
Producer surplus TR TVC =
$9 110 $5.55 110 =
$990 $610 =
$380 =
Producer surplus = Area of trapezoid in Figure 11.6 edba
Or, equivalently,
$380 multiplied by 100 firms ($380 100) $38, 000 = =
= Height Average base
80 110
($9 $5)
2
+
| |
=
|
\ .
$380 =
11-16
Short-Run Firm & Industry Supply
(Figure 11.6)
11-17
Long-Run Profit-Maximizing
Equilibrium (Figure 11.7)

Profit = ($17 - $12) x 240
= $1,200
11-18
Long-Run Competitive Equilibrium
All firms are in profit-maximizing
equilibrium (P = LMC)
Occurs because of entry/exit of
firms in/out of industry
Market adjusts so P = LMC = LAC

11-19
Long-Run Competitive
Equilibrium (Figure 11.8)

11-20
Long-Run Industry Supply
Long-run industry supply curve
can be flat (perfectly elastic) or
upward sloping
Depends on whether constant cost
industry or increasing cost industry
Economic profit is zero for all
points on the long-run industry
supply curve for both types of
industries
11-21
Long-Run Industry Supply
Constant cost industry
As industry output expands, input prices
remain constant, & minimum LAC is
unchanged
P = minimum LAC, so curve is horizontal
(perfectly elastic)
Increasing cost industry
As industry output expands, input prices
rise, & minimum LAC rises
Long-run supply price rises & curve is upward
sloping
11-22
Long-Run Industry Supply for a
Constant Cost Industry (Figure 11.9)

11-23
Long-Run Industry Supply for an
Increasing Cost Industry (Figure 11.10)

Firms output
11-24
Economic Rent
Payment to the owner of a scarce,
superior resource in excess of the
resources opportunity cost
In long-run competitive equilibrium
firms that employ such resources earn
zero economic profit
Potential economic profit is paid to the
resource as economic rent
In increasing cost industries, all long-run
producer surplus is paid to resource
suppliers as economic rent
11-25
Economic Rent in Long-Run
Competitive Equilibrium (Figure 11.11)

11-26
Profit-Maximizing Input Usage
Profit-maximizing level of input
usage produces exactly that level
of output that maximizes profit

11-27
Marginal revenue product (MRP)
MRP of an additional unit of a variable input is
the additional revenue from hiring one more unit
of the input

If choose to produce:
If the MRP of an additional unit of input is
greater than the price of input, that unit should
be hired
Employ amount of input where MRP = input price
TR
MRP P MP
L
A

A
= =
11-28
Average revenue product (ARP)
Average revenue per worker

Shut down in short run if ARP < MRP
When ARP < MRP, TR < TVC
TR
ARP P AP
L
= =
11-29
Profit-Maximizing Labor Usage
(Figure 11.12)

11-30
Implementing the Profit-
Maximizing Output Decision
Step 1: Forecast product price
Use statistical techniques from
Chapter 7
Step 2: Estimate AVC & SMC

SMC a bQ cQ
2
2 3 = + +
AVC a bQ cQ
2
= + +
11-31
Step 3: Check shutdown rule
If P > AVC
min
then produce
If P < AVC
min
then shut down
To find AVC
min
substitute Q
min
into
AVC equation
min
b
Q
c 2
=
min min min
AVC a bQ cQ
2
= + +
11-32
Step 4: If P > AVC
min
, find output
where P = SMC
Set forecasted price equal to
estimated marginal cost & solve for Q
*
* *
P a bQ cQ
2
2 3 = + +
11-33
Step 5: Compute profit or loss
Profit = TR - TC
If P < AVC
min
, firm shuts down &
profit is -TFC

* *
P Q AVC Q TFC =
*
( P AVC )Q TFC =
11-34
Profit & Loss at Beau Apparel
(Figure 11.13)

11-35
Profit & Loss at Beau Apparel
(Figure 11.13)

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Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.

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