<h5 id="41-perfect-competition-defining-features">4.1 Perfect Competition: Defining Features</h5> <ul> <li>A perfectly competitive market is characterized by a large number of buyers and sellers, homogenous products, free entry and exit, and perfect information.</li> <li>Under perfect competition, no individual buyer or seller can influence the market due to their small size compared to the market.</li> <li>Each firm is a price-taker, believing that they can only sell their product at the market price, and no more.</li> <li>Buyers are also price-takers, believing that they cannot purchase the product at a price lower than the market price.</li> <li>The assumption of price-taking behavior is reasonable in a market with many firms and perfect information, as any attempt to raise prices above the market price will result in the loss of buyers to other firms.</li> </ul> <p>======</p> <h5 id="42-revenue">4.2 Revenue</h5> <ul> <li>A Total Revenue Curve plots the quantity sold or output on the X-axis and the Revenue earned on the Y-axis.</li> <li>The Total Revenue (TR) curve of a firm is an upward rising straight line, with a slope equal to the market price (p).</li> <li>Average Revenue (AR) of a firm is defined as total revenue per unit of output, which equals the market price (p) for a price-taking firm.</li> <li>The Price Line, a horizontal straight line at a height equal to the market price (p), depicts the firm’s AR curve under perfect competition and the demand curve facing a firm.</li> <li>Marginal Revenue (MR) of a firm is the increase in total revenue for a unit increase in the firm’s output, and for a price-taking firm, MR equals the market price (p).</li> </ul> <p>======</p> <h5 id="43-profit-maximisation">4.3 Profit Maximisation</h5> <ul> <li>Profit of a firm is defined as the difference between its total revenue (TR) and total cost of production (TC), i.e., $\pi=T R-T C$.</li> <li>A firm aims to maximize its profit by identifying the quantity ${q_0}$ at which its profits are maximum.</li> <li>For profits to be maximum at ${q_0}$, three conditions must hold:</li> </ul> <ol> <li>Price $p$ must be equal to marginal cost (MC).</li> <li>Marginal cost must be non-decreasing at ${q_0}$.</li> <li>In the short run, price must be greater than the average variable cost ( $p$ > AVC); in the long run, price must be greater than the average cost ( $p>AC$).</li> </ol> <ul> <li>If any of these conditions are not met, the firm’ could increase its profit by adjusting its production level.</li> </ul> <p>======</p> <h5 id="431-condition-1">4.3.1 Condition 1</h5> <ul> <li>Profits are defined as the difference between total revenue and total cost.</li> <li>As output increases, both total revenue and total cost also increase.</li> <li>The change in total revenue per unit increase in output is marginal revenue (MR), and the change in total cost per unit increase in output is marginal cost (MC).</li> <li>For profits to be maximum, MR should be equal to MC. Therefore, the profit maximizing output is the level of output (q0) for which MR=MC.</li> <li>For a perfectly competitive firm, MR=P. So, the firm’s profit maximizing output is the level of output at which P=MC.</li> </ul> <p>======</p> <h5 id="432-condition-2">4.3.2 Condition 2</h5> <ul> <li>The marginal cost curve cannot slope downwards at the profit-maximizing output level because, if it did, the firm would not be maximizing its profits.</li> <li>At output levels q1 and q4, the market price is equal to the marginal cost, but only q4 can be the profit-maximizing output level.</li> <li>At output level q1, the marginal cost curve is downward sloping, and the market price is lower than the marginal cost for all output levels slightly to the left of q1.</li> <li>The firm’s profit at an output level slightly smaller than q1 exceeds that corresponding to the output level q1, making q1 an unsuitable candidate for a profit-maximizing output level.</li> <li>Output levels q2, q3, q5, and q6 (where the market price exceeds marginal cost or marginal cost exceeds market price) are also not profit-maximizing output levels.</li> </ul> <p>======</p> <h5 id="433-condition-3">4.3.3 Condition 3</h5> <ul> <li>In the short run, a profit-maximizing firm will not produce at an output level where the market price is lower than the AVC. This is because the firm would incur a loss, as total variable cost would exceed revenue, and the loss would be greater than the loss incurred by not producing at all.</li> <li>In the long run, a profit-maximizing firm will not produce at an output level where the market price is lower than the AC. This is because the firm would incur a loss, as total cost would exceed revenue, and the firm would be better off not producing at all, as they could then avoid fixed costs and have a profit of zero.</li> <li>The short-run condition is demonstrated in a figure showing that a profit-maximizing firm produces zero output in the short run when the market price is less than the minimum of its AVC.</li> <li>The long-run condition is demonstrated in a figure showing that a profit-maximizing firm produces zero output in the long run when the market price is less than the minimum of its LRAC.</li> <li>The figures also illustrate that at the profit-maximizing output level, the market price is equal to the marginal cost, which is the same as the slope of the total cost curve at that point.</li> </ul> <p>======</p> <h5 id="434-the-profit-maximisation-problem-graphical-representation">4.3.4 The Profit Maximisation Problem: Graphical Representation</h5> <ul> <li>The profit maximization problem of a firm in the short run can be graphically represented using the market price, marginal cost, and average cost.</li> <li>Equating the market price ($p$) with the short-run marginal cost (SMC), we obtain the output level ($q_{0}$). At $q_{0}$, SMC slopes upwards and $p$ exceeds AVC, indicating the profit-maximizing output level of the firm is $q_{0}$.</li> <li>The total revenue of the firm at $q_{0}$ is the area of rectangle OpAq0 (price * quantity), and the total cost at $q_{0}$ is the area of rectangle OEBq0 (short-run average cost * quantity).</li> <li>The firm earns a profit equal to the area of the rectangle EpAB at $q_{0}$, which is the difference between total revenue and total cost.</li> <li>This profit maximization is achieved when the firm is producing at the output level where price is greater than AVC and SMC, ensuring the firm’s profitability in the short run.</li> </ul> <p>======</p> <h5 id="44-supply-curve-of-a-firm">4.4 Supply Curve of a Firm</h5> <ul> <li>A firm’s supply is the quantity it decides to sell at a specific price, given technology and factor prices.</li> <li>A supply schedule, a table describing the quantities sold by a firm at various prices, represents this information.</li> <li>A supply curve, a graph with levels of output on the x-axis and market price on the y-axis, can also represent this information.</li> <li>The short-run supply curve and the long-run supply curve are distinguished, with the latter considering changes in technology and factor prices.</li> <li>Both supply curve types represent the firm’s chosen output levels at different market prices, with all other factors held constant.</li> </ul> <p>======</p> <h5 id="441-short-run-supply-curve-of-a-firm">4.4.1 Short Run Supply Curve of a Firm</h5> <ul> <li>The short run supply curve of a firm is derived in two cases: when the market price is greater than or equal to the minimum AVC, and when the market price is less than the minimum AVC.</li> <li>Case 1: If the market price ($p_{1}$) is greater than or equal to the minimum AVC, the firm’s output level is determined by equating the market price with SMC on the rising part of the SMC curve, leading to the output level $q_{1}$.</li> <li>Case 2: If the market price ($p_{2}$) is less than the minimum AVC, the firm cannot supply a positive output as the AVC strictly exceeds $p_{2}$ for all positive output levels. The firm produces zero output in this case.</li> <li>A firm’s short run supply curve is the rising part of the SMC curve from and above the minimum AVC, together with zero output for all prices strictly less than the minimum AVC.</li> <li>The short run supply curve of a firm is represented by the bold line, based on its short run marginal cost curve (SMC) and average variable cost curve (AVC).</li> </ul> <p>======</p> <h5 id="442-long-run-supply-curve-of-a-firm">4.4.2 Long Run Supply Curve of a Firm</h5> <ul> <li>The long run supply curve of a firm is derived from its long run marginal cost curve (LRMC) and long run average cost curve (LRAC).</li> <li>When the market price is greater than or equal to the minimum LRAC, the firm determines its profit-maximizing output level by equating the market price with LRMC on the rising part of the LRMC curve, which results in output level $q_{1}$.</li> <li>When the market price is less than the minimum LRAC, the firm cannot supply a positive output as the LRAC at all positive output levels strictly exceeds the market price.</li> <li>Hence, when the market price is less than the minimum LRAC, the firm produces zero output.</li> <li>A firm’s long run supply curve is the rising part of the LRMC curve from and above the minimum LRAC together with zero output for all prices less than the minimum LRAC.</li> </ul> <p>======</p> <h5 id="443-the-shut-down-point">4.4.3 The Shut Down Point</h5> <ul> <li>The shut down point is the point at which a firm stops producing.</li> <li>In the short run, this occurs when the price is less than the minimum of the AVC.</li> <li>The short run shut down point is where the SMC curve intersects the AVC curve at its minimum point.</li> <li>There is no production below this point in the short run.</li> <li>In the long run, the shut down point is the minimum of the LRAC curve.</li> </ul> <p>======</p> <h5 id="444-the-normal-profit-and-break-even-point">4.4.4 The Normal Profit and Break-even Point</h5> <ul> <li>Normal profit is the minimum level of profit needed to keep a firm in business.</li> <li>Super-normal profit is the profit earned over and above the normal profit.</li> <li>In the long run, a firm does not produce if it earns anything less than the normal profit.</li> <li>The break-even point is the point on the supply curve at which a firm earns only normal profit.</li> <li>Opportunity cost is the gain foregone from the second best activity.</li> </ul> <p>======</p> <h5 id="45-determinants-of-a-firms-supply-curve">4.5 Determinants of a Firm’s Supply Curve</h5> <ul> <li>A firm’s supply curve is a portion of its marginal cost curve.</li> <li>Factors affecting a firm’s marginal cost curve also affect its supply curve.</li> <li>The two factors discussed in this section are: <ol> <li>Technological changes: Improvements in technology can decrease a firm’s marginal costs and increase its supply.</li> <li>Input prices: Changes in input prices, such as wages or raw materials, can impact a firm’s marginal cost and thus its supply.</li> </ol> </li> <li>Therefore, technological changes and input prices are determinants of a firm’s supply curve.</li> </ul> <p>======</p> <h5 id="451-technological-progress">4.5.1 Technological Progress</h5> <ul> <li>Technological progress can be seen as an organizational innovation in a firm that uses two factors of production, such as capital and labor.</li> <li>This innovation allows the firm to produce more units of output with the same levels of capital and labor, or to produce the same level of output with fewer units of inputs.</li> <li>As a result, the firm’s marginal cost at any level of output is reduced, leading to a rightward (downward) shift of the MC curve.</li> <li>The supply curve of the firm, which is a segment of the MC curve, also shifts to the right due to technological progress.</li> <li>This means that at any given market price, the firm supplies more units of output, increasing its productivity and competitiveness in the market.</li> </ul> <p>======</p> <h5 id="452-input-prices">4.5.2 Input Prices</h5> <ul> <li> <p>A change in input prices affects a firm’s supply curve. An increase in input prices leads to a rise in the firm’s average and marginal cost at any level of output, causing a leftward shift of the MC curve and a leftward shift of the supply curve.</p> </li> <li> <p>A unit tax is a tax imposed per unit sale of output. The firm must pay an extra tax for each unit of the good produced, leading to an increase in the firm’s long run average cost and long run marginal cost at any level of output.</p> </li> <li> <p>The long run supply curve of a firm is the rising part of the LRMC curve from and above the minimum LRAC together with zero output for all prices less than the minimum LRAC. The unit tax shifts the firm’s long run supply curve to the left, leading to fewer units of output supplied at any given market price.</p> </li> <li> <p>The long run supply curve of a firm before and after the imposition of the unit tax is represented by $S^{0}$ and $S^{1}$ respectively.</p> </li> <li> <p>Figures 4.11 and 4.12 illustrate the cost curves and supply curves before and after the imposition of a unit tax.</p> </li> </ul> <p>======</p> <h5 id="46-market-supply-curve">4.6 Market Supply Curve</h5> <ul> <li>The market supply curve is a graph showing the total output levels produced by all firms in a market at different market prices.</li> <li>It is derived by summing the individual supply curves of all firms in the market horizontally.</li> <li>For a fixed number of firms, the market supply curve shifts right (left) with an increase (decrease) in the number of firms.</li> <li>An example of a market supply curve with two firms: Firm 1 has a supply curve S1(p) = [0, p-10] and Firm 2 has a supply curve S2(p) = [0, p-15]. The market supply curve is then Sm(p) = S1(p) + S2(p) = [0, p-10, 2p-25].</li> <li>The market supply curve is derived for a fixed number of firms, and it does not consider changes in the cost structures of individual firms.</li> </ul> <p>======</p> <h5 id="47-price-elasticity-of-supply">4.7 Price Elasticity of Supply</h5> <ul> <li>The text provides an explanation of price elasticity of supply and its calculation.</li> <li>The formula for percentage change in quantity supplied is $\frac{Q_{2}-Q_{1}}{Q_{1}} \times 100$ and for percentage change in market price is $\frac{P_{2}-P_{1}}{P_{1}} \times 100$.</li> <li>Price elasticity of supply is calculated as the ratio of percentage change in quantity supplied to percentage change in market price.</li> <li>A supply curve that is vertical has a price elasticity of supply of zero, indicating complete insensitivity to price.</li> <li>The geometric method for determining price elasticity of supply involves the use of a supply curve and the ratio of the distances from the point of interest on the curve to the origin and to the quantity axis.</li> <li>The price elasticity of supply for a straight line supply curve is constant at all points and is greater than 1 if it cuts the price-axis at its positive range, less than 1 if it cuts the quantity-axis at its positive range, and equal to 1 if it goes through the origin.</li> </ul> <p>======</p>