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Chapter 11: Managerial Decisions in Competitive Markets
Chapter 11:
MANAGERIAL DECISIONS IN COMPETITIVE MARKETS
Essential Concepts
1. Perfect competition occurs when a market possesses the following three characteristics:
i. Firms are price-takers because each firm produces only a very small portion of total
2. The demand curve facing a competitive price-taking firm is horizontal or perfectly elastic at
the price determined by the intersection of the market demand and supply curves. Since
Profit Maximization in the Short Run:
4. Shut down refers to the decision in the short run to produce zero output, which means the
5. A manager makes two decisions in the short run: (1) whether to produce or shut down, and
(2) if the decision is to produce, how much to produce.
6. In making the decision to produce or shut down, the manager will consider only the
(avoidable) variable costs and will ignore fixed costs.
7. Profit margin is the difference between price and average total cost, which is equal to
average profit (or profit per unit), as long as every unit is sold for the same price:
9. Break-even points are the output levels – there are usually two of these points—where price
equals average total cost, and thus profit equals zero at these points.
10. In the short run, the manager of a firm will choose to produce the output where P = SMC,
rather than shut down, as long as total revenue is greater than or equal to the firm’s total
11. Fixed costs are irrelevant in the production decision because the level of fixed cost has no
12. Sunk costs are irrelevant in the production decision because such costs are forever
unrecoverable, no matter what output decision is made, and so sunk costs cannot affect
current or future decisions.
13. Average costs are also irrelevant for production decisions. Only marginal cost matters when
14. Summary of the manager's output decision in the short-run:
i. Average variable cost tells whether to produce; the firm ceases to produce—shuts
15. The short-run supply curve for an individual price-taking firm is the portion of the firm’s
marginal cost curve above minimum average variable cost. For market prices less than
minimum average variable cost, quantity supplied is zero.
16. The short-run supply curve for a competitive industry can be obtained by horizontally
17. Short-run producer surplus is the amount by which total revenue exceeds total variable cost
Profit Maximization in the Long Run:
18. In long-run competitive equilibrium, all firms are maximizing profit (P = LMC). Long-run
competitive equilibrium occurs because of the entry of new firms into the industry or the exit
of existing firms from the industry. The market adjusts so that P = LMC = LAC, which is at
the minimum point on LAC.
19. The long-run industry supply curve can be either flat (perfectly elastic) or upward sloping
depending upon whether the industry is a constant cost industry or an increasing cost
industry, respectively.
20. For both constant-cost and increasing-cost industries, long-run industry supply curves give
supply prices for various levels of industry output allowing the industry to reach long-run
21. Economic rent is a payment to the owner of a scarce, superior resource in excess of the
resource’s opportunity cost. Firms that employ such exceptionally productive resources earn
22. As noted above, firms that employ exceptionally productive, superior resources earn zero
economic profit in long-run competitive equilibrium. In increasing industries, all long-run
producer surplus is paid to resource suppliers as economic rent. And, of course, for constant-
cost industries there is zero producer surplus (and zero rent) since industry supply is perfectly
horizontal.
Profit-Maximizing Input Usage:
23. Choosing either output or input usage to maximize profit leads to the same maximum profit
level. The profit-maximizing level of input usage produces exactly that level of output that
maximizes profit.
a. The marginal revenue product (MRP) of an additional unit of a variable input is the
b. Average revenue product (ARP) is the average revenue per worker (ARP = TR/L). ARP
can be calculated as the product of price times the average product of labor:
Implementing the Profit-Maximizing Output Decision:
24. The following steps that use empirical estimates of price and costs can be employed to
find the profit-maximizing rate of production and the level of profit a competitive firm
will earn.
Step 1: Forecast the price of the product. Use the statistical techniques presented in
Chapter 7 to forecast the price of the product.
Chapter 11: Managerial Decisions in Competitive Markets
Answers to Applied Problems
1. The fact that the club closed implies that it incurred economic losses, i.e., implicit costs must have
2. a. – c. Your spreadsheet when price is $190 per unit should look like:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
Q
TC
TFC
TVC
AFC
AVC
ATC
SMC
TR
MR
PROF
AVGPROF
PROFMARG
0
5000
5000
0
xx
xx
xx
xx
0
xx
-5000
xx
xx
100
10000
5000
5000
50.00
50.00
100
50
19000
190
9000
90
90
d. 300 units minimizes ATC ($90) and maximizes profit margin ($100)
Chapter 11: Managerial Decisions in Competitive Markets
(1)
…
(9)
(10)
(11)
(12)
(13)
Q
TR
MR
PROF
AVGPROF
PROFMARG
0
0
xx
-5000
xx
xx
100
6500
65
-3500
-35
-35
200
13000
65
-5000
-25
-25
3. a.
Number of Real
Estate Agents
Marginal Revenue
Product
1
$40,000
2
34,000
4. A support price above the price that would prevail in the absence of controls will induce new
5. In the short run, increased insurance rates could raise the income of insurance agents. If the
demand for insurance is inelastic, an increase in insurance rates will increase agents' income. In
6. Firms engage in research and development (R&D) in order to earn profits from introducing new
products or from discovering more efficient methods of production. Firms in a competitive
7. a. The plant in Miami should continue to be operated because the firm loses only $60,000 per month
if the plant is operated; but would lose $68,000 if the plant is shut down. We can deduce that
total revenue exceeds variable costs by $8,000. This $8,000 can be applied toward fixed costs so
8. a. Production costs will rise because the entry of new firms encouraged by economic profits will bid
up input prices for all the firms in the remodeling industry. Input prices would not be bid up if
9. The pushcart owner must at least be covering his opportunity costs at this fee. The city of New
York is earning the rent in this case because it controls the location, which is the reason for the
high returns. The pushcart owner is probably not making much, if any, economic profit with the
new license fee.
10. a. There are two ways grocery and gasoline markets may fail to be competitive markets.
(1) Even though a large city has many grocery stores and gasoline stations within the
metropolitan area, consumers of groceries and gasoline typically shop close to home. So a
(2) Another possible divergence from competition results if the firms sell differentiated products.
The characteristics of grocery stores and gasoline stations may not be as standardized as they
seem. Grocery stores and gasoline stations can vary in terms of the quality of customer
service, the various brand names offered, and particularly location.
11. The statement is correct in the sense that the Brazilian division should be shut down if losses
exceed TFC. If management mistakenly continues to operate the Brazilian division if and when
price falls below AVC, then more than TFC could be lost.
12. a. The long-run competitive equilibrium price for milk is the lowest possible price consumers can
pay for milk and still create financially viable dairy farms. The competitive market price just
covers all costs, including a payment to farm owners equal to their opportunity costs.
b. Every farmer knows that if each one of them produced 10 percent less milk, the market-
determined price would be higher. The problem is that reducing output is voluntary, and each
14. a. U.S. airline markets appear to be highly competitive for several reasons. First, entry of new
airlines and exit of airlines are both common, suggesting that no barriers to entry or exit exist.
Second, consumers typically view different airlines as very close substitutes, and very small price
differences will cause travelers to switch to the lower-priced airline. Third, airline profits swing
15. a. While a firm can survive in the short-run with higher costs than its rival firms, it cannot survive in
the long run if its LAC curve lies above the LAC curves of its rivals. In the long run, price is
equal to minimum LAC of the low-cost producers, not the high-cost producer. The high-cost
