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08 perfect competition

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08 perfect competition

  1. 1. Chapter 8Perfect Competition • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing 1
  2. 2. In this chapter, you will learn to solve these economic puzzles: Why is theademand Why would firm stay In the long-run, can curve horizontal foran alligator farmswhile in business earn a firm in a money? perfectly economic profit? losing competitive market? 2
  3. 3. Who was Adam Smith? The father of modern economics who wrote The Wealth of Nations, published in 1776 3
  4. 4. What did Adam Smith sayabout Competitive Forces? They are like an “invisible hand” that leads people who simply pursue their own interests to serve the interests of society 4
  5. 5. What is the purpose of this chapter? To explain how competitive markets determine prices, output, and profits 5
  6. 6. What is Market Structure?A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit 6
  7. 7. What isPerfect Competition?1. many small firms2. homogeneous product3. very easy entry and exit4. price taker 7
  8. 8. What doesHomogeneous mean?Goods that cannot be distinguished from one another; for example, one potato cannot be distinguished from another potato 8
  9. 9. What is a Price Taker? A seller that has no control over the price of the product it sells 9
  10. 10. What determines price? Supply and demand 10
  11. 11. P$140 Market Supply and Demand$130$120 S$100 $80 $60 $40 $20 DQ 5 10 15 20 25 30 35 40 45 11
  12. 12. What determines the individual firm’s Demand Curve? A horizontal line at the market price 12
  13. 13. $140$130$120 Individual firm demand$100 $80 D $60 $40 $20 5 10 15 20 25 30 35 40 45 13
  14. 14. Why is this horizontalline the firm’s Demand Curve?If the firm charges more than this price, it will not sell anything, and it has no incentive to charge less than this price 14
  15. 15. Why does the firm haveno incentive to charge less than the market price? It can sell everything it brings to market at the market price 15
  16. 16. What does the PerfectlyCompetitive Firm control? The only thing it controls is how many units it produces 16
  17. 17. How many units should this firm produce?The number of units whereby it will maximize its profits, or at least minimize its losses 17
  18. 18. What are the two methods to determine how many units to produce? • TR and TC • MR and MC 18
  19. 19. Using the Total Revenue -Total Cost method, where should a firm produce? Where the distance between TR and TC is the greatest 19
  20. 20. P$500 TR Maximize Profit$400 TC$300$200$100 Quantity of Output 1 2 3 4 20 5 Q
  21. 21. P Maximize Profit Output$150$100 TR $50 0-$50 Quantity of Output 1 2 3 4 21 5 Q
  22. 22. What is Marginal Revenue?MR = TR / 1 output 22
  23. 23. What is Marginal Cost?MC = TC / 1 output 23
  24. 24. Using the MarginalRevenue and Marginal Cost method, whereshould a firm produce? MR = MC 24
  25. 25. Why should a firmcontinue to produce as long as MR > MC?As long as MR is > than MC, money is being made on that last unit 25
  26. 26. Why will a firm not produce that unit where MR < MC?At the unit of output where MR < MC, money is being lost on that last unit 26
  27. 27. Why does P = AR inPerfect Competition?Each additional unit sold is adding the market price to TR and TR divided by P = AR 27
  28. 28. $80 ATC MR=MC MC Price & Cost per unit$70 P = MR = AR$60$50 Profit AVC$40$30$20$10 1 2 3 4 5 6 7 8 9 28
  29. 29. P Price & Cost per unit MR=MC MC$70 ATC$60$50 AVC$40 Loss P=MR=AR$30$20$10 1 2 3 4 5 6 7 8 9 Q 29
  30. 30. P Short-Run Shutdown Price & Cost per unit$70 MC$60 ATC$50 AVC$40$30 Loss P=MR=AR$20$10 MR=MC 1 2 3 4 5 6 7 8 9 Q 30
  31. 31. Firm will shut downPrice (MR) is below minimum average variable cost 31
  32. 32. What is the PerfectlyCompetitive Firm’s Short- Run Supply Curve? The firm’s marginal cost curve above the minimum point on its average variable cost curve 32
  33. 33. P Firm’s Short-Run Supply Curve$70 MC ATC MR3$60$50 MR2 AVC$40 MR1$30$20$10 1 2 3 4 5 6 7 8 9 Q 33
  34. 34. What is the Industry’s Supply Curve?The summation of the individual firm’s MC curves that lie above their minimum AVC points 34
  35. 35. P Industry Equilibrium$130 S =∑$120 MC$100 $80 $60 $40 $20 5 10 15 20 25 30 35 40 45 Q 35
  36. 36. What is a Normal Profit? The minimum profit necessary to keep a firm in operation 36
  37. 37. In the long-run, whathappens when Economic Profits are made?When firms make more than a normal profit, firms enter the industry, as supply increases, a downward pressure is put on prices 37
  38. 38. In the long-run, what happens when Losses are made?When firms make less than a normal profit, firms leave the industry, as supply decreases, an upward pressure is put on prices 38
  39. 39. In the long-run, where is Equilibrium? At the market price that enables firms to make a normal profit 39
  40. 40. What exists at long-run perfectly competitive equilibrium? P = MR = SRMC = SRATC = LRAC 40
  41. 41. Long-Run Competitive Equilibrium P Equilibrium SRMC$70$60 SATC$50 LRAC$40$30 MR$20$10 1 2 3 4 5 6 7 8 9 Q 41
  42. 42. P Industry Equilibrium$130 S =∑$120 MC$100 $80 $60 $40 $20 D 5 10 15 20 25 30 35 40 45 Q 42
  43. 43. What different typesof industries can exist in the long-run? • Constant-cost • Decreasing-cost • Increasing-cost 43
  44. 44. What is aConstant-cost Industry?An industry in which the expansion of industry output by the entry of new firms has no effect on the firm’s cost curves 44
  45. 45. What does the long-run supply curve look like ina Constant-cost industry? It is perfectly elastic, which is horizontal 45
  46. 46. Increase in demand sets aIncrease in demand sets a higher equilibrium price higher equilibrium price Entry of new firms Entry of new firms increases supply increases supply Initial equilibrium Initial equilibrium price is restored price is restoredPerfectly elastic long-runPerfectly elastic long-run supply curve supply curve 46
  47. 47. What is a Decreasing- cost Industry?An industry in which the expansion of industry output by the entry of new firms decreases the firm’s cost curves 47
  48. 48. What does the long-runsupply curve look like in aDecreasing-cost industry? It is downward sloping 48
  49. 49. Increase in demand sets aIncrease in demand sets a higher equilibrium price higher equilibrium price Entry of new firms Entry of new firms increases supply increases supply Equilibrium price Equilibrium price and ATC decrease and ATC decreaseDownward sloping long-runDownward sloping long-run supply curve supply curve 49
  50. 50. What is an Increasing- cost Industry?An industry in which the expansion of industry output by the entry of new firms increases the firm’s cost curves 50
  51. 51. What does the long-runsupply curve look like in aIncreasing-cost industry? It is upward sloping 51
  52. 52. Increase in demand sets aIncrease in demand sets a higher equilibrium price higher equilibrium price Entry of new firms Entry of new firms increases supply increases supply Equilibrium price Equilibrium price and ATC increase and ATC increaseUpward sloping long-runUpward sloping long-run supply curve supply curve 52
  53. 53. Key Concepts 53
  54. 54. Key Concepts• What is Perfect Competition?• What is a Price Taker?• What determines price?• What determines the individual firm’s Demand• Why does the firm have no incentive to charge l• Using the Marginal Revenue and Marginal Cost method, where should a firm produce? 54
  55. 55. Key Concepts cont.• Why does MR = P in Perfect Competition?• What is a Normal Profit?• In the long-run, what happens when Economic Profits are made?• In the long-run, what happens when Losses are made?• In the long-run, where is equilibrium?• What different types of industries can exist in the long-run? 55
  56. 56. Summary 56
  57. 57. Market structure consists ofthree market characteristics: (1) thenumber of sellers, (2) the nature ofthe product, (3) the case of entryinto or exit from the market. 57
  58. 58. Perfect competition is a marketstructure in which an individual firmcannot affect the price of the productit produces. Each firm in the industryis very small relative to the market asa whole, all the firms sell ahomogeneous product, and firms arefree to enter and exit the industry. 58
  59. 59. A price-taker firm in perfectcompetition faces a perfectly elasticdemand curve. It can sell all itwishes at the market-determinedprice, but it will sell nothing abovethe given market price. This isbecause so many competitive firmsare willing to sell at the goingmarket price. 59
  60. 60. The total revenue-total costmethod is one way the firmdetermines the level of output thatmaximizes profit. Profit reaches amaximum when the verticaldifference between the total revenueand the total cost curves is at amaximum. 60
  61. 61. P$500 TR Maximize Profit$400 TC$300$200$100 Quantity of Output 1 2 3 4 61 5 Q
  62. 62. The marginal revenue equalsmarginal cost method is a secondapproach to finding where a firmmaximizes profits. Marginalrevenue is the change in totalrevenue from a one-unit change inoutput. Marginal revenue for aperfectly competitive firm equalsthe market price. 62
  63. 63. The MR = MC rule states thatthe firm maximizes profit orminimizes loss by producing theoutput where marginal revenueequals marginal cost. If the price(average revenue) is below theminimum point on the averagevariable cost curve, the MR = MCrule does not apply, and the firmshuts down to minimize its losses. 63
  64. 64. $80 ATC MR=MC MC Price & Cost per unit$70 P = MR = AR$60$50 Profit AVC$40$30$20$10 1 2 3 4 5 6 7 8 9 64
  65. 65. P Price & Cost per unit MR=MC MC$70 ATC$60$50 AVC$40 Loss P=MR=AR$30$20$10 1 2 3 4 5 6 7 8 9 Q 65
  66. 66. P Short-Run Shutdown Price & Cost per unit$70 MC$60 ATC$50 AVC$40$30 Loss P=MR=AR$20$10 MR=MC 1 2 3 4 5 6 7 8 9 Q 66
  67. 67. The perfectly competitive firm’sshort-run supply curve is a curveshowing the relationship between theprice of a product and the quantitysupplied in the short run. The individualfirm always produces along its marginalcost curve above its intersection with theaverage variable cost curve. Theperfectly competitive industry’s short-run supply curve is the horizontalsummation of the short-run supplycurves of all firms in the industry. 67
  68. 68. P Industry Equilibrium$130 S =∑$120 MC$100 $80 $60 $40 $20 5 10 15 20 25 30 35 40 45 Q 68
  69. 69. Long-run perfectly competitiveequilibrium occurs when the firmearns a normal profit by producingwhere price equals minimum long-run average cost equals minimumshort-run average total cost equalsshort-run marginal cost. 69
  70. 70. Long-Run Competitive Equilibrium P Equilibrium SRMC$70$60 SATC$50 LRAC$40$30 MR$20$10 1 2 3 4 5 6 7 8 9 Q 70
  71. 71. A constant-cost industry is anindustry whose total output can beexpanded without an increase in thefirm’s average total cost. Becauseinput prices remain constant, thelong-run supply curve in a constant-cost industry is perfectly elastic. 71
  72. 72. A decreasing-cost industry is anindustry in which lower input pricesresult in a downward-sloping long-run supply curve. As industry outputexpands, the firm’s average total costcurve shifts downward, and the long-run equilibrium market price falls. 72
  73. 73. An increasing-cost industry is anindustry in which input prices rise asindustry output increases. As a result,the firm’s average total cost curverises, and the long-run supply curvefor an increasing-cost industry isupward sloping. 73
  74. 74. Chapter 8 Quiz ©2000 South-Western College Publishing 74
  75. 75. 1. A perfectly competitive market is not characterized by a. many small firms. b. a great variety of different products. c. free entry into and exit from the market. d. any of the above.B. Perfect competition is characterized by goods that cannot be distinguished from one another. 75
  76. 76. 2. Which of the following is a characteristic of perfect competition? a. Entry barriers. b. Homogeneous products. c. Expenditures on advertising. d. Quality of service.B. A homogeneous product is one that cannot be distinguished from the others, for example, one potato looks just like another potato. 76
  77. 77. 3. Which of the following are the same at all levels of output under perfect competition? a. Marginal cost and marginal revenue. b. Price and marginal revenue. c. Price and marginal cost. d. All of the above.B. Price equals marginal revenue because each unit is sold at the same price; therefore, every additional unit sold adds the price to total revenue. 77
  78. 78. 4. If a perfectly competitive firm sells 100 units of output at a market price of $100 per unit, its marginal revenue per unit is a. $1. b. $100. c. more than $1, but less than $100. d. less than $100.B. Marginal revenue is defined as the addition to total revenue when selling one unit. 78
  79. 79. 5. Short-run profit maximization for a perfectly competitive firm occurs when the firm’s marginal cost equals a. average total cost. b. average variable cost. c. marginal revenue. d. all of the above.C. Profits are maximized or losses are minimized at the unit of output where MR = MC. If MR were > than MC, an additional unit would be produced. If MR were < MC, that last unit would not be produced. 79
  80. 80. 6. A perfectly competitive firm sells its output for $100 per unit, and the minimum average variable cost is $150 per unit. The firm should a. increase output. b. decrease output, but not shut down. c. maintain its current rate of output. d. shut down. D. At this output a firm’s losses exceed its fixed costs; it would therefore lose more money by staying open than by closing down. 80
  81. 81. Short-Run Shutdown$80 Price & Cost per unit$70 MR=MC MC$60 ATC$50 AVC$40$30 P=MR=AR$20$10 1 2 3 4 5 6 7 8 9 81
  82. 82. 7. A perfectly competitive firm’s supply curve follows the upward sloping segment of its marginal cost curve above the a. average total cost curve. b. average variable cost curve. c. average fixed cost curve. d. average price curve. B. The supply curve does not extend below the AVC curve because below this price the firm would close down; there would not be a supply curve. 82
  83. 83. P$20 Exhibit 15 MC Price & Cost per unit D$15 C ATC$10 B AVC$5 A 500 1,000 1,500 2,000 Q 83
  84. 84. 8. Assume the price of the firm’s product in Exhibit 15 is $15 per unit. The firm will produce a. 500 units per week. b. 1,000 units per week. c. 1,500 units per week. d. 2,000 units per week. e. 2,500 units per week.D. This is the number of units in which MR = MC. 84
  85. 85. 9. The lowest price in Exhibit 15 at which the firm earns zero economic profit in the short-run is a. $5 per unit. b. $10 per unit. c. $20 per unit. d. $30 per unit.B. This is the minimum point of the ATC curve at which P = ATC. Exactly a normal profit is being made, that is, zero economic profit. 85
  86. 86. 10. Assume the price of the firm’s product in Exhibit 15 is $6 per unit. The firm should a. continue to operate because it is earning an economic profit. b. stay in operation for the time being even though it is earning an economic loss. c. shut down temporarily. d. shut down permanently. B. At this price, the firm’s losses are less than its fixed costs; it will therefore lose less money by staying open than closing. 86
  87. 87. 11. Assume the price of the firm’s product in Exhibit 15 is $10 per unit. The maximum profit the firm earns is a. zero. b. $5,000 per week. c. $1,500 per week. d. $10,500 per week.A. In perfect competition, Price = AR = MR = the firm’s short-run demand curve. When P = ATC, the firm’s revenues equal its costs, so zero economic profits are made. Normal profit is included as a part of the firm’s cost data because it is a necessary expense of operating the business. 87
  88. 88. 12. In Exhibit 15, the firm’s total revenue at a price of $10 per unit pays for a. a portion of total variable costs. b. a portion of total fixed costs. c. none of the total fixed costs. d. all of the total fixed costs and total variable cost.D. At a price of $10, the firm is making an economic profit - more than enough money is being made to meet its fixed costs. 88
  89. 89. 13. As shown in Exhibit 15, the short-run supply curve for this firm corresponds to which segment of its marginal cost curve? a. A to D and all points above. b. B to D and all points above. c. C to D and all points above. d. B to C only.B. A supply curve shows how many units will be produced at various prices. The firm’s supply curve is its MC curve which lies above its AVC curve because it will always produce where MR (AR, P) = MC. 89
  90. 90. 14. In long-run equilibrium, the perfectly competitive firm’s price equals which of the following? a. Short-run marginal cost. b. Minimum short-run average total cost. c. Marginal revenue. d. All of the above.D. Long-run equilibrium is at the price in which a normal profit is being made. Normal profit is when P(AR) = ATC in long-run equilibrium. 90
  91. 91. 15. In a constant-cost industry, input prices remain constant as? a. the supply of inputs fluctuates. b. firms encounter diseconomies of scale. c. workers become more experienced. d. firms enter and exit the industry.D. A constant-cost industry is when the entry or exit of firms has little impact on a firm’s cost curves. 91
  92. 92. 16. Suppose that , in the long run, the price of feature films rises as the movie production industry expands. We can conclude that movie production is a (an) a. increasing-cost industry. b. constant-cost industry. c. decreasing-cost industry. d. marginal-cost industry.A. An industry in which the expansion of industry output by the entry of new firms increases the firm’s cost curves 92
  93. 93. 17. Which of the following is true of a perfectly competitive market? a. If economic profits are earned, then the price will fall over time. b. In long-run equilibrium, P = MR = SRMC = SRATC = LRAC. c. A constant-cost industry exists when the entry of new firms has no effect on their cost curves. d. All of the above.D. All of the above statements are true. 93
  94. 94. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 94
  95. 95. END 95

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