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Micro w7

Under perfect competition, firms are price-takers and produce at the quantity where marginal cost equals price. For a profit-maximizing firm, this occurs where marginal revenue equals marginal cost. The supply curve under perfect competition is the marginal cost curve for quantities where marginal cost exceeds average variable cost. Social welfare is maximized at a Pareto efficient allocation where no one can be made better off without making someone else worse off.

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49 views2 pages

Micro w7

Under perfect competition, firms are price-takers and produce at the quantity where marginal cost equals price. For a profit-maximizing firm, this occurs where marginal revenue equals marginal cost. The supply curve under perfect competition is the marginal cost curve for quantities where marginal cost exceeds average variable cost. Social welfare is maximized at a Pareto efficient allocation where no one can be made better off without making someone else worse off.

Uploaded by

Julia Lopez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Micro w7

1. Perfect competition:
This happens when QD(P) = QS (P) ...but under certain conditions:
- Free entry/exit
- Homogenous goods
- No market power
- Transparency
a. Competitive market equilibrium: characteristics
All gains from trade are exploited in equilibrium (no deadweight loss). Equilibrium
allocation is Pareto efficient, assuming:
- Participants are price-takers.
- Contracts are complete.
- Free entry and exit
- Transaction only affects buyers and sellers
b. Perfect competition: how much to prduce?
What is the biggest difference between the profit maximising decision of a price-
setter and a price-taker? If the price cannot be influenced, the supplier can only
influence the size of his own output. How?
By supplying that quantity, that generates maximum profit
How much will be supplied?
How is the supply function determined?
c. Profit maximization: profit = revenue – cost
π(q) = TR(q) − TC(q) maximum profit at q*
- Largest difference between R and C
- Point on the profit curve where slope is 0
- Optimization (any function) derivative = 0
- ∂π/ ∂q = ∂TR/ ∂q − ∂TC/ ∂q = 0
- ∂π /∂q = MR − MC = 0

d. Profit maximization under perfect competition: So for profitmaximization we need


to look at the MC-curve and compare it with the MR-curve
e. And for a price-taker P=MR=AR (ar= average revenue)
f. Increase or decrease production
- A supplier should increase her production as long as MR > MC,
- and reduce her production as soon as MR < M
- Conclusion: With any price above the minimum level of AVC, q* is determined by
P=MR=MC → MC-curve is the supply-curve (in as far as MC > AVC)

2. Price takers vs price setters


a. Profit maximization for price setters
- The firm’s constrained optimization problem is analogous to the consumer’s from
Unit 3.
- Demand curve: Firm’s feasible frontier (slope = MRT)
- Isoprofit curves: Firm’s indifference curves (slope = MRS)
- Firm maximizes profits by choosing point where MRS=MRT
b. Profit maximization for price takers
- Demand curve: Firm’s feasible frontier (slope = MRT)
- Isoprofit curves: Firm’s indifference curves (slope = MRS)
- Firm maximizes profits by choosing point where MRS=MRTBut...
- Price-taking firms cannot benefit by choosing a price, or influencing the price.
- Demand curve is flat and feasible set is a rectangle.
- P=MC=MR → Slope of isoprofit is 0.
- Firm only chooses quantity, not price.

3. Social welfare:
- Social welfare function (SWF) is a mathematical representation of the overall well-
being or satisfaction of a society. It is used in welfare economics to measure the
economic efficiency and equity of different economic systems or policies. SWF
ranks social states as less desirable, more desirable, or indifferent for every
possible pair of social states. It provides the government with a simple guideline
for achieving the optimal distribution of income. The optimal distribution is
achieved at the point where the marginal benefits to society are equal to the
marginal costs to society, this is known as social efficiency. Additionally, issues of
equity are difficult to judge due to the subjective assessment of what is, and what
is not, a fair distribution of resources.
- Pareto improvement: An action in an economy that makes at least one person
better off and no person worse off.
- Pareto efficiency: A state in which no Pareto improvements can occur, i.e. nobody
can be made better off without making someone else worse off.
a. Consumer surplus: measures the total benefit to all consumers.

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