Managerial Economics
Managerial Decisions under
Competitive Markets
Perfect Market
11-1
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
11-2
Managerial Economics
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
11-3
Managerial Economics
Demand for a Competitive
Price-Taking Firm
Price (dollars)
Price (dollars)
P0 P0
D=
MR
0 Q0 0
Quantity Quantity
Panel A – Panel B – Demand curve
Market facing a
11-4 price-taker
Managerial Economics
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
profit
11-5
Managerial Economics
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
11-6
Managerial Economics
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
11-7
Managerial Economics
Profit Maximization: P = $36
Total revenue
Profit =$36 x 600
= $21,600 -
$11,400= $21,600
= $10,200
Total cost = $19 x
600 = $11,400
11-8
Managerial Economics
Short-Run Loss Minimization:
P = $10.50
Profitcost
Total = $3,150
= $17 x- 300
$5,100 = $5,100 =
-$1,950
Total revenue = $10.50 x
300 = $3,150
11-9
Managerial Economics
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
11-10
Managerial Economics
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 AVC, produce output at which
P = SMC or MR = MC
• ATC tells how much profit/loss if
produce
• ( P ATC )Q
11-11
