Chapter 8Perfect Competition
Perfect Competition• What is a market structure anyways?  – Def: A market structure describes the key traits of    a marke...
http://www.youtube.com/watch?v=9Hxy-TuX9fs&
Characteristics of Perfect Competition• Three Characteristics:  – Many buyers and sellers  – A standardized (or homogenous...
What do these characteristics mean?• If these conditions exist in a market, an individual  buyer or seller has no control ...
Does Perfect Competition Really Exist in the               Real-World?• Examples of Perfectly Competitive Markets.  – Agri...
Why is Perfect Competition Important• The model of perfect competition allows us to  make a number of predictions that hol...
Demand Under Perfect Competition• Market price  – Where supply and demand are equal• Demand curve for one supplier  – Hori...
The Perfectly Competitive Firm as Price                Taker• Def: A price taker is a seller that has no  control over the...
Market Equilibrium and a Firm’s Demand                             Curve in Perfect Competition                          (...
Short-Run Profit Maximization for a       Perfectly Competitive Firm• We now know that the perfectly competitive  (PC) fir...
The Total Revenue (TR)- Total Costs (TC)               Method• Using the total revenue - total cost method, where  should ...
EXAMPLE OF FINDING PROFITEXAMPLE OF FINDING PROFIT
The Marginal Revenue Equals Marginal            Cost Method• Remember that the Marginal Cost is the change in total  cost ...
Short-Run Cost and Revenue for a   Perfectly Competitive Firm
Total cost       Total revenue    Short-Run Profit                                                            (=$5 × q)   ...
Important Points• Remember that the demand curve for a  perfectly competitive firm is horizontal.• In a perfectly competit...
MR=MC Method• Why should a firm continue to produce as  long as MR > MC?• Why should a firm continue to produce as  long a...
Why does P=AR=MR=Demand Curve• P=AR(average revenue)• P=MR
Total cost       Total revenue    Short-Run Profit                                                            (=$5 × q)   ...
A Perfectly Competitive Firm Facing a           Short-Run LossesIf market conditions cause the price to fall, then the fi...
Example of Minimizing LossesExample of Minimizing Losses
Minimizing Short-Run Losses
Total cost         Total revenue                                                   (=$3 × q)                              ...
A Perfectly Competitive Firm Facing               Shut-Down• What if the price drops below AVC?  – If the price drops belo...
Example of Shut-DownExample of Shut-Down
http://www.youtube.com/watch?v=61GCogalzVc
The Perfectly Competitive Firm’s Short-          Run Supply Curve• We are going to now develop the S-R supply  curve for t...
Summary of Short-Run Output Decisions                                      Break-even                                     ...
The Perfectly Competitive Industry’s S-R               Supply Curve• Now, we are going to derive the industry’s S-R  suppl...
Aggregating Individual Supply to Form                 Market Supply                 (a) Firm A             (b) Firm B     ...
Short-Run Profit Maximization and Market Equilibrium Market price $5 determines the        S = horizontal sum of the suppl...
L-R Equilibrium for a Perfectly Competitive                    Firm• In the L-R, all inputs are variable.• If there are ec...
L-R Conclusions• P=MR=SRMC=SRATC=LRAC• If these variables do not change, then the  firms have no reason to change output l...
Long-Run Equilibrium for a Firm and the Industry                        (a) Firm                                          ...
Example of Long-Run Adjustment toExample of Long-Run Adjustment to      a Change in Demand       a Change in Demand
Long-Run Adjustment to an Increase in Demand                        (a) Firm                                              ...
The Long-Run Industry Supply              Curve• The long-run industry supply curve shows the  relationship between price ...
Constant-Cost Industries• Each firm’s long-run average cost curve does not  shift up or down as industry output changes.• ...
Increasing-Cost Industries• This occurs when the expanding output bids  up the prices of resources or otherwise  increases...
An Increasing-Cost IndustryD increases to D’, new short-run equilibrium: point b. Higher price pb; firm’s demandcurve shif...
Perfect Competition               and Efficiency Productive efficiency: Making Stuff Right    Produce output at the leas...
What’s So Perfect About      Perfect Competition? Consumer surplus    Consumers pay less price than they are willing to ...
LO7                      Exhibit 13                    Consumer Surplus and Producer Surplus                          for ...
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Chapter 8 perfect competitio-micro

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Chapter 8 perfect competitio-micro

  1. 1. Chapter 8Perfect Competition
  2. 2. Perfect Competition• What is a market structure anyways? – Def: A market structure describes the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry into and exit from the market. – The most competitive of the market structures is “perfect competition.”
  3. 3. http://www.youtube.com/watch?v=9Hxy-TuX9fs&
  4. 4. Characteristics of Perfect Competition• Three Characteristics: – Many buyers and sellers – A standardized (or homogenous) product – Buyers and sellers are fully informed about the price and availability of all resources and products – Firms and resources are freely mobile- easy entry or exit from the market • No patents, licenses, and no high capital costs.
  5. 5. What do these characteristics mean?• If these conditions exist in a market, an individual buyer or seller has no control over the price.• Price is determined by market demand and supply. – Once the market establishes price, then a firm is free to supply whatever quantity that maximizes profit. – A perfectly competitive firm is so small relative to the market that the firm’s supply decision does not affect the market price.
  6. 6. Does Perfect Competition Really Exist in the Real-World?• Examples of Perfectly Competitive Markets. – Agricultural products- wheat, corn, livestock – In the U.S., 75,000 farmers raise hogs, and tens of millions of U.S. households buy pork products
  7. 7. Why is Perfect Competition Important• The model of perfect competition allows us to make a number of predictions that hold up pretty well when compared to the real world.• It is also an important benchmark for evaluating the efficiency of other types of markets.
  8. 8. Demand Under Perfect Competition• Market price – Where supply and demand are equal• Demand curve for one supplier – Horizontal – Perfectly elastic• Price taker
  9. 9. The Perfectly Competitive Firm as Price Taker• Def: A price taker is a seller that has no control over the price of the product it sells. – What does it mean to be a price taker? – Take it or leave it
  10. 10. Market Equilibrium and a Firm’s Demand Curve in Perfect Competition (a) Market equilibrium (b) Firm’s demand S Price per bushelPrice per bushel $5 $5 d D 0 1,200,000 Bushels of 0 5 10 15 Bushels of wheat per day wheat per day Market price ($5)- determined by the intersection of the market demand and market supply curves. A perfectly competitive firm can sell any amount at that price. The demand curve facing the perfectly competitive firm - horizontal at the market price.
  11. 11. Short-Run Profit Maximization for a Perfectly Competitive Firm• We now know that the perfectly competitive (PC) firm has no control over price. So, what can it control? How can it make a profit? – The PC firm makes ONE decision- What quantity of output to produce that maximizes profit? How much should I produce to earn the most profit? – Two methods of finding this profit • TR-TC, where TC includes implicit and explicit costs. • MR=MC
  12. 12. The Total Revenue (TR)- Total Costs (TC) Method• Using the total revenue - total cost method, where should a firm produce? – Where the distance between TR and TC is the greatest (i.e. where profit is the greatest)
  13. 13. EXAMPLE OF FINDING PROFITEXAMPLE OF FINDING PROFIT
  14. 14. The Marginal Revenue Equals Marginal Cost Method• Remember that the Marginal Cost is the change in total cost as the output level changes one unit.• So, now we need to introduce marginal revenue (MR), this concept is very similar to marginal cost. – Def: Marginal revenue is the change in total revenue from the sale of one additional unit change in TR MR = change in output
  15. 15. Short-Run Cost and Revenue for a Perfectly Competitive Firm
  16. 16. Total cost Total revenue Short-Run Profit (=$5 × q) $60 MaximizationTotal dollars Maximum economic 48 profit = $12 (a) Total revenue minus total cost 15 TR: straight line, slope=5=P TC increases with output Bushels of wheat per day Max Economic profit: 0 5 7 10 12 15 where TR exceeds TC by Marginal cost the greatest amountDollars per bushel Average total cost e $5 d = Marginal revenue (b) Marginal cost equals Profit 4 = Average revenue marginal revenue a MR: horizontal line at P=$5 Max Economic profit: at 12 bushels, Bushels of wheat per day where MR=MC 0 5 7 10 12 15
  17. 17. Important Points• Remember that the demand curve for a perfectly competitive firm is horizontal.• In a perfectly competitive firm, P=MR• MC curve will have a J-Shaped curve• The firm maximizes profit by producing the output where marginal revenue equals marginal cost (MR=MC).
  18. 18. MR=MC Method• Why should a firm continue to produce as long as MR > MC?• Why should a firm continue to produce as long as MR < MC?
  19. 19. Why does P=AR=MR=Demand Curve• P=AR(average revenue)• P=MR
  20. 20. Total cost Total revenue Short-Run Profit (=$5 × q) $60 MaximizationTotal dollars Maximum economic 48 profit = $12 (a) Total revenue minus total cost 15 TR: straight line, slope=5=P TC increases with output Bushels of wheat per day Max Economic profit: 0 5 7 10 12 15 where TR exceeds TC by Marginal cost the greatest amountDollars per bushel Average total cost e $5 d = Marginal revenue (b) Marginal cost equals Profit 4 = Average revenue marginal revenue a MR: horizontal line at P=$5 Max Economic profit: at 12 bushels, Bushels of wheat per day where MR=MC 0 5 7 10 12 15
  21. 21. A Perfectly Competitive Firm Facing a Short-Run LossesIf market conditions cause the price to fall, then the firm could experience losses in the short-run.When this occurs, then there is NO level of output that the firm could produce to earn a profitWhat should they do? Firms will continue to operate at these losses for a short-time. They will operate at this loss when the price is high enough to cover average variable cost, but not average total cost.
  22. 22. Example of Minimizing LossesExample of Minimizing Losses
  23. 23. Minimizing Short-Run Losses
  24. 24. Total cost Total revenue (=$3 × q) Short-Run Loss Minimization Total dollars $40 30 Minimum economic (a) Total revenue minus loss = $10 total cost 15 TC>TR; loss Bushels of wheat per day Minimize loss: 10 0 5 10 15 bushels Marginal cost Average total costDollars per bushel (b) Marginal cost equals Average variable cost $4.00 marginal revenue Loss e 3.00 d = Marginal revenue MR=MC=$3; ATC=$4 2.50 = Average revenue P=$3; P>AVC Continue to produce Bushels of wheat per day in short run 0 5 10 15
  25. 25. A Perfectly Competitive Firm Facing Shut-Down• What if the price drops below AVC? – If the price drops below AVC then the firm will shut-down. – The firm is better off to shut-down and produce no output.
  26. 26. Example of Shut-DownExample of Shut-Down
  27. 27. http://www.youtube.com/watch?v=61GCogalzVc
  28. 28. The Perfectly Competitive Firm’s Short- Run Supply Curve• We are going to now develop the S-R supply curve for the individual firm.• The perfectly competitive firms’ S-R supply curve is its marginal cost curve above the minimum point on its average variable cost curve.• Why is it above the AVC curve?
  29. 29. Summary of Short-Run Output Decisions Break-even point Marginal cost Firm’s short-run S curve 5 p5 d5 p5>ATC, q5, economic profit Average total cost 4Dollars per unit p4 d4 p4=ATC, q4, normal profit Average variable cost 3 p3 d3 ATC>p3>AVC, q3, loss <FC 2 p2 d2 p2=AVC, q2 or 0, loss=FC p1 1 d1 p1<AVC, shut down, Shutdown q1=0,loss=FC 0 point q1 q2 q3 q4 q5 Quantity per period
  30. 30. The Perfectly Competitive Industry’s S-R Supply Curve• Now, we are going to derive the industry’s S-R supply curve. – The perfectly competitive industry’s S-R supply curve is the horizontal summation of the MC curves of all firms in the industry above the minimum point of each firm’s AVC curve.
  31. 31. Aggregating Individual Supply to Form Market Supply (a) Firm A (b) Firm B (c) Firm C (d) Industry, or market, supply SA SB SCPrice per unit SA + SB + SC = Sp’ p’ p’ p’ p p p p 0 10 20 0 10 20 0 10 20 0 30 60 Quantity Quantity Quantity Quantity per period per period per period per period
  32. 32. Short-Run Profit Maximization and Market Equilibrium Market price $5 determines the S = horizontal sum of the supply perfectly elastic demand curve (and curves of all firms in the industry MR) facing the individual firm. Intersection of S and D: market price $5
  33. 33. L-R Equilibrium for a Perfectly Competitive Firm• In the L-R, all inputs are variable.• If there are economic profits, then new firms enter, shifting the S-R industry supply curve to the right, causing price to fall until the profits are zero.• But if there are economic losses, existing firms leave, shifting the S-R industry supply curve to the left, and prices rise to the point where economic profit is zero.
  34. 34. L-R Conclusions• P=MR=SRMC=SRATC=LRAC• If these variables do not change, then the firms have no reason to change output levels.
  35. 35. Long-Run Equilibrium for a Firm and the Industry (a) Firm (b) Industry or market MC S Dollars per unit Price per unit ATC LRAC e p d p D Quantity Quantity 0 q per period 0 Q per period Long run equilibrium: P=MC=MR=ATC=LRAC. No reason for new firms to enter the market or for existing firms to leave. As long as the market demand and supply curves remain unchanged, the industry will continue to produce a total of Q units of output at price p.
  36. 36. Example of Long-Run Adjustment toExample of Long-Run Adjustment to a Change in Demand a Change in Demand
  37. 37. Long-Run Adjustment to an Increase in Demand (a) Firm (b) Industry or market MC S S’Dollars per unit d’ b Price per unit p’ p’ Profit ATC LRAC a p d p c S* D’ D Quantity Quantity 0 q q’ per period 0 Qa Qb Qc per period Increase in D to D’ moves the market Long run: new firms enter the equilibrium point from a to b; firm’s demand industry; supply increases to S’; price increases to d’; economic profit in short run. drops back to p; firm’s demand drops back to d.
  38. 38. The Long-Run Industry Supply Curve• The long-run industry supply curve shows the relationship between price and quantity supplied once firms fully adjust to any short- term economic profit of loss resulting from a change in demand.
  39. 39. Constant-Cost Industries• Each firm’s long-run average cost curve does not shift up or down as industry output changes.• Each firm’s per-unit costs are independent of the number of firms in the industry.• Thus, the long-run supply curve for a constant- cost industry is horizontal.• It uses such a small portion of the resources available that increasing output does not bid up resource prices. – Example: Pencil Market
  40. 40. Increasing-Cost Industries• This occurs when the expanding output bids up the prices of resources or otherwise increases per-unit production costs, and these higher costs shift up each firm’s cost curves.• Example – The expansion of oil production could bid up the prices of drilling rigs.
  41. 41. An Increasing-Cost IndustryD increases to D’, new short-run equilibrium: point b. Higher price pb; firm’s demandcurve shifts up (db); economic profit, which attracts new firms.Input prices go up, MC and ATC curves shift up.Market S increases to S’; new price pc, firm’s demand curve shifts down to dc; normalprofit.
  42. 42. Perfect Competition and Efficiency Productive efficiency: Making Stuff Right  Produce output at the least possible cost  Min point on LRAC curve  P = min average cost in long run Allocative efficiency: Making the Right Stuff  Produce output that consumers value most  Marginal benefit = P = Marginal cost  Allocative efficient market 7
  43. 43. What’s So Perfect About Perfect Competition? Consumer surplus  Consumers pay less price than they are willing to pay (along Demand curve) Producer surplus  Producers are willing to accept less (along Supply curve; MC) than what they are receiving (the market price) Gains from voluntary exchange  Consumer and producer surplus  Productive and allocative efficiency  Maximum social welfare  The overall well-being of people in the economy.  The surplus (or bonus) from the market exchange that the sellers and buyers receive.
  44. 44. LO7 Exhibit 13 Consumer Surplus and Producer Surplus for a Competitive Market Dollars per unit Consumer surplus: area above the S market-clearing price ($10) and below the demand. Consumer surplus e Producer surplus: area above the$10 Producer short-run market supply curve and surplus below the market-clearing price 6 D 5 m At p=$5: no producer surplus; the price just covers each firms AVC. At p=$6: producer surplus is the Quantity 0 100,000 200,000 area between $5, $6, and S curve. 120,000 per period

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