ch06 - perfectly competitive markets
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8/3/2019 Ch06 - Perfectly Competitive Markets
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The Perfectly Competitive
MarketEconomics 11
UPLB
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Market Economy
the market is a system where buyers and sellersexchange goods or services
market is actually a very logical mechanism that
helps answer the basic economic questions of what, how much and for whom to producedifferent commodities.
system continually allocates goods and servicesto various units with the help of a pricing mechanism
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The Market System
a market for commodities - rice, milk, water,coffee, clothes and many others.
a market for the inputs used in the production
of these commodities like steel, minerals andlabor.
Each market may have a different structure:
the number of sellers or buyers demand for the commodity
control in the market.
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Two General Types of Markets
I. the Perfectly Competitive Market [5 main
features]
II. the imperfect market
Monopoly – one firm
Oligopoly – two or more, but few firms
Monopolistic competition – many firms selling
differentiated products.
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5 Features of Perfectly Competitive Market
1. Smallness of buyers and sellers relative to the
market
2. Homogeneous product
3. Absence of artificial restraints or controls
4. Perfect mobility of goods and resources
5. Perfect information
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The Demand Curve Faced by the Firm
since the firm cannot control the market price,owing to its smallness relative to the market, thefirm can actually sell as much output as it wants
without influencing the price. the firm in perfect competition faces a perfectly
elastic demand curve
the equilibrium price is still determined in themarket by the forces of demand and supply
P
Q
d
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Revenues of the Firm
Total revenue (TR) is the firm's gross income from the sale of itsproduct
TR=P.Q
Marginal revenue (MR) is the additional revenue earned fromeach additional unit of output sold.
MR=∆TR/∆Q
Average revenue (AR) is total revenue divided by output.
AR=TR/Q
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Market Firm
Q
D
P* P* d
0 0Q
Price
Equilibrium price is determined
in the market
Once determined, a firm can sell as
much as it wants at that price
S
Market
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Market Firm
Q
D
P* P* d
0 0Q
Price
Equilibrium price is determined
in the market
Once determined, a firm can sell as
much as it wants at that price
S
D2
Market
P2
d2
P2
D2
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FIGURE 6.1. The market and firm demand curves for a perfectly competitive good.In the left panel of this diagram, we find a downward sloping market demand curve forthe good. Its intersection with the market supply curve determines the equilibrium price(P* ) that will prevail in the market. Since a perfectly competitive firm can sell all that itwants at P* , the firm’s demand curve is the horizontal line shown at the right panel of thisdiagram.
P
Q
0 Output
P r i c e
Demand
Supply
P
Q
0 Output
P r i c e
(A) Market (B) Firm
P* P*
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Price, MR and AR
Q P TR MR AR
0 200 0 - -
1 200 200 200 200
2 200 400 200 200
3 200 600 200 200
4 200 800 200 200
5 200 1000 200 200
Under pure competition, P = MR = AR
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0 1 2 3
P= 200
400
600
Revenue
Q
TR
MR = AR
Output
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Output Price Total Revenue
Marginal
Revenue Total Cost Marginal Cost Profit
(Q) (P) (TR) (MR) (TC) (MC) (Π)
0 200 0 ~ 500 ~ -500
1 200 200 200 591 91 -391
2 200 400 200 668 77 -268
3 200 600 200 737 69 -137
4 200 800 200 804 67 -4
5 200 1000 200 875 71 125
6 200 1,200 200 956 81 244
7 200 1,400 200 1,053 97 347
8 200 1,600 200 1,172 119 428
9 200 1,800 200 1,319 147 481
10 200 2,000 200 1,519 200 481 11 200 2,200 200 1,784 265 416
12 200 2,400 200 2,119 335 281
13 200 2,600 200 2,529 410 71
14 200 2,800 200 3,019 490 -291
15 200 3,000 200 3,599 580 -599
Total Cost, Total Revenue, and Profit at Different Levels of Output
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TR,TC
π
TC
TR
Q
Q0
0
P r o f i t
T o t
a l R e v e n u e ,
T o t a l C o
s t
Q0 Q* Q1
Output
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Deriving profits from the TR and TC curves
Top panel Profits or losses are measured by the vertical distance between the TR
and TC curves. For quantities between Q0 and Q1, the TR curve is abovethe TC curve. For these levels of output, the firm’s profits are positive.
The TR and TC curves intersect at output levels Q0 and Q1. This meansthat the firm’s profits at these levels of output are zero since TR=TC.
For output levels to the left of Q0 and to the right of Q1, the TR curve isbelow the TC curve, which implies that the profits are negative.
Bottom Panel - a “bell-shaped” profit curve.
firm’s profits are highest at Q* where the slope of the TR curve (MR) andthe slope of the TC curve (TC) are equal. Hence, Q* is the firm’s profit-maximizing level of output.
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P r
i c e ,
R e v e n u e a n d
C o s t
Output
MC
AC
AVC
Q
200
Q*
0
profit
A
C B
E
D
150
100
MR = ARP*
Total Revenue TR = 0P*AQ*,
Total Cost TC = 0CBQ*,
Profit π= CP*AB
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Profit maximization for a perfectly
competitive firm The firm maximizes its profit at the intersection of the MR and
MC curves (point A) This means that the firm’s profit-maximizing level of output is equal to Q*.
How large is the firm’s profit? The firm’s total revenue is equal to the product of the price (line segment
0P*) and its output (line segment 0Q*). This suggests that its totalrevenue is equal to the area 0P*AQ*.
On the other hand, the firm’s total cost is equal to the product of itsaverage cost at Q* (line segment 0C) and its output (line segment 0Q*). This means that total cost is equal to the area 0CBQ*.
Since profit is equal to TR less TC, it is therefore equal to the differencebetween areas 0P*AQ* and 0CBQ*. In other words, the firm’s profit isequal to CP*AB
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P r i c e ,
R e v e n
u e a n d C o s t
Output
MC
AC
AVC
Q
P2
Q2
*
P2= MR2= AR2
0
profit
P1
Q2
*
EFFECT OF A FALL IN PRICE FROM P1 TO P2
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The effects of a fall in the output price
Since profit maximization requires the equality
between MR and MC, the fall in the price leads
to a fall in the firm’s output from Q1 to Q2 .
Profit also decreases
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P r i c e ,
R e v e n u e a n d C o s t
Output
MC
AC
AVC
Q
P3
Q3
* 0
P3= MR3= AR3
IF PRICE FALLS TO P3 WHERE P=AC
At P3, P=AC, so TR=TC,profit is zero
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Break even point
When price falls down to P 3 , price equals the
lowest point of the firm’s average cost curve.
This means that the firm’s total cost and total
revenue are equal
Thus, the firm’s profit at P 3 is equal to zero. We
refer to this as the break-even point.
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P r i c e ,
R e v e n u e a n d C o s t
Output
MC
AC
AVC
Q
P4
Q4
* 0
loss
P4= MR4= AR4
PRICE falls below AC at P4
If price falls below AC at P4. The firm incurs a loss but mustcontinue to produce to minimize losses.
A
BC
DE
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Loss Minimization at a price between the minimum
AC and AVC curves
If the output price (such as P4) is between theminimum points of the AC and AVC curves, MR =MC at point A, and the best output level is equal toQ4.
The firm is experiencing losses at P4. TR<TCimplying a loss of P4 CBA.
To minimize its losses, the firm will continue to produce. If the firm decides to stop production, it
will still continue to pay for its fixed costs ECBD Since area ECBD is larger than P2CBA, its losses
from closing down are larger than its losses fromcontinued production.
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P r i c e ,
R e v e n u e a n d C o s t
Output
MC
AC
AVC
Q
P5
Q5*0
loss
P5= MR5= AR5
At P5 = min AVC, the loss is equal to the Total Fixed
Cost (TFC), which is the also the loss if the firm did
not produce. Therefore the firm should shut down.
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P r i c e ,
R e v e n u
e a n d C o s t
Output
MC
AC
AVC
Q
P5
Q5
0
P1
P2
P3
P4
Q4 Q3 Q2 Q1
Note that Q changes as P changes. Given the P, Q is
determined at P=MC. There for the MC curve traces the
firm’s supply curve, but only above the minimum AVC
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P r i c e ,
R e v e n u e a n d C o s t
Output
MC
AC
AVC
Q
P5
Q5
P= MR= AR
0
loss
P1
P2
P3
P4
Q4 Q3 Q2 Q1
Firm’s Supply Curve:
Portion of MC curve above
the AVC curve
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Long Run Equilibrium
Suppose that the price level (determined by D-S)
is such that it is profitable for firms to operate.
Positive profits will attract new firms into the
industry.
Supply curve will shift to the right
Price will decline until profit is driven down to zero.
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Long Run Equilibrium
Suppose that the price level (as determined by
D-S conditions) is such that it not profitable for
firms to operate.
Negative profits will make some firms leave the
industry.
Supply curve will shift to the left
Price will increase until profit is no longer negative.
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SACMC
LAC
MR, AR
S0
Q0
P
At Po, firms are reaping profits. Newfirms are attracted as long as profitsare positive. Supply curve shifts tothe right, so price falls.
D
S1
P0
P1
P0
P1
The entry or exit of firms will stoponly when profit is reduced tozero. This is at the lowest point ofthe LAC curve.
Q1
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LAC
SAC1
Q0
COST
SMC1
LMC
Long Run Equilibrium of the Industry: P = LMC = SMC, P = LAC = SAC
P MR, AR
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Constant cost industry
Suppose that the industry’s initial long -run equilibriumcorresponds to price and output levels P0 and Q0,respectively.
With an increase demand from D0 to D1 “short-run”
equilibrium price and quantity increase The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. This causes arightward shift in the market supply curve.
We have a constant cost industry if the shift in thesupply curve leads to a long-run equilibrium whereinthe market price goes back to P0.
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D0 D1
P
Q
Quantity
P r i c
e
S0S1
P0
P1
Q0 Q1
Long Run Supply Curve
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LAC
SAC1
Q0
COST
SMC1
LMC
The increase in price will make the industry profitable. This will result
in entry of new firms. The increased supply will drive the price down
until profits are back to zero at P0.
P0 MR 0
P1 MR 1
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Increasing cost industry
Suppose that the industry’s initial long -run equilibriumcorresponds to price and output levels P0 and Q0,respectively.
With an increase demand from D0 to D1 “short-run”
equilibrium price and quantity increase. The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. The entry of firms causes LAC to shift upwards.
We have a increasing cost industry if the shift in thesupply curve leads to a long-run equilibrium whereinthe market price P1 is greater than P0.
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LAC0
SAC1
Q0
COST
SMC1
LMC
The increase in price will make the industry profitable. The entry of
new firms causes the LAC to increase (move up). Equilibrium will be
established at P1,Q
1
P0 MR 0
P1 MR 1
P’1
LAC1
Q0 Q1
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D0 D1
P
Q
Quantity
P r i c
e
S0
S1
P0
P’1
Q0 Q1
P’1 P1
Long Run Supply Curve
INCREASING COST INDUSTRY
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Decreasing cost industry
Industry’s initial long -run equilibrium corresponds toprice and output levels P0 and Q0, respectively.
An increase demand from D0 to D1 results in higher
equilibrium price and quantity.
The higher price makes the industry profitable. Firms
will be encouraged to enter the industry. However, the
entry of firms causes LAC to shift downwards.
We have a decreasing cost industry if the shift in thesupply curve leads to a long-run equilibrium wherein
the market price P1 is less than P0.
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LAC0
SAC1
Q0
COST
SMC1
The initial increase in price will make the industry profitable.
However, the entry of new firms will cause the LAC to decrease (shift
downward). Equilibrium will be established at P1
,Q1
P0
MR 0P1
MR 1
P’1
LAC1
Q0Q1
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D0 D1
P
Q
Quantity
P r i c e
S0 S1
P0
P’1
Q0
Q1
P1
Long Run Supply Curve
DECREASING COST INDUSTRY
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Letter from parents to son…
Dear Anak,
Naipadala ko na 50 thousand pesos na tuition feemo, pinagbili na namin ang
mga kalabaw natin. Ang mahal pala ng kursongCOUNTER STRIKE, Wala na din pala tayong baboy naibenta na din
para dun sa sinasabi mo na project nyo na NOKIAN75, ang mahal naman ng project nayun.
Kasama din ang 7 thousand dun para sa field tripnyo sa MALL OF ASIA, anak malayo ba yun?mag ingat ka sa pagbibiyahe mo,
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Letter from parents to son…
Isasanla palang namin ang palayan natin para mabili mona yung instrumentong I-POD na kinakailangan mo salaboratory nyo.
Anak komportable kaba dyan sa boarding house mo san bakamu yan sa VICTORIA COURT ??? - maganda ba dyan?
Presco ba hangin katulad dito sa atin? Anak kamusta na pala yung sayans group project nyo na
SANMIG LIGHT?Napailaw nyo na ba? Mataas ba nakuha nyo na grado dun?
Anak sana bago pa maubos ang lahat lahat ng ari ariannatin ay makagradweyt ka na, walong taon ba talaga angkurso mo sa SECRETARIAL? ?? Sanapag gradweyt momakakuha ka ng trabaho kaagad kagaya ng manager ngkumpanyapara mabawi natin ang mga ari arian natingnasa sanglaan.
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Letter from parents to son…
Ay sya nga pala anak diba sabi mo sa JOLLIBEE / MAKDONALD ka palagi kumakain ok ba naman sayo angmga ulam dyan? Baka hindi masarap kawawa ka naman.
Anak hanggang dito na lang at sa susunod ay ipapadala
ko sayo ang pera na pambili mo ng ALTIS na gagamitinmo sa VACANT SUBJECT mo.
Ang nagmamahal
Itang at Inang
P.S. Anak mag aral ka ng mabuti. Mahal na mahal kanamin at gagawin namin ang lahat alang-alang sa iyo.