Ppt ch05 perfect competition 33

Chapter 5
Perfect Competition

Learning Objectives
After this chapter you will be able to:
 identify the four market structures and
the main differences among them
 describe the profit-maximizing output
rule and explain how perfect
competitors use it in the short run
 identify how perfect competitive
markets adjust in the long run and the
benefits they provide to consumers

Market Structures
There are four main market structures:
 perfect competition
 monopolistic competition
 oligopoly
 monopoly

Perfect Competition
Perfectly competitive markets have
three main features:
 many buyers and sellers
 a standard product
 no firm can affect the market price
 easy entry and exit
 price taker

Monopolistic Competition
Monopolistically competitive
markets have three main features:
 many buyers and sellers
 slightly different products
 easy entry and exit

Oligopoly and Monopoly
In an oligopoly a few businesses
(protected by entry barriers)
provide standard or similar
products.
In a monopoly a single business
(protected by entry barriers)
provides a product with no close
substitutes.

Entry Barriers
There are six main entry barriers in
oligopolies and monopolies:
 increasing returns to scale
 market experience
 restricted ownership of resources
 legal obstacles (such as patents)
 market abuses (such as predatory pricing)
 advertising (which is most common in
oligopolies)

Market Power
Market power:
 is a business’s ability to affect the
price it charges
 varies with market structure, such that
monopolists have the most and
perfect competitors have the least

Attributes of Market Structures
FIGURE 5.1
Numbers of
Businesses
Type of
Product
Entry and Exit of
New Business
Market Power
Example
Perfect
Competition
very many
standard
very easy
none
farming
Monopolistic
Competition
many
differentiated
fairly easy
some
restaurants
Oligopoly
few
standard or
differentiated
difficult
some
automobile
manufacturing
Monopoly
one
not
applicable
very
difficult
great
public
utilities

Perfect Competitor’s Demand
 A perfect competitor has a demand
curve different from the market demand
curve.
 The business’s demand curve is
horizontal at the prevailing market price.

Perfect Competitor’s Demand
FIGURE 5.2
Market Demand and Supply
Curves for T-Shirts
0 27 000
6
Quantity of T-Shirts per Day
Price($perT-Shirt)
Sm
Dm
Pure ‘n’ Simple T-Shirts’
Demand Curve
0
6
Price($perT-Shirt)
Db

Average and Marginal Revenue
Total revenue (TR=PxQ) is used to
find two other revenue concepts:
 average revenue (total revenue
divided by output) AR=TR/Q or
AR=(PxQ)/Q or AR=P
 marginal revenue (change in total
revenue divided by change in output)

Revenues for a Perfect
Competitor
Average revenue equals price, so
that a perfect competitor’s average
revenue curve is its horizontal
demand curve.
 Because average revenue (price) has a
constant value, marginal revenue and
average revenue are always equal.

An Individual Price Taker’s
Demand Curve
A perfectly competitive firm must sell at the price
determined by market supply and demand.
At a higher price, potential buyers would simply buy
from competitors.
They wouldn’t charge less because they can sell all
they want at the market price.
Copyright © 2016 by Nelson Education Ltd.
15

venues for a Perfect Competitor
Figure 5.3, page 122
$--
6
6
6
6
6
Revenue Curves for Pure ‘n’ Simple T-Shirts
0
6
$perT-Shirt
Db = AR = MR
$ 0
80
200
250
270
280
$ 0
480
1200
1500
1620
1680
480/80 = $6
720/120 = 6
300/50 = 6
120/20 = 6
60/10 = 6
480/80 = $6
1200/200 = 6
1500/250 = 6
1620/270 = 6
1680/280 = 6
Price
(P)
($ per T-shirt)
Revenue Schedules for Pure ‘n’ Simple T-Shirts
Quantity
(q)
(T-Shirts per day)
Total Revenue
(TR)
(P x q)
Marginal Revenue
(MR)
(ΔTR/Δq)
Average Revenue
(AR)
(TR x q)
Revenues for a Perfect
Competitor
ACTIVITY 1 & 2

The Profit-Maximizing Output
Rule (The marginal approach)
The profit-maximizing output rule states
that profit is maximized when marginal
revenue equals marginal cost (MR=MC).
This means:
 output should be increased if marginal
revenue exceeds marginal cost
 output should be decreased if marginal
cost exceeds marginal revenue

How do firms maximize profits?
Finding the Profit-Maximizing Level of Output
18

Total Revenue – Total Cost Approach:
Revenue – Cost = Profit
Profit is maximized where the difference between
total revenue and total cost is the greatest.
Total cost – total revenue and the marginal approach
give the same result.
19

 Producing at the profit-maximizing output level
does not mean a firm is actually generating profits.
 It means a firm is maximizing its profit opportunity
at a given price level.
 A firm could be:
 earning profits, generating losses, or breaking even.
20
Short-Run Profits and Losses

 The Four-Step Method to determine if a firm is generating an
economic profit or loss:
1. Find the profit-maximizing output:
 where MR = MC and go straight down to the horizontal axis
to find q*.
2. Determine the total revenue being generated at q*:
• At q*, go straight up to demand curve, and then to price axis to
find the market price, P*. Multiply P* x q* to find TR.
3. Find the total cost at q*:
 Go straight up to the average total cost (ATC ) curve, and then
left to the vertical axis to find average total cost per unit.
 Multiply by the output level q* to find TC. 21

4. Determine the amount of either profit or loss at q*:
 If TR > TC at the profit-maximizing output level, the firm
has economic profits.
 If TR < TC, the firm has economic losses.
 If TR = TC, the firm has zero economic profits. This is called
a normal rate of return because owners are doing as well as
they could do elsewhere.
22

Short-Run Profits, Losses, and Zero Economic Profits
23

Profit Maximization for a Perfect Competitor
Figure 5.4, page 124
0
80
200
250
270
280
Total
Product
(q)
Price
(P)
(=AR)
Marginal
Revenue
(MR)
Marginal
Cost
(MC)
(ΔTC/Δq)
Average
Variable Cost
(AVC)
(VC/q)
Profit Maximization Table for Pure ‘n’ Simple T-Shirts
Average
Cost
(AC)
(TC/q)
Total
Revenue
(TR)
Total
Cost
(TC)
Total
Profit
(TR - TC)
$6
6
6
6
6
6
$6
6
6
6
6
$1.75
1.33
2.50
5.50
10.50
$1.75
1.50
1.70
1.98
2.29
$12.06
5.63
5.00
5.04
5.24
$ 0
480
1200
1500
1620
1680
$ 825
965
1125
1250
1360
1465
$-825
-485
75
250
260
215
5.04
Profit Maximization Graph for Pure ‘n’ Simple T-Shirts
0
$perT-Shirt
6.00
270
MC
AC
AVC
Db = MR = AR
a
b
Profit = $260
Profit-Maximization for a Perfect
Competitor FIGURE 5.4

The Breakeven and Shutdown
Points
The breakeven point is where a business
breaks even while maximizing profit.
 For a perfect competitor this occurs where
price equals minimum average cost.
The shutdown point is the lowest price at
which a business will choose to operate
in the short run.
 It occurs where price equals minimum
average variable cost

 Evaluating economic losses in the short run
 A firm generating economic loss must decide whether to
 continue producing, or shut down in the short run.
 The variable costs – costs that vary with output like
wages, raw materials – are relevant for this decision.
 If the firm’s revenue cannot cover VC, then it should shut
down and minimize its loss (limit losses to fixed costs).
26

 Operating at a loss
 If P < ATC, the firm has an economic loss.
 It may still operate in the short run, as long as
Price > AVC.
 FC continue whether the firm produces or not.
 Loss is minimized if some portion of FC is covered by revenue.
27

◦ In this case, the firm
operates in the short run
but incurs a loss
because
P < ATC. Nevertheless,
P > AVC, and revenues
cover variable costs and
partially defray fixed
costs.
Short-Run Losses: Price above AVC but below ATC
28

The decision to shut down
If price is less than both ATC and AVC, the firm
can minimize losses by shutting down.
 It loses not only FC, but some portion of VC on each unit
produced.
29

◦ Because its average
variable costs exceed
price at all levels of
output, this firm
would cut its losses
by discontinuing
production.
30
Short-Run Losses: Price below AVC

A Perfect Competitor’s Supply Curve
 A perfect competitor’s supply curve is its
marginal cost curve above the shutdown
point or minimum of the AVC curve.
 At all prices above minimum AVC, the firm will continue to produce
in the short run.
 At prices below AVC, the firm will shut down.
 The market supply curve can be found by
horizontally adding the supply curves for all
the businesses in the industry.
ACTIVITY 3

Supply Curve for Pure ‘n’ Simple T-Shirts
0
5.00
$perT-Shirt
6.00
270
1.40
1.50
200 250
a
b
c
d
MC(=Sb)
MR1
AC
MR2
AVC
Supply Schedule for
Pure ‘n’ Simple T-Shirts
Price
(P)
($ per T-Shirt
Quantity
Supplied
(q)
(T-Shirts per day)
$6.00
5.00
1.50
1.40
270
250
200
0
Perfect Competitor’s Supply
Curve FIGURE 5.5

Supply Curve for
Pure ‘n’ Simply T-Shirts
0
5.00
Price($perT-Shirt)
6.00
270250200
1.50
0
Supply Curve for T-Shirt Market
5.00
Price($perT-Shirt)
6.00
27 00025 00020 000
1.50
$6.00
5.00
1.50
270
250
200
27 000
25 000
20 000
Business and Market Supply Schedules for T-Shirts
Price
(P)
($ per T-Shirt)
Quantity Supplied
(q)
(Sb)
(Q)
(Sm)
(T-Shirts per day)
Sb Sm
Supply Curves for a Perfectly Competitive
Business and Market FIGURE 5.6

Perfect Competition in the Long
Run
Entry and exit by businesses in the long
run drives a perfectly competitive market
to the breakeven point.
 Businesses enter markets where economic
profits are made so that supply shifts right
and price falls.
 Businesses leave markets where economic
losses are made so that supply shifts left
and price rises.

T-Shirt Market
0
$perT-Shirt
30 00027 00025 000
5
6
Pure ‘n’ Simply T-Shirts
0
5
$perT-Shirt
6
270250
MR0
MC
AC
a
b
D0
S0
S1
D1
d
e
c
Long-Run Equilibrium for a Perfectly
Competitive Business FIGURE 5.7
MR1

The Long-Run Competitive Equilibrium
◦ In the long run in perfect
competition, a stable situation
or equilibrium is achieved when
economic profits are zero.
At long-run equilibrium point:
Price = ATC (zero economic
profit)
Since Price = MR = AR, all are
equal to ATC
MC = MR (profit maximization)
MC intersects ATC at lowest point
Firms produce at the quantity that
minimizes per-unit total costs 36
Long-Run Equilibrium

The Benefits of Perfect
Competition
Perfectly competitive markets in long-run
equilibrium meet two conditions that
benefit consumers:
 minimum-cost pricing (price = minimum
average cost)
 marginal-cost pricing (price = marginal
cost)

Marginal Productivity Theory
 The demand for resources is based on
the demand for the products that these
resources are used to produce.
 According to marginal productivity
theory, businesses use resources based
on how much extra profit each of these
resources provides.

The Determinants of Resource
Demand
Three factors are important in
determining the demand for a
resource:
 a resource’s marginal cost
 a resource’s marginal product
 the marginal revenue of new units of
output

A Product and Resource Price-
Taker
If a business is a price-taker in its
product and resource markets:
 the resource’s marginal cost is
constant
 the resource’s marginal product is
variable
 the marginal revenue of new units of
output is constant

The Profit-Maximizing
Employment Rule
The profit-maximizing employment rule
states that profits are maximized when
marginal revenue product equals
marginal resource cost.
 Marginal revenue product is the change in
total revenue when employing a new unit
of a resource.
 Marginal resource cost is the change in
total cost when employing a new unit of a
resource.

0
1
2
3
4
5
MRP = Db
a
Labour Demand and Supply Schedules for a Strawberry Farm
Total Product
(P)
(q)
(kilograms)
Labour
(L)
(no. of
workers)
Marginal Product
(MP)
(Δq/ΔL)
(kilograms)
Output Price
(P)
($ per kilogram)
Total
Revenue
(TR)
(P x q)
Marginal
Revenue
Product
(MRP = ΔTR)
Marginal
Resource Cost
(MRC = W)
($ per hour)
0
10
18
24
28
30
10
8
6
4
2
$2
2
2
2
2
2
$ 0
20
36
48
56
60
$20 (a)
16 (b)
12 (c)
8 (e)
4 (f)
$10
10
10
10
10
> (d)
30 1 4
No. of Workers
Labour Demand and Supply Curves for a Strawberry Farm
Wage($perhour)
4
8
16
20
2
12
5
MRC = Sb
b
c
d
e
f
Labour Demand and Supply for a Product
and Resource Price-Taker FIGURE A

Market Demand and Supply
In a competitive labour market:
 the market demand curve is found by
horizontally summing the labour
demand curves for all businesses in
the industry
 the market supply curve shows the
total number of workers offering their
services in this industry at each wage

$18
14
10
6
2
SM
Labour Demand and Supply Schedules
for Strawberry Farm Workers
Labour Demanded
(DM)
Wage
(W)
($ per
hour)
Labour
Supplied
(SM)
(no. of
workers)
(market)
(no. of
workers)
(farm)
(no. of
workers)
(market)
1
2
3
4
5
1000
2000
3000
4000
5000
5000
4000
3000
2000
1000
DM
e
3000
10
0 1000 2000 4000
No. of Workers
Labour Demand and Supply Curves
for Strawberry Farm Workers
Wage($perhour)
2
6
14
18
5000
Demand and Supply in a
Competitive Labour Market FIGURE B

Demand for Other Resources
Marginal productivity theory is not
always applicable to other resources.
 The theory can be employed for labour and
for natural resources, because these
resources are measured in standardized
units.
 It is harder to calculate marginal revenue
product for capital goods, because one
investment project differs from another.

Can Capitalism Survive?
Joseph Schumpeter:
 believed that entrepreneurs are the
driving force of economic progress in
capitalism
 predicted that capitalism was doomed
because of the growing dominance of
government bureaucracy antagonistic
to capitalism

Ppt ch05 perfect competition 33

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