chapter 24: perfect competition econ 152 – principles of microeconomics materials include content...
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Chapter 24: Perfect Competition
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
2
Characteristics of a Perfectly Competitive Market Structure Perfect Competition
A market structure in which the decisions of individual buyers and sellers have no effect on market price
Perfectly Competitive FirmA firm that is such a small part of the total
industry that it cannot affect the price of the product or service that it sells
3
Characteristics of a Perfectly Competitive Market Structure Price Taker
A competitive firm that must take the price of its product as given because the firm cannot influence its price
4
Characteristics of a Perfectly Competitive Market Structure Price taker:
A firm can sell as much as wants at the going market price.
There is no incentive to sell for a lower price.Attempts to charge a higher price will result in
no sales.
5
Characteristics of a Perfectly Competitive Market Structure
Characteristics of perfect competitionLarge number of buyers and sellersHomogenous products
When you buy a head of lettuce do you ask what farm it came from?
No barriers to entry or exitBuyers and sellers have equal access to
information
6
The Industry Demand Curvefor Recordable DVDs
Neither an individualbuyer nor seller caninfluence the price
10,000 20,000 30,000 40,000 50,000
S
D
0
DVDs per Day
Pric
e pe
r D
VD
5E
The interaction of marketsupply and demand yieldsan equilibrium price of $5and quantity of 30,000 units
Figure 24-1, Panel (a)
7
The Demand Curve of the Perfect Competitor The perfectly competitive firm:
Is a price taker (i.e., must sell for $5) Will sell all units for $5 Will not be able to sell at a higher price Will not choose to sell more units at a lower
price
8
The Demand Curve Facing the Perfectly Competitive Firm
Figure 24-1, Panels (a) and (b)
9
How Much Should the Perfect Competitor Produce? The firm will produce the level of output
that will maximize profits given the market price.
Economic profit = total revenue (TR) - total cost (TC)
TR = P x Q
Total RevenuesThe price per unit times the total quantity sold
10
How Much Should the Perfect Competitor Produce?
TC explicit implicit costs
Economic profit = total revenue (TR) - total cost (TC)
TC fixed variable costs
As well as…
11
Profit Maximization
Figure 24-2, Panel (a)
12
Profit MaximizationTotal
Output/Sales/ Total Market Total Total
day Costs Price Revenue Profit
Figure 24-2, Panel (b)
0 $10 $5 $0 $10
1 15 5 5 10
2 18 5 10 8
3 20 5 15 5
4 21 5 20 1
5 23 5 25 2
6 26 5 30 4
7 30 5 35 5
8 35 5 40 5
9 41 5 45 4
10 48 5 50 2
11 56 5 55 1
TR = P x Q
13
How Much Should the Perfect Competitor Produce? Profit-maximizing rate of production
The rate of production that maximizes total profits, or the difference between total revenues and total costs
Also, the rate of production at which marginal revenue equals marginal cost
14
Profit Maximization
Figure 24-2, Panel (c)
TotalOutput/Sales/ Market Marginal Marginal
day Price Cost Revenue
0 $5
1 5
2 5
3 5
4 5
5 5
6 5
7 5
8 5
9 5
10 5
11 5
$5 $5
3 5
2 5
1 5
2 5
3 5
4 5
5 5
6 5
7 5
8 5
15
Using Marginal Analysis to Determinethe Profit-Maximizing Rate of Production
Marginal revenue is the change in total revenue divided by the change in output
Marginal cost is the change in total cost divided by the change in output
16
Using Marginal Analysis to Determinethe Profit-Maximizing Rate of Production
Profit maximizationEconomic profits = TR TC
Profit-maximizing output occurs when MC = MR
For a perfectly competitive firm, this is at the intersection of the firm’s demand curve and its marginal cost curve since price equals marginal revenue.
17
Short-Run Profits
To find out what our competitive individual DVD producer is making in terms of profits per unit produced in the short run, we have to determine the excess of price above average total cost.
18
Short-Run Profits
DVDs per Day3 5 7 9 111 4 6 8 102 120
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Pric
e an
d C
ost
per
Uni
t ($
)
• Recall: Profits are maximized at 7.5 units where MC = MR.
• How do we measure profits?
19
Short-Run Profits
DVDs per Day
Pric
e an
d C
ost
per
Uni
t ($
)
3 5 7 9 111 4 6 8 102 120
1
2
3
4
5
6
7
8
9
10
11
12
13
14
P = MR = AR
MC
ATCd
Profits
• Profit is maximized where MR = MC
• ATC = TC/output• TC = ATC output• TR = P output• Profit = (P - ATC)
output
Figure 24-3
20
Minimization of Short-Run Losses
DVDs per Day
Pric
e an
d C
ost
per
Uni
t ($
)
3 5 7 9 111 4 6 8 102 120
1
2
3
4
5
6
7
8
9
10
11
12
13
14
P = MR = AR
MC
ATCd1
Losses
d2
• Losses are minimized where MR = MC
• Loss = ($3 - 4.35) 5.5 or $7.43
Figure 24-4
21
Short-Run Profits
Short-run average profits or average losses are determined by comparing average total costs with price (average revenue) at the profit-maximizing rate of output.
In the short run, the perfectly competitive firm can make economic profits or economic losses.
22
The Short-Run Shutdown Price
What do you think?Would you continue to produce if you were
incurring a loss? In the short run? In the long run?
23
Short-Run Shutdownand Break-Even Price
Figure 24-5
24
The Short-Run Shutdown Price
As long as the price per unit sold exceeds the average variable cost per unit produced, the firm will be covering at least part of the opportunity cost of the investment in the business—that is, part of its fixed costs.
25
The Short-Run Shutdown Price
Short-Run Break-Even Price The price at which a firm’s total revenues equal its
costs At the break-even price, the firm is just making a
normal rate of return on its capital investment
Short-Run Shutdown Price The price that just covers average variable costs It occurs just below the intersection of the marginal
cost curve and the average variable cost curve
26
The Meaning of Zero Economic Profits Why produce if you are not making a
profit? Hint:
Distinguish between economic profits and accounting profits
When economic profits are zero, accounting profits are positive
27
The Perfect Competitor’s Short-Run Supply Curve Question
What does the supply curve for the individual firm look like?
Answer The firm’s supply curve is the marginal cost curve
above the short-run shutdown point. Thus, the competitive firm’s short-run supply curve is
its marginal costs curve equal to and above the point of intersection with the average variable cost curve.
28
The Individual Firm’sShort-Run Supply Curve
Figure 24-6
• Given the price, the quantity is determined where MC = MR
• Short-run supply = MC above minimum AVC
29
The Perfect Competitor’s Short-Run Supply Curve The Industry Supply Curve
The locus of points showing the minimum prices at which given quantities will be forthcoming
30
Deriving the Industry Supply Curve
Figure 24-7, Panels (a), (b), and (c)
S = ΣMC
(qA2 + q B2)(qA1 + qB1)
P1
Panel (c)
Quantity per Time Period
P2
q B2
MCB
q B1
P1
Panel (b)
Quantity per Time Period
P2
qA2
MCA
q A1
P2
Panel (a)
Quantity per Time Period
P1
Pric
e a
nd
Ma
rgin
al C
ost
pe
r U
nit
Pric
e a
nd
Ma
rgin
al C
ost
pe
r U
nit
Pric
e a
nd
Ma
rgin
al C
ost
pe
r U
nit
G
F
31
The Perfect Competitor’s Short-Run Supply Curve Factors that influence the industry supply
curve (determinants of supply)Firm’s productivityFactor costsTaxes and subsidiesNumber of firms
32
Competitive Price Determination
QuestionHow is the market, or “going,” price
established in a competitive market? Answer
This price is established by the interaction of all the suppliers (firms) and all the demanders.
33
Competitive Price Determination
The competitive price is determined by the intersection of the market demand curve and the market supply curveThe market supply curve is equal to the
horizontal summation of the supply curves of the individual firms
34Figure 24-8, Panel (a)
Competitive Price Determination
Pe and Qe determinedby the interaction ofthe industry S and market D
Pe is the pricethe firm must take
35
Competitive Price Determination
Given Pe, firm produces qe where MC = MR-If AC = AC1, break-even-If AC = AC2, losses-If AC = AC3, economic profit
Figure 24-8, Panel (b)
36
The Long-Run Industry Situation: Exit and Entry Profits and losses act as signals for
resources to enter an industry or to leave an industry.
37
The Long-Run Industry Situation: Exit and Entry Signals
Compact ways of conveying to economic decision makers information needed to make decisions
A true signal not only conveys information but also provides the incentive to react appropriately
38
The Long-Run Industry Situation: Exit and Entry
SummaryEconomic profits
Signal resources to enter the market and the price falls to the break-even price
Economic losses Signal resources to exit the market and the price
increases to the break-even level
39
The Long-Run Industry Situation: Exit and Entry
SummaryAt break-even
Resources will not enter or exit because the market is yielding a normal rate of return
In the long run, the perfectly competitive firm will make zero economic profits (a normal rate of return)
40
The Long-Run Industry Situation: Exit and Entry Long-Run Industry Supply Curve
A market supply curve showing the relationship between price and quantities forthcoming after firms have been allowed time to enter or exit from an industry
41
The Long-Run Industry Situation: Exit and Entry Constant-Cost Industry
An industry whose total output can be increased without an increase in long-run per-unit costs
42
Constant-Cost Industry
Figure 24-9, Panel (a)
P1
Panel (a)Constant Cost
Quantity per Time Period
D2
SL
S 2
S 1
D 1
P2
Pric
e pe
r U
nit
E 3E 1
E 2
43
The Long-Run Industry Situation: Exit and Entry Increasing-Cost Industry
An industry in which an increase in industry output is accompanied by an increase in long-run per unit costs
44
Increasing-Cost Industry
Figure 24-9, Panel (b)
P1
Panel (b)Increasing Cost
Quantity per Time Period
D 2
'SL
S2
S1
D 1
Pric
e pe
r U
nit
P2
45
The Long-Run Industry Situation: Exit and Entry Decreasing-Cost Industry
An industry in which an increase in industry output leads to a reduction in long-run per-unit costs
46
Decreasing-Cost Industry
Figure 24-9, Panel (c)
P2
Panel (c)Decreasing Cost
Quantity per Time Period
D 2
''SL
S 2
S 1
D 1
P1
Pric
e pe
r U
nit
47
Long-Run Equilibrium
Firms will adjust plant size until there is no further incentive to change.
In the long run, a competitive firm produces where price, marginal revenue, marginal cost, short-run minimum average cost, and long-run minimum average cost are equal.
48
Long-Run FirmCompetitive Equilibrium
Figure 24-11Units per Year
Qe
Pd = MR = P = AR
LAC
MC SAC
E
Pri
ce p
er
Un
it
49
Competitive Pricing: Marginal Cost Pricing Marginal Cost Pricing
A system of pricing in which the price charged is equal to the opportunity cost to society of producing one more unit of the good or service in question
50
Competitive Pricing: Marginal Cost Pricing Market Failure
A situation in which an unrestrained market operation leads to either too few or too many resources going to a specific economic activity
Chapter 24: Perfect Competition
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.