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Perfect Competition

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  • 1. Team Member’s
    • Varun Aggarwal
    • Jyoti chauhan
    • Shashank Rana
    • Preeti Pawaria
    • Rahul Yadav
    • Vijay Kundra
    • Nitin Kumar
    • Sapna Rana
  • 2. Perfect Competition
  • 3. Perfect Competition
    • The concept of competition is used in two ways in economics.
      • Competition as a process is a rivalry among firms.
      • Competition as the perfectly competitive market structure.
  • 4. A Perfectly Competitive Market
    • A perfectly competitive market is one in which economic forces operate unimpeded.
  • 5. A Perfectly Competitive Market
    • A perfectly competitive market must meet the following requirements:
      • Both buyers and sellers are price takers.
      • The number of firms is large.
      • There are no barriers to entry.
      • The firms’ products are identical.
      • There is complete information.
      • Firms are profit maximizers.
  • 6. The Necessary Conditions for Perfect Competition
    • Both buyers and sellers are price takers.
      • A price taker is a firm or individual who takes the market price as given.
      • In most markets, households are price takers – they accept the price offered in stores.
  • 7. The Necessary Conditions for Perfect Competition
    • Both buyers and sellers are price takers.
      • The retailer is not perfectly competitive.
      • A retail store is not a price taker but a price maker.
  • 8. The Necessary Conditions for Perfect Competition
    • The number of firms is large.
      • Large means that what one firm does has no bearing on what other firms do.
      • Any one firm's output is minuscule when compared with the total market.
  • 9. The Necessary Conditions for Perfect Competition
    • There are no barriers to entry.
      • Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market.
      • Barriers sometimes take the form of patents granted to produce a certain good.
  • 10. The Necessary Conditions for Perfect Competition
    • There are no barriers to entry.
      • Technology may prevent some firms from entering the market.
      • Social forces such as bankers only lending to certain people may create barriers.
  • 11. The Necessary Conditions for Perfect Competition
    • The firms' products are identical.
      • This requirement means that each firm's output is indistinguishable from any competitor's product.
  • 12. The Necessary Conditions for Perfect Competition
    • There is complete information.
      • Firms and consumers know all there is to know about the market – prices, products, and available technology.
      • Any technological breakthrough would be instantly known to all in the market.
  • 13. The Necessary Conditions for Perfect Competition
    • Firms are profit maximizers.
      • The goal of all firms in a perfectly competitive market is profit and only profit.
      • The only compensation firm owners receive is profit, not salaries.
  • 14. The Definition of Supply and Perfect Competition
    • If all the necessary conditions for perfect competition exist, we can talk formally about the supply of a produced good.
  • 15. The Definition of Supply and Perfect Competition
    • Supply is a schedule of quantities of goods that will be offered to the market at various prices.
  • 16. The Definition of Supply and Perfect Competition
    • When a firm operates in a perfectly competitive market, it’s supply curve is that portion of its short-run marginal cost curve above average variable cost.
  • 17. Demand Curves for the Firm and the Industry
    • The demand curves facing the firm is different from the industry demand curve.
    • A perfectly competitive firm’s demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.
  • 18. Demand Curves for the Firm and the Industry
    • Individual firms will increase their output in response to an increase in demand even though that will cause the price to fall thus making all firms collectively worse off.
  • 19. Market Demand Versus Individual Firm Demand Curve Market Firm Individual firm demand Market supply Market demand 1,000 3,000 Price $10 8 6 4 2 0 Quantity 10 20 30 Price $10 8 6 4 2 0 Quantity
  • 20. Profit-Maximizing Level of Output
    • The goal of the firm is to maximize profits.
    • Profit is the difference between total revenue and total cost.
  • 21. Profit-Maximizing Level of Output
    • What happens to profit in response to a change in output is determined by marginal revenue ( MR ) and marginal cost ( MC ).
    • A firm maximizes profit when MC = MR .
  • 22. Profit-Maximizing Level of Output
    • Marginal revenue ( MR ) – the change in total revenue associated with a change in quantity.
    • Marginal cost ( MC ) – the change in total cost associated with a change in quantity.
  • 23. Marginal Revenue
    • A perfect competitor accepts the market price as given.
    • As a result, marginal revenue equals price ( MR = P ).
  • 24. Marginal Cost
    • Initially, marginal cost falls and then begins to rise.
    • Marginal concepts are best defined between the numbers.
  • 25. Profit Maximization: MC = MR
    • To maximize profits, a firm should produce where marginal cost equals marginal revenue.
  • 26. How to Maximize Profit
    • If marginal revenue does not equal marginal cost, a firm can increase profit by changing output.
    • The supplier will continue to produce as long as marginal cost is less than marginal revenue.
  • 27. How to Maximize Profit
    • The supplier will cut back on production if marginal cost is greater than marginal revenue.
    • Thus, the profit-maximizing condition of a competitive firm is MC = MR = P .
  • 28. Marginal Cost, Marginal Revenue, and Price McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. C A P = D = MR Costs 1 2 3 4 5 6 7 8 9 10 Quantity 60 50 40 30 20 10 0 A B MC 0 1 2 3 4 5 6 7 8 9 10 $28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 40.00 54.00 68.00 Price = MR Quantity Produced Marginal Cost $35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00
  • 29. The Marginal Cost Curve Is the Supply Curve
    • The marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost.
  • 30. The Marginal Cost Curve Is the Supply Curve
    • The MC curve tells the competitive firm how much it should produce at a given price.
    • The firm can do no better than produce the quantity at which marginal cost equals marginal revenue which in turn equals price.
  • 31. The Marginal Cost Curve Is the Firm’s Supply Curve A B C Marginal cost Cost, Price $70 60 50 40 30 20 10 0 1 Quantity 2 3 4 5 6 7 8 9 10
  • 32. Firms Maximize Total Profit
    • Firms seek to maximize total profit, not profit per unit.
      • Firms do not care about profit per unit.
      • As long as increasing output increases total profits, a profit-maximizing firm should produce more.
  • 33. Profit Maximization Using Total Revenue and Total Cost
    • Profit is maximized where the vertical distance between total revenue and total cost is greatest.
    • At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.
  • 34. Profit Determination Using Total Cost and Revenue Curves Profit =$45 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. TC TR 0 Total cost, revenue $385 350 315 280 245 210 175 140 105 70 35 Quantity 1 2 3 4 5 6 7 8 9 Maximum profit =$81 $130 Loss Loss Profit
  • 35. Total Profit at the Profit-Maximizing Level of Output
    • The P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit.
    • It does not tell us how much profit the firm makes.
  • 36. Determining Profit and Loss From a Table of Costs
    • Profit can be calculated from a table of costs and revenues.
    • Profit is determined by total revenue minus total cost.
  • 37. Costs Relevant to a Firm McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
  • 38. Costs Relevant to a Firm McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
  • 39. Determining Profit and Loss From a Graph
    • Find output where MC = MR .
      • The intersection of MC = MR ( P ) determines the quantity the firm will produce if it wishes to maximize profits.
  • 40. Determining Profit and Loss From a Graph
    • Find profit per unit where MC = MR.
      • Drop a line down from where MC equals MR, and then to the ATC curve.
      • This is the profit per unit.
      • Extend a line back to the vertical axis to identify total profit.
  • 41. Determining Profit and Loss From a Graph
    • The firm makes a profit when the ATC curve is below the MR curve.
    • The firm incurs a loss when the ATC curve is above the MR curve.
  • 42. Determining Profit and Loss From a Graph
    • Zero profit or loss where MC=MR.
      • Firms can earn zero profit or even a loss where MC = MR.
      • Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.
  • 43. Determining Profits Graphically (a) Profit case (b) Zero profit case (c) Loss case © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Quantity Quantity Quantity Price 65 60 55 50 45 40 35 30 25 20 15 10 5 0 65 60 55 50 45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12 D MC A P = MR B ATC AVC E Profit C MC ATC AVC MC ATC AVC Loss 65 60 55 50 45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 12 P = MR P = MR Price Price
  • 44. The Shutdown Point
    • The firm will shut down if it cannot cover average variable costs.
      • A firm should continue to produce as long as price is greater than average variable cost.
      • If price falls below that point it makes sense to shut down temporarily and save the variable costs.
  • 45. The Shutdown Point
    • The shutdown point is the point at which the firm will be better off it shuts down than it will if it stays in business.
  • 46. The Shutdown Point
    • If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss.
    • It is taking less of a loss than it would by shutting down.
  • 47. The Shutdown Decision MC P = MR 2 4 6 8 Quantity Price 60 50 40 30 20 10 0 ATC AVC Loss A $17.80
  • 48. Short-Run Market Supply and Demand
    • While the firm's demand curve is perfectly elastic, the industry's is downward sloping.
    • For the industry's supply curve we use a market supply curve.
  • 49. Short-Run Market Supply and Demand
    • The market supply curve is the horizontal sum of all the firms' marginal cost curves, taking account of any changes in input prices that might occur.
  • 50. Long-Run Competitive Equilibrium
    • Profits and losses are inconsistent with long-run equilibrium.
      • Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made.
      • The existence of losses will cause firms to leave the industry.
  • 51. Long-Run Competitive Equilibrium
    • Only at zero profit will entry and exit stop.
    • The zero profit condition defines the long-run equilibrium of a competitive industry.
  • 52. Long-Run Competitive Equilibrium 0 MC P = MR 60 50 40 30 20 10 Price 2 4 6 8 Quantity SRATC LRATC
  • 53. Long-Run Competitive Equilibrium
    • Zero profit does not mean that the entrepreneur does not get anything for his efforts.
    • Normal profit – the amount the owners of business would have received in the next-best alternative.
  • 54. Long-Run Competitive Equilibrium
    • Normal profits are included as a cost and are not included in economic profit.
    • Economic profits are profits above normal profits.
  • 55. Long-Run Competitive Equilibrium
    • Firms with super-efficient workers or machines will find that the price of these specialized inputs will rise.
    • Rent is the income received by those specialized factors of production.
  • 56. Long-Run Competitive Equilibrium
    • The zero profit condition makes the analysis of competitive markets applicable to the real world.
    • To determine whether markets are competitive, many economist focus on whether barriers to entry exist.
  • 57. Adjustment from the Long Run to the Short Run
    • Industry supply and demand curves come together to lead to long-run equilibrium.
  • 58. An Increase in Demand
    • An increase in demand leads to higher prices and higher profits.
      • Existing firms increase output.
      • New firms enter the market, increasing output still more.
      • Price falls until all profit is competed away.
  • 59. An Increase in Demand
    • If input prices remain constant, the new equilibrium will be at the original price but with a higher output.
  • 60. An Increase in Demand
    • The original firms return to their original output but since there are more firms in the market, the total market output increases.
  • 61. An Increase in Demand
    • In the short run, the price does more of the adjusting.
    • In the long run, more of the adjustment is done by quantity.
  • 62. Market Response to an Increase in Demand Profit B A B A C McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. $9 10 12 0 Firm Price Quantity Market Quantity Price 0 MC AC S LR S 0 SR D 0 7 700 $9 840 1,200 D 1 S 1 SR 7
  • 63. Long-Run Market Supply
    • In the long run firms earn zero profits.
    • If the long-run industry supply curve is perfectly elastic, the market is a constant-cost industry .
  • 64. Long-Run Market Supply
    • Two other possibilities exist:
      • Increasing-cost industry – factor prices rise as new firms enter the market and existing firms expand capacity.
      • Decreasing-cost industry – factor prices fall as industry output expands.
  • 65. An Increasing-Cost Industry
    • If inputs are specialized, factor prices are likely to rise when the increase in the industry-wide demand for inputs to production increases.
  • 66. An Increasing-Cost Industry
    • This rise in factor costs would force costs up for each firm in the industry and increases the price at which firms earn zero profit.
  • 67. An Increasing-Cost Industry
    • Therefore, in increasing-cost industries, the long-run supply curve is upward sloping.
  • 68. A Decreasing-Cost Industry
    • If input prices decline when industry output expands, individual firms' marginal cost curves shift down and the long-run supply curve is downward sloping.
  • 69. A Decreasing-Cost Industry
    • Input prices may decline to the zero-profit condition when output rises.
    • New entrants make it more cost-effective for other firms to provide services to all firms in the market.
  • 70. An Example in the Real World
    • K-mart decided to close over 300 stores after experiencing two years of losses (a shutdown decision).
    • K-mart thought its losses would be temporary.
  • 71. An Example in the Real World
    • Price exceeded average variable cost, so it continued to keep some stores open even though those stores were losing money.
  • 72. An Example in the Real World Price Quantity MC ATC AVC P = MR Loss
  • 73. An Example in the Real World
    • After two years of losses, its prospective changed.
    • The company moved from the short run to the long run.
  • 74. An Example in the Real World
    • They began to think that demand was not temporarily low, but permanently low.
    • At that point they shut down those stores for which P < AVC .
  • 75. Thank you!