managment decisions by tubespeed

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									 Managerial Economics                        Thomas
                  eighth edition             Maurice




            Chapter 11


                         Managerial Decisions in
                          Competitive Markets
The McGraw-Hill Series
    2       Managerial Economics


            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



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            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

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                          Demand for a Competitive
                          Price-Taking Firm (Figure 11.2)

                                                 S




                                                         Price (dollars)
        Price (dollars)




                          P0                                               P0
                                                                                                 D = MR




                                                     D

                          0          Q0                                    0

                                   Quantity                                           Quantity

                               Panel A –                                    Panel B – Demand curve
                               Market                                       facing        a price-taker
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              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

                            Profit =   TR  TC
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            Profit Margin (or Average Profit)
                                    
                                    ( P  ATC )Q
                 Average profit  
                                 Q        Q
                                    P  ATC  Profit margin

          • 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
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            Short-Run Output Decision
          • Firm’s 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
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            Profit Maximization: P = $36
            (Figure 11.3)


                                 Total revenue =$36 x -600
                                     Profit = $21,600 $11,400
                                               = $21,600
                                          = $10,200




                                  Total cost = $19 x 600
                                            = $11,400




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            Profit Maximization: P = $36
            (Figure 11.4)


           Panel A: Total revenue
           & total cost




           Panel B: Profit curve
           when P = $36



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        Short-Run Loss Minimization:
        P = $10.50 (Figure 11.5)




                      Profit = $3,150 x 300
                      Total cost = $17 - $5,100
                             = -$1,950
                                 = $5,100




                     Total revenue = $10.50 x 300
                                  = $3,150




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         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



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         Summary of Short-Run Output
         Decision
       • 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
          •   ( P  ATC )Q
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         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
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         Derivation of Short-Run Supply
         Curves (Figure 11.6)




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         Long-Run Profit-Maximizing
         Equilibrium (Figure 11.7)



                              Profit = ($17 - $12) x 240
                                     = $1,200




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        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




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         Long-Run Competitive
         Equilibrium (Figure 11.8)




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        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
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        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

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        Long-Run Industry Supply for a
        Constant Cost Industry (Figure 11.9)




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




                        Firm’s output




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        Economic Rent
       • Payment to the owner of a scarce,
         superior resource in excess of the
         resource’s opportunity cost
       • In long-run competitive equilibrium
         firms that employ such resources
         earn only normal profit
            • Economic profit is zero
            • Potential economic profit is paid to
              the resource as rent
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       Economic Rent in Long-Run
       Competitive Equilibrium (Figure 11.11)




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




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        Profit-Maximizing Input Usage
      • 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
                                    TR
                              MRP       P  MP
                                     L
      • 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
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        Profit-Maximizing Input Usage
     • Average revenue product (ARP)
           • Average revenue per worker

                                    TR
                              ARP      P  AP
                                     L

     • Shut down in short run if ARP < MRP
       • When ARP < MRP, TR < TVC


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       Profit-Maximizing Labor Usage
       (Figure 11.12)




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        Implementing the Profit-
        Maximizing Output Decision
       • Step 1: Forecast product price
            • Use statistical techniques from
              Chapter 7
       • Step 2: Estimate AVC & SMC
          • AVC  a  bQ  cQ
                              2


            •   SMC  a  2bQ  3cQ 2


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        Implementing the Profit-
        Maximizing Output Decision
       • Step 3: Check shutdown rule
            • If P  AVCmin, produce
            • If P < AVCmin, shut down
            • To find AVCmin, substitute Qmin into
              AVC equation
                                        b
                              Qmin   
                                        2c
                       AVC min  a  bQmin  cQmin
                                               2


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        Implementing the Profit-
        Maximizing Output Decision
      • Step 4: If P  AVCmin, find output
        where P = SMC
            • Set forecasted price equal to
              estimated marginal cost & solve for Q*

                          P  a  2bQ  3cQ
                                    *         *2




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        Implementing the Profit-
        Maximizing Output Decision
      • Step 5: Compute profit or loss
        • Profit = TR - TC
                               P  Q  AVC  Q  TFC
                                    *          *


                               ( P  AVC )Q  TFC
                                           *




            • If P < AVCmin, firm shuts down &
              profit is -TFC

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         Profit & Loss at Beau Apparel
         (Figure 11.13)




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         Profit & Loss at Beau Apparel
         (Figure 11.13)




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