lecture 10 perfect competition

7/31/2019 Lecture 10 Perfect Competition

1/16

2010

S1

2010 Pearson Canada

ChapterPerfect Competition

Define perfect competitionLearningObjectives

Explain how firms make their supply

decisions and why they sometimes shut

own temporar y an ay o wor ers

Explain how price and output are

determined, and why firms enter and leave a

market

Predict the effects of a change in demand

and a technological advance

2010 Pearson Education Australia

Explain why perfect competition is efficient

What Is Perfect Competition?

PRICETAKERS

Inperfectcompetition,eachfirmisapricetaker.

Apricetaker isafirmthatcannotinfluencethepriceofagood

.

Nosinglefirmcaninfluencethepriceitmusttakethe

equilibriummarketprice.

Each firms out ut is a er ect substitute for the out ut of the

otherfirms,sothedemandforeachfirmsoutputisperfectly

elasticatthemarketprice.



Thegoalofeachfirmistomaximiseeconomicprofit,which

equa stota revenue m nustota cost.

Total

profit

=

TR

TC

TR=PxQ

TC=Opportunitycostofproduction

minimisation).



2/16


Figure14.1illustratesafirmsrevenueconcepts.

Part(a)showsthatmarketdemandandmarketsupply

determinethemarketpricethatthefirmmusttake.



Part(b)showsthefirmstotalrevenuecurve(TR)the

relationshipbetweentotalrevenueandquantitysold.



Part(c)showsthemarginalrevenuecurve(MR).

Thefirmcansellanyquantityitchoosesatthemarketprice,so

mar inal revenue e uals rice and the demand curve for the

firmsproductishorizontalatthemarketprice.



Thedemandforafirmsproductisperfectlyelasticbecauseone

firmsTshirtisaperfectsubstituteforthe

s r o ano er rm.

Themarket

demand

is

not

perfectly

elastic

because

a

Tshirtisasubstituteforsomeothergood.



3/16

What Is Perfect Com etition?

economicprofit,giventheconstraintsitfaces.

Sot e irmmust eci e:

1. How

to

produce

at

minimum

cost

2. Whatquantitytoproduce

3. Whethertoenterorexitamarket

.


The Firms Out ut Decision

Aperfectlycompetitivefirmchoosestheoutputthatmaximises

itseconomicpro it.

One

way

to

find

the

profit

maximising

output

is

to

look

at

the

firmsthetotalrevenueandtotalcostcurves.

.

thefirmstotalprofitcurve.



Part(a)showsthetotal

revenue,TR,curve.

Part(a)alsoshowsthetotal

costcurve,TC,whichislike

theoneinLecture9.

Totalrevenueminustotalcost

iseconomicprofit(orloss),

shownbythecurveEP inpart

(b).



Atlowoutputlevels,thefirmincursaneconomic ossitcan tcoveritsfixedcosts.

Atintermediateoutputlevels,thefirmmakesaneconomicprofit.

Athighoutputlevels,thefirmagainincursaneconomiclossnowthe

becauseofdiminishingreturns.

profitwhenitproduces9Tshirtsaday.



4/16


MARGINALANALYSIS

Thefirmcanusemarginalanalysistodeterminetheprofit

.

Becausemarginalrevenueisconstantandmarginalcost

eventuallyincreasesasoutputincreases,profitismaximisedbyproducingtheoutputatwhichmarginalrevenue,MR,equals

, .

Figure14.3onthenextslideshowsthemarginalanalysisthat

determinestheprofitmaximisingoutput.



,econom c

profitincreasesifoutput

increases.

.

IfMR


5/16


e u own o n

Afirmsshutdownpoint isthepriceandquantityatwhichitis

indifferentbetweenproducingandshuttingdown.

.

ItisalsothepointatwhichtheMCcurvecrossestheAVCcurve.

Attheshutdownpoint,thefirmisindifferentbetween

producingandshuttingdowntemporarily.

ThefirmincursalossequaltoTFCfromeitheraction.



. shutdownpoint.

n mum s aTshirt.

Ifthe

price

is

$17,

the

profit

maximisingoutputis7Tshirts a da .

.

Thefirmincursalossequal .

Thefirmisattheshutdown


.


and$20.14,thefirm

roduces the uantit at

whichmarginalcostequals

price.

Thefirmcoversallits

variable cost and at least

partofitsfixedcost.

ncursa oss a s ess

thanTFC.



THEFIRMSSUPPLYCURVE

A erfectl com etitive firms su l curve shows how the

firmsprofitmaximisingoutputvariesasthemarketprice

varies,

other

things

remaining

the

same.Becausethefirmproducestheoutputatwhichmarginalcost

e uals mar inal revenue and because mar inal revenue e uals

,

price,thefirmssupplycurveislinkedtoitsmarginalcostcurve.

utatapr ce e owt es ut ownpo nt,t e rmpro uces

nothing.



6/16


.

firmssupplycurveis

constructed.

IfpriceequalsminimumAVC,

,

indifferentbetweenproducing

nothingandproducingatthe

shutdownpoint,T.



epr ce s , e rm

produces9Tshirtsaday,the

uantit at which P = MC.

.

Ifthepriceis$31,thefirm

pro uces

s r sa

ay,

e

quantityatwhichP =MC.

Thebluecurveinpart(b)traces

thefirmsshortrunsupplycurve.


Out ut, Price, and Profit in the Short Run

MARKETSUPPLYINTHESHORTRUN

byallfirmsinthemarketateachpricewheneachfirmsplant

and the number of firms remain the same.

.



Figure14.6showsthe

supplycurveforamarket

thathas1,000firmslike

SamsTShirts.

Thequantitysuppliedby

themarketatanygiven

priceisthesumofthe

quantitiessuppliedbyall

t e irmsint emar etat

thatprice.



7/16

Out ut Price and Profit in the Short Run

Atapriceequaltominimum

AVC,theshutdownprice,

shutdownquantityand

others

will

produces

zero.

Themarketsupplycurveis

.


Out ut Price and Profit in the Short Run

SHORT-RUN EQUILIBRIUM

Shortrunmarketsupplyand

marketdemanddetermine

themarketpriceandoutput.

Figure14.7showsashort

runequilibrium.



ange n eman

Anincreaseindemandbring

arightwardshiftofthe

marketdemandcurve:The

pr cer ses

an

e

quan y

increases.

Adecreaseindemandbring

aleftwardshiftofthe

mar e eman curve: e

pricefallsandthequantity

decreases.


.

Output, Price, and Profit in the Short Run

Profits and Losses in the Short Run

Maximumprofitisnotalwaysapositiveeconomicprofit.

To determine whether a firm is makin an economic rofit or

incurringaneconomicloss,wecomparethefirmsaveragetotal

costattheprofitmaximisingoutputwiththemarketprice.



8/16


ThreePossibleShortRunOutcomes

Inpart(a)priceequals averagetotalcost andthefirmmakes

.



Inpart ,priceexceeds averagetota costan t e irmma esapositiveeconomicprofit.



,

incursaneconomiclosseconomicprofitisnegative.


Out ut, Price, and Profit in the Lon Run

Inshortrunequilibrium,afirmmaymakeaneconomicprofit,

breakeven,orincuraneconomicloss.

Onlyoneofthemisalongrunequilibriumbecausefirmscan

enterorexitthemarket.

ENTRYANDEXIT

Newfirmsenter anindustryinwhichexistingfirmsmakean

economicprofit.

Firmsexit anindustryinwhichtheyincuraneconomicloss.



9/16

Out ut Price and Profit in the Lon Run

A CLOSER LOOK AT ENTRY

Whenthemarketpriceis$25aTshirt,firmsinthemarketare

.



Newfirmshaveanincentivetoenterthemarket.

Whentheydo,themarketsupplyincreasesandthemarketprice

.



Firmsenteraslongasfirmsaremakingeconomicprofits.

Inthelongrun,themarketsupplyincreases,themarketpricefalls

and firms make zero economic rofit .



A CLOSER LOOK AT EXIT

Whenthemarketpriceis$17aTshirt,firmsinthemarketare

incurringeconomicloss.



10/16


Firmshaveanincentivetoexitthemarket.

Whentheydo,themarketsupplydecreasesandthemarket

pricerises.



Firmsexitaslon asfirmsareincurrin economiclosses.

Inthelongrun,themarketsupplydecreases,themarketpricerises

.


Chan in Tastes & Advancin Technolo

APERMANENTCHANGEINDEMAND

Adecreaseindemandshiftsthemarketdemandcurveleftward.

Thepricefallsandthequantitydecreases.

Figure14.10illustratestheeffectsofapermanentdecreasein

demandwhenthemarketisinlongrunequilibrium.



DecreaseinDemand

Adecreaseindemandshiftsthemarketdemandcurveleftward.Themarketpricefalls,andeachfirmdecreasesthe

uantit it roduces .



11/16


Themarket riceisnowbeloweachfirmsminimumavera e

totalcost,sofirmsincureconomiclosses.



,

decreasesthemarketsupplyandthepricestartstorise.



Asthepricerises,thequantityproducedbyallfirmscontinuesto

decreaseasmorefirmsexit,buteachfirmremaininginthe

marketstartstoincreaseitsquantity.



Anewlongrunequilibriumoccurswhenthepricehasrisento

equalminimumaveragetotalcost.Firmsmakezeroeconomic

profits,andfirmsnolongerexitthemarket.



12/16


Themaindifferencebetweentheinitialandnewlongrunequilibriumisthenumberoffirmsinthemarket.

Fewer firms roduce the e uilibrium uantit . .



Apermanentincreaseindemandhastheoppositeeffectstot ose ust escr e an s own n gure . .

Apermanentincreaseindemandshiftsthedemandcurverightward.

The

price

rises

and

the

quantity

increases.

Economicprofitinducesentry,whichincreasesshortrunsupplyandshiftstheshortrunmarketsupplycurverightward.

As the market su l increases the rice falls and the market quantitycontinuestoincrease.



Withafallingprice,eachfirmdecreasesitsoutputasitmoves

alongitsmarginalcostcurve(supplycurve).

Anewlongrunequilibriumoccurswhenthepricehasfallento

.

Firmsmakezeroeconomicprofit,andfirmshavenoincentive

toenterthemarket.

Inthenewequilibrium,alargernumberoffirmsproducethe

equilibriumquantity.



Thechangeinthelongrunequilibriumpricefollowinga

permanentchangeindemanddependsonexternaleconomies

andexternaldiseconomies.

Externaleconomies arefactorsbeyondthecontrolofan

individualfirmthatlowerthefirmscostsastheindustryoutput

increases.

thatraisethefirmscostsasindustryoutputincreases.



13/16


Intheabsenceofexternaleconomiesorexternaldiseconomies,

afirmscostsremainconstantasthemarketoutputchanges.

Figure14.11illustratesthethreepossiblecasesandshowsthe

longrunmarketsupplycurve.

Thelongrunmarketsupplycurve showshowthequantity

suppliedinamarketvariesasthemarketpricevariesafterall

thepossibleadjustmentshavebeenmade,includingchangesin

eachfirmsplantandthenumberoffirmsinthemarket.


Chan in Tastes and Advancin Technolo

Figure14.11(a)showsthatinthe

absence of external economies

orexternaldiseconomies,an

increaseindemanddoesnot

changethe

price

in

the

long

run.

The lon run market su l

curveLSA ishorizontal.



Figure14.11(b)showsthatwhen

external diseconomies are

present,anincreaseindemand

bringsahigherpriceinthelong

run.

curveLSB isupwardsloping.



Figure14.11(c)showsthatwhen

externaleconomiesarepresent,

anincreaseindemandbringsa

lowerpriceinthelongrun.

Thelongrunmarketsupplycurve

LSC isdownwardsloping.



14/16


TECHNOLOGICALCHANGE

Newtechnologiesareconstantlydiscoveredthatlowercosts.

Anewtechnologyenablesfirmstoproduceataloweraverage

downward.

Firmsthatadoptthenewtechnologymakeaneconomicprofit.



Newtechnologyfirmsenterandoldtechnologyfirmseither

exitoradoptthenewtechnology.

Industrysupplyincreasesandtheindustrysupplycurveshifts

ri htward.

Thepricefallsandthequantityincreases.

Eventually,anewlongrunequilibriumemergesinwhichall

firmsusethenewtechnology,thepriceequalsminimum

averagetotalcost,andeachfirmmakeszeroeconomicprofit.


Competition and Efficiency

EFFICIENTUSEOFRESOURCES

Resourcesareusedefficientlywhennoonecanbemadebetter

offwithoutmakingsomeoneelseworseoff.

marginalsocialcost.



CHOICES E UILIBRIUM AND EFFICIENCY, ,

Wecandescribeanefficientuseofresourcesintermsofthe

equilibrium.

o ces

Aconsumersdemandcurveshowshowthebestbudgeta ocationc angesast epriceo agoo c anges.

Soconsumersgetthemostvalueoutoftheirresourcesatallpointsalongtheirdemandcurves.

Withnoexternalbenefits,themarketdemandcurveisthe


marginalsocialbenefitcurve.


15/16


Acompetitivefirmssupplycurveshowshowtheprofit

maximisingquantitychangesasthepriceofagoodchanges.

Sofirmsgetthemostvalueoutoftheirresourcesatallpoints

alongtheirsupplycurves.

Withnoexternalcost,themarketsupplycurveisthemarginal

socialcostcurve.



Incompetitiveequilibrium,resourcesareusedefficientlythe

quantity eman e equa st equantitysupp ie ,somargina

socialbenefitequalsmarginalsocialcost.

Thegainsfromtradeforconsumersismeasuredbyconsumersurplus.

Thegainsfromtradeforproducersismeasuredbyproducer

surplus.

Totalgainsfromtradeequaltotalsurplus.


.


Figure14.12illustratesan

efficientallocationof

resources naper ec y

competitivemarket.

AtthemarketpriceP*,

eachfirmisproducingthe

quant tyq att e owest

possiblelongrunaverage

.



Figure14.12(b)showsthe

market.

Alongthemarketdemand

curveD =MSB,consumers

areefficient.

curveS =MSC,producersare

efficient.



16/16


ThequantityQ*andprice

P*arethecompetitive

equ r umva ues.

Socompetitiveequilibrium

isefficient.

,

consumersurplusand

producersurplus,is

maximised.


lecture 10 perfect competition

Documents