Perfect Competition - Supplementary notes.ppt

Theoretical framework and application of economic conncepts for perfectly competitive firms

1. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
ECON
Designed by
Amy McGuire, B-books, Ltd.8
Perfect
Competition
Micro

2. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2
An Introduction to
Perfect Competition
LO
1
Market structure
–Number of suppliers
–Product’s degree of uniformity
–Ease of entry into the market
–Forms of competition among forms
Industry
–All firms supplying output to a market

3. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3
Perfectly Competitive
Market Structure
LO
1
Many buyers and sellers
Commodity; standardized product
Fully informed buyers and sellers
No barriers to entry
Individual buyer or seller
–No control over price
–Price takers

4. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4
Demand Under
Perfect Competition
LO
1
Market price
–Determined by S and D
Demand curve facing one supplier
–Horizontal line at the market price
–Perfectly elastic
Price taker

5. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5
LO
1
Market Equilibrium and a Firm’s Demand
Curve in Perfect Competition
P
r
ic
e

p
e
r

b
u
s
h
e
l
$5
D
S
(a) Market equilibrium
P
r
ic
e

p
e
r

b
u
s
h
e
l
$5 d
(b) Firm’s demand
1,200,000
Bushels of
wheat per day
0 15
Bushels of
wheat per day
0 510
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.
Exhibit 1

6. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6
Short-Run Profit
Maximization
Maximize economic profit
Quantity at which TR exceeds TC
by the greatest amount
Total revenue TR
Total cost TC
Profit = TR – TC
If TR > TC: economic profit
If TC > TR: economic loss
LO
2

7. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7
Short-Run Profit
Maximization
Marginal revenue MR = P = AR (perfect
competition)
Marginal cost MC
Maximize economic profit:
Increase production as long as each
additional unit adds more to TR than
TC
Golden rule
Expand output: MR>MC
Stop before MC>MR
LO
2

8. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 8
LO
2
Short-Run Cost and Revenue for a
Perfectly Competitive Firm
E
x
h
i
b
i
t

2

9. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 9
LO
2
Short-Run Profit
Maximization
(a) Total revenue minus
total cost
(b) Marginal cost equals
marginal revenue
TR: straight line, slope=5=P
TC increases with output
Max Economic profit:
where TR exceeds TC by
the greatest amount
MR: horizontal line at P=$5
Max Economic profit:
at 12 bushels,
where MR=MC
Exhibit 3
Total cost
Total revenue
(=$5 × q)
T
o
t
a
l
d
o
lla
r
s$60
48
15
Bushels of wheat per day
0 57101215
D
o
lla
r
s

p
e
r

b
u
s
h
e
l
$5
4
Bushels of wheat per day
0 57101215
Average total cost
d = Marginal revenue
= Average revenue
Marginal cost
Maximum economic
profit = $12
a
e
Profit

10. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 10
Minimizing
Short-Run Losses
LO
3
–TC = FC+VC
–Shut down in short run: pay fixed cost
–If TC<TR: economic loss
•Produce if TR>VC (P>AVC)
–Revenue covers variable costs and a
portion of fixed cost
–Loss < fixed cost
•Shut down if TR<VC (P<AVC)
–Loss = FC

11. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 11
LO
3
Minimizing Short-Run Losses
Exhibit 4

12. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 12
LO
3
Short-Run Loss
Minimization
(a) Total revenue minus
total cost
TC>TR; loss
Minimize loss: 10
bushels
(b) Marginal cost equals
marginal revenue
MR=MC=$3; ATC=$4
P=$3; P>AVC
Continue to produce
in short run
Exhibit 5
Total cost
Total revenue
(=$3 × q)
T
o
t
a
l
d
o
lla
r
s
$40
30
15
Bushels of wheat per day
0 5 10 15
Average total cost
d = Marginal revenue
= Average revenue
Marginal cost
Minimum economic
loss = $10
e
Loss
Bushels of wheat per day
0 5 10 15
D
o
lla
r
s

p
e
r

b
u
s
h
e
l
$4.00
3.00
2.50
Average variable cost

13. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 13
Firm and Industry
Short-Run S Curves
LO
4
Short-run firm supply curve
–Upward sloping portion of MC curve
–Above minimum AVC curve
Short-run industry supply curve
–Horizontal sum of
all firms’ short-run
supply curves

14. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 14
LO
4
Summary of Short-Run Output Decisions
Average total cost
Average variable cost
Marginal cost
d
1
d
2
d
3
d
4
d
5
1
2
3
4
5
q
2
q
3
q
4
q
5
q
1
Quantity per period
p
2
p
1
p
3
p
4
p
5
0
D
o
lla
r
s

p
e
r

u
n
it
Shutdown
point
Break-even
point
p
5
>ATC, q
5
, economic profit
p
2=AVC, q
2 or 0, loss=FC
ATC>p
3
>AVC, q
3
, loss <FC
p
1<AVC, shut down,
q
1
=0,loss=FC
p
4
=ATC, q
4
, normal profit
Firm’s short-run S curve
Exhibit 6

15. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 15
LO
4
Aggregating Individual Supply to Form Market Supply
1020
Quantity
per period
0
p
p’
P
r
ic
e

p
e
r

u
n
it
S
A
(a) Firm A
1020
Quantity
per period
0
p
p’
S
B
(b) Firm B
1020
Quantity
per period
0
p
p’
S
C
(c) Firm C
30 60
Quantity per period
0
p
p’
S
A
+ S
B
+ S
C
= S
(d) Industry, or market, supply
Exhibit 7

16. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 16
Firm Supply and
Market Equilibrium
LO
4
Short run, perfect competition
–Market converges to equilibrium P and Q
–Firm
•Max profit
•Min loss
•Shuts down
temporarily

17. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 17
LO
4
Short-Run Profit Maximization and Market Equilibrium
S = horizontal sum of the supply curves of all firms in
the industry Intersection of S and D: market price $5
Market price $5 determines the perfectly elastic
demand curve (and MR) facing the individual firm.
Exhibit 8

18. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 18
LO
4
C
a
s
e

S
t
u
d
y
Auction Markets
Dutch auction
Starts at a high price and
works down
Selling multiple lots of
similar items
English open outcry auction
Starts at low price and
works up
Internet auctions
Nasdaq – virtual stock market

19. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 19
LO
5
Perfect Competition
in the Long Run
Long run
Firms enter/exit the market
Firms adjust scale of operations
Until average cost is minimized
All resources are variable

20. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20
LO
5
Perfect Competition
in the Long Run
Economic profit in short run
New firms enter market in long run
Existing firms expand in long run
Market S increases
P decreases
Economic profit disappears
Firms break even

21. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21
LO
5
Perfect Competition
in the Long Run
Economic loss in short run
Some firms exit the market in long run
Some firms reduce scale in long run
Market S decreases
P increases
Economic loss disappears
Firms break even

22. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22
LO
5
Zero Economic Profit
in the Long Run
Firms enter, leave, change scale
Market:
S shifts; P changes
Firm
d(P=MR=AR) shifts
Long run equilibrium
MR=MC =ATC=LRAC
Normal profit
Zero economic profit

23. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23
LO
4
(a) Firm
d
(b) Industry or market
Q
Quantity
per period
0q
Quantity
per period
0
MC
ATC
D
o
lla
r
s

p
e
r

u
n
it
p
P
r
ic
e

p
e
r

u
n
it
p
S
D
LRAC
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.
e
Long-Run Equilibrium for a Firm and the Industry
Exhibit 9

24. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24
LO
5
Long-Run Adjustment
to a Change in D
Effects of an Increase in Demand
Short run
P increases; d increases
Firms increase quantity supplied
Economic profit
Long run
New firms enter the market
S increases, P decreases
Firm’s d curve decreases
Normal profit

25. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 25
LO
5
Long-Run Adjustment to an Increase in Demand
Long run: new firms enter the industry;
supply increases to S’; price drops back
to p; firm’s demand drops back to d.
Increase in D to D’ moves the market equilibrium
point from a to b; firm’s demand increases to d’;
economic profit in short run.
Exhibit 10
(a) Firm
d
(b) Industry or market
MC
ATC
S
D
LRAC
D’
a
b
P
r
ic
e

p
e
r

u
n
it
p
p’
Q
a
Quantity
per period
0 Q
b
Q
c
D
o
lla
r
s

p
e
r

u
n
it
p
p’ d’
q
Quantity
per period
0 q’
Profit
S’
c
S*

26. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26
LO
5
Long-Run Adjustment
to a Change in D
Effects of a Decrease in Demand
Short run
P decreases; d decreases
Firms decrease quantity supplied
Economic loss
Long run
Firms exit the market
S decreases, P increases
Firm’s d curve increases
Normal profit

27. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27
LO
5
Long-Run Adjustment to a Decrease in Demand
Long run: firms exit the industry; supply
decreases to S’’; price increases back to
p; firm’s demand rises back to d.
Decrease in D to D’’ moves the market equilibrium
point from a to f; firm’s demand decreases to d’’;
economic loss in short run.
Exhibit 11
(a) Firm
d
(b) Industry or market
MC
ATC
S
D
LRAC
D’’
a
f
P
r
ic
e

p
e
r

u
n
it
p
p’’
Q
g
Quantity
per period
0 Q
f
Q
a
D
o
lla
r
s

p
e
r

u
n
it
p
p’’ d’’
q
Quantity
per period
0 q’’
Loss
S’’
g
S*

28. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28
The Long-Run Industry
Supply Curve
LO
6
Short run
Change quantity supplied along
MC curve
Long run industry supply curve S*
After firms fully adjust
Constant-cost industries
LRAC doesn’t shift with output
Long run S* curve for industry:
straight horizontal line

29. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29
Increasing Cost
Industries
LO
6
Average costs increase as output expands
Effects of an increase in demand
Short run
P increases; d increases
Firms increase q; Economic profit
Long run
New firms enter the market;
Market: S increases; P decreases
Firm: MC and ATC increase; d curve
decreases; Zero economic profit

30. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30
LO
6
An Increasing-Cost Industry
D increases to D’, new short-run equilibrium: point b. Higher price p
b; firm’s demand curve shifts up (d
b);
economic profit, which attracts new firms.
Input prices go up, MC and ATC curves shift up.
Market S increases to S’; new price p
c, firm’s demand curve shifts down to d
c; normal profit.
Exhibit 12

31. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31
Perfect Competition
and Efficiency
LO
7
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

32. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32
What’s So Perfect About
Perfect Competition?
LO
7
Consumer surplus
Consumers pay less (P) than they are willing
to pay (along D curve)
Producer surplus
Producers are willing to accept less (along S
curve; MC) than what they are receiving (P)
Gains from voluntary exchange
Consumer and producer surplus
Productive and allocative efficiency
Maximum social welfare

33. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33
LO
7
Consumer Surplus and Producer Surplus
for a Competitive Market
0 100,000
120,000
200,000
Quantity
per period
$10
6
5
D
o
lla
r
s

p
e
r

u
n
it
S
D
e
m
Consumer
surplus
Producer
surplus
Consumer surplus: area above the
market-clearing price ($10) and
below the demand.
Producer surplus: area above the
short-run market supply curve and
below the market-clearing price
At p=$5: no producer surplus; the
price just covers each firms AVC.
At p=$6: producer surplus is the
area between $5, $6, and S curve.
Exhibit 13

34. Chapter 8 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 34
LO
7
C
a
s
e

S
t
u
d
y
Experimental Economics
Double-continuous auction
Tests subjects (buyers, sellers)
Market equilibrium
Max social welfare
Adjust fast to changing market
conditions
High transaction costs
Posted-offer pricing
Price is marked not negotiated
Slow adjustment to changing
market conditions
Low transaction costs