Transcript
Objectives
After studying this chapter, you will be able to:
Define perfect competition
Explain how firms make their supply decisions and why they sometimes shut down temporarily and lay off workers
Explain how price and output are determined and why firms enter and leave an industry
Predict the effects of a change in demand and of a technological advance
Explain why perfect competition is efficient
Rivalry in Personal Computers
The personal computer business is a highly competitive business made of such firms as Apple, Dell, Gateway etc competing with hundreds of smaller firms.
How do firms operate when they face the fiercest competition from other firms. What determines their production decisions? Why do firms enter or leave the industry?
These and other questions about competitive markets will be answered in this chapter
What is Perfect Competition?
Perfect competition is an industry in which:
Many firms sell identical products to many buyers.
There are no restrictions to entry into the industry.
Existing firms have no advantages over new ones.
Sellers and buyers are well informed about prices.
What is Perfect Competition?
How Perfect Competition Arises
Perfect competition arises when two conditions are present:
A firm’s minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level.
When each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm they buy from.
What is Perfect Competition?
Price Takers
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the market price of a good or service.
Each firm produces a tiny fraction of the total output and buyers are well informed about the prices of other firms.
The firm faces a perfectly elastic demand for its output
What is Perfect Competition?
Economic Profit and Revenue
The goal of each firm is to maximise economic profit, which equals total revenue minus total cost.
Total cost is the opportunity cost of production, which includes normal profit.
A firm’s total revenue equals price times quantity sold
A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal
sold (P) Total revenue
(Q) (dollars revenue
(T-shirts per TR = P ? Q (dollars per additional
per day) T-shirts) (dollars) T-shirts)
7 25 200
8 25 225
9 25 250
Demand, Price, and Revenue
in Perfect Competition
The Firm’s Decisions in Perfect Competition
A perfectly competitive firm faces two constraints:
A market constraint summarised by the market price and the firm’s revenue curves.
A technology constraint summarised by the firm’s product curves and cost curves.
The Firm’s Decisions in Perfect Competition
Short-Run Decisions
The perfectly competitive firm makes two
decisions in the short run:
Whether to produce or to temporarily shut down
What quantity to produce
The Firm’s Decisions in Perfect Competition
Long-Run Decisions
A firm’s long-run decisions are:
Whether to increase or decrease its plant size
Whether to remain in, enter, or leave an industry
The Firm’s Decisions in Perfect Competition
Profit-Maximising Output
A perfectly competitive firm chooses the output that maximises its economic profit.
One way to find the profit maximising output is to look at the firm’s the total revenue and total cost curves.
Revenue and Cost
Economic Profit and Loss
The Firm’s Decisions in Perfect Competition
Marginal Analysis
The firm can use marginal analysis to determine the profit-maximising output.
Profit is maximised by producing the output at which marginal revenue, MR, equals marginal cost, MC.
Profit-Maximizing Output
The Firm’s Decisions in Perfect Competition
Profits and Losses in the Short-run
Maximum profit is not always a positive economic profit.
To determine whether a firm is earning an economic profit or incurring an economic loss, we compare the firm’s average total cost, ATC, at the profit maximising output with the market price.
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
The Firm’s Decisions in Perfect Competition
Temporary Plant Shutdown
If price is less than the minimum average variable cost, the firm shuts down temporarily and incurs a loss equal to total fixed cost.
This loss is the largest that the firm must bear.
If the firm were to produce just 1 unit of output at price below average variable cost, it would incur an additional (and avoidable) loss.
The Firm’s Decisions in Perfect Competition
The Firm’s Short-run Supply Curve
A perfectly competitive firm’s short-run supply curve shows how the firm’s profit-maximising output varies as the market price varies, other things remaining the same.
Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve.
But there is a price below which the firm produces nothing and shuts down temporarily.
The Firm’s Decisions in Perfect Competition
The shutdown point is the output and price at which the firm just covers its total variable cost.
This point is where average variable cost is at its minimum.
It is also the point at which the marginal cost curve crosses the average variable cost curve.
At the shutdown point, the firm is indifferent between producing and shutting down temporarily.
It incurs a loss equal to total fixed cost from either action.
The Firm’s Decisions in Perfect Competition
If the price exceeds minimum average variable cost, the firm produces the quantity at which marginal cost equals price.
Price exceeds average variable cost, and the firm covers all its variable cost and at least part of its fixed cost.
A Firm’s Shutdown Point and Supply Curve
A Firm’s Supply Curve
The Firm’s Decisions in Perfect Competition
Short-run Industry Supply Curve
The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant.
The quantity supplied by the industry at any given price is the sum of the quantities supplied by all the firms in the industry at that price.
Industry Supply Curve
Output, Price, and Profit in Perfect Competition
Short-Run Equilibrium
Short-run industry supply and industry demand determine the market price and output.
A short-run equilibrium occurs at the intersection of the demand and supply curves.
Short-run Equilibrium
Output, Price, and Profit in Perfect Competition
A Change in Demand
An increase in demand brings a rightward shift of the industry demand curve: the price rises and the quantity increases.
A decrease in demand brings a leftward shift of the industry demand curve: the price falls and the quantity decreases.
Short-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Adjustments
In short-run equilibrium, a firm may earn an economic profit, earn normal profit, or incur an economic loss and which of these states exists determines the further decisions the firm makes in the long run.
In the long run, the firm may:
Enter or exit an industry
Change its plant size
Output, Price, and Profit in Perfect Competition
Entry and Exit
New firms enter an industry in which existing firms earn an economic profit.
Firms exit an industry in which they incur an economic loss.
Entry and exit of new firms shifts the industry supply curve.
Entry and Exit
Output, Price, and Profit in Perfect Competition
Changes in Plant Size
Firms change their plant size whenever doing so is profitable.
If average total cost exceeds the minimum long-run average cost, firms change their plant size to lower costs and increase profits.
Figure 10.9 on the next slide shows the effects of changes in plant size.
Plant Size and
Long-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Equilibrium
Long-run equilibrium occurs in a competitive industry when:
Economic profit is zero, so firms neither enter nor exit the industry.
Long-run average cost is at its minimum, so firms don’t change their plant size.
Changing Tastes and Advancing Technology
A Permanent Change in Demand
A decrease in demand shifts the demand curve leftward. The price falls and the quantity decreases.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
A Decrease in Demand
Changing Tastes and Advancing Technology
Increase in Demand
An increase in demand shifts the demand curve rightward. The price rises and the quantity increases.
Economic profit induces entry, which increases short-run supply and shifts the short-run industry supply curve rightward.
As industry supply increases, the price falls and the market quantity continues to increase.
Changing Tastes and Advancing Technology
External Economics and Diseconomies
The change in the long-run equilibrium price following a permanent change in demand depends on external economies and external diseconomies.
External economies are factors beyond the control of an individual firm that lower the firm’s costs as the industry output increases.
External diseconomies are factors beyond the control of a firm that raise the firm’s costs as industry output increases.
Changing Tastes and Advancing Technology
A long-run industry supply curve shows how the quantity supplied by an industry varies as the market price varies, after all the possible adjustments have been made, including changes in plant size and changes in the number of firms in the industry
Long-Run Changes in
Price and Quantity
Changing Tastes and Advancing Technology
Technological Change
New technologies are constantly discovered that lower costs.
A new technology enables firms to produce at a lower average cost and lower marginal cost—firms’ cost curves shift downward.
Firms that adopt the new technology earn an economic profit.
Competition and Efficiency
Efficient Use of Resources
Resource use is efficient when we produce the goods and services that people value most highly
If someone can become better off without anyone else becoming worse off, resources are not being used efficiently.
In other words, resource use is efficient when marginal benefit equals marginal cost.
Competition and Efficiency
Choices, Equilibrium, and Efficiency
We can describe an efficient use of resources in terms of the choices of consumers and firms coordinated in market equilibrium.
Consumers allocate their resources to get the most value possible out of them
Consumers get the most value possible out of their resources at all points along their demand curves, which are also their marginal benefit curves.
Competition and Efficiency
In competitive equilibrium, the quantity demanded equals the quantity supplied. This means that the consumer’s marginal benefit equals the producer’s marginal cost.
The gains from trade — consumer surplus plus producer surplus — are maximised.
Efficiency of Competition
Chapter 10:
Perfect Competition
25
25
Replace Figure 10.1 Table
Quantity (thousands
of T-shirts per day)
Quantity (T-shirts per day)
Quantity (T-shirts
per day)
Price (dollars per T-shirt)
Price (dollars per T-shirt)
Total revenue (dollar per day)
0 9 0 9 0 10 20
25
50
225
S
D
TR
A
T-shirt market
Sam’s demand,
average revenue, and
marginal revenue
Sam’s total
revenue
25
50
AR=
MR
Demand for
Sam’s T-shirts
Figure 10.1
Total Revenue, Total Cost,
and Economic Profit
Quantity Total Total Economic
(Q) revenue cost profit
(T-shirts (TR) (TC) (TR – TC)
per day) (dollars) (dollars) (dollars)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 105 141 34
8 175 160 40
9 225 183 42
10 250 210 40
11 275 245 30
12 300 300 0
13 325 360 -35
Replace Fig 10.2 Table
Economic
loss
Economic
profit =
TR - TC
Economic
loss
Quantity (T-shirts per day)
Total revenue & total cost
(dollars per day)
0 4 9 12
300
183
225
TR
TC
100
Figure 10.2(a)
Profit
maximising
quantity
Profit/
loss
Economic
profit
Economic
loss
Economic profit and loss
Quantity
(T-shirts
per day)
4 9 12
-20
0
-40
42
20
Profit/loss
(dollars per day)
Figure 10.2(b)
Profit-Maximising Output
Marginal Marginal
revenue cost
Quantity Total (MR) Total (MC) Economic
(Q) revenue (dollars per cost (dollars per profit
(T-shirts (TR) additional (TC) additional (TR – TC)
per day) (dollars) T-shirt) (dollars T-shirt) (dollars)
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
25
25
25
25
19
23
27
35
Replace Figure 10.3 table
MC
MR
Profit-
maximization
point
Loss from an extra
10th T-shirt
Profit from
an extra 10th
T-shirt
0
Quantity (T-shirts per day)
8 9 10
Marginal revenue & marginal cost
(dollars per T-shirt)
10
20
30
25
Figure 10.3
AR = MR
MC
Break-even
point
Normal profit
0
Quantity (T-shirts per day)
Price (dollars per T-shirt)
8
15.00
20.00
25.00
30.00
ATC
10
Figure 10.4(a)
Economic
Profit
0
MR
Economic profit
Quantity ( T-shirts per day)
Price (dollars per T-shirt)
MC
9
15.00
20.00
25.00
30.00
ATC
10
Figure 10.4(b)
Economic
loss
MR
MC
ATC
Economic loss
0
Quantity ( T-shirts per day)
Price (dollars per T-shirt)
17.00
7
15.00
20.00
25.00
30.00
10
Figure 10.4(c)
MR0
MR2
MR1
MC
AVC
T
Shutdown
point
0
Quantity (T-shirts per day)
7 9 10
17
25
31
Marginal revenue & marginal cost
(dollars per T-shirt)
Figure 10.5(a)
S
T
0
Quantity (T-shirts per day)
60 70 80
Marginal revenue & marginal cost
(dollars per T-shirt)
17
25
31
Figure 10.5(b)
Quantity (thousands of T-shirts per day)
7 8 9 10
Price (dollars per T-shirt)
17
25
31
0
A
B
20
S1
C
D
Figure 10.6
D1
Quantity (thousands of T-shirts per day)
7 8 9 10
Price (dollars per T-shirt)
17
25
31
0
A
B
20
S1
C
D
Figure 10.7(a)
D3
D2
S
D1
Increase in demand:
price rises and firms
increase production
0
Quantity (thousands of T-shirts per day)
6 7 8 9 10
Price (dollars per T-shirt)
17
25
31
20
Decrease in demand:
price falls and firms
decrease production
Figure 10.4(b)
S0
S2
D1
S1
Entry
increases
supply
Exit
decreases
supply
0
Quantity (thousands of T-shirts per day)
7 8 9 10
Price (dollars per T-shirt)
17
23
31
20
Figure 10.8
SRAC0
MC0
SRAC1
MR0
MR1
LRAC
Long-run
competitive
equilibrium
M
Quantity (T-shirts per day)
Price (dollars per T-shirt)
25
20
6 8
Short-run profit
maximizing point
MC1
Figure 10.9
P0
MR0
ATC
MC
MR1
P1
D1
D0
S0
Quantity
Price
0
Quantity
Price and Cost
P0
Industry
Firm
P1
q0
q1
Q0
Q1
S1
Q2
Figure 10.10
LSC
LSB
LSA
Constant-cost industry
Increasing-cost industry
Decreasing-cost industry
Quantity
Price
P0
Q0
D1
Ps
S0
Quantity
Price
P0
Q0
D0
D1
Ps
S0
Quantity
Price
P0
Q0
D0
D1
Ps
S0
S1
Qs
Qs
Qs
Q1
P2
Q2
S3
S2
P3
Q3
D0
Figure 10.11
Producer
surplus
Consumer
surplus
Quantity
Price
S
D=MSB
q*
P*
0
MC
0
Quantity
Price and cost
q*
P*
MR
Long-run
Competitive
equilibrium
SRAC
LRAC
Efficient
allocation
A Single Firm
A Market
END
CHAPTER 10
Objectives
After studying this chapter, you will be able to:
Define perfect competition
Explain how firms make their supply decisions and why they sometimes shut down temporarily and lay off workers
Explain how price and output are determined and why firms enter and leave an industry
Predict the effects of a change in demand and of a technological advance
Explain why perfect competition is efficient
Rivalry in Personal Computers
The personal computer business is a highly competitive business made of such firms as Apple, Dell, Gateway etc competing with hundreds of smaller firms.
How do firms operate when they face the fiercest competition from other firms. What determines their production decisions? Why do firms enter or leave the industry?
These and other questions about competitive markets will be answered in this chapter
What is Perfect Competition?
Perfect competition is an industry in which:
Many firms sell identical products to many buyers.
There are no restrictions to entry into the industry.
Existing firms have no advantages over new ones.
Sellers and buyers are well informed about prices.
What is Perfect Competition?
How Perfect Competition Arises
Perfect competition arises when two conditions are present:
A firm’s minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level.
When each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm they buy from.
What is Perfect Competition?
Price Takers
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the market price of a good or service.
Each firm produces a tiny fraction of the total output and buyers are well informed about the prices of other firms.
The firm faces a perfectly elastic demand for its output
What is Perfect Competition?
Economic Profit and Revenue
The goal of each firm is to maximise economic profit, which equals total revenue minus total cost.
Total cost is the opportunity cost of production, which includes normal profit.
A firm’s total revenue equals price times quantity sold
A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.
Demand, Price, and Revenue
in Perfect Competition
Quantity Price Marginal
sold (P) Total revenue
(Q) (dollars revenue
(T-shirts per TR = P ? Q (dollars per additional
per day) T-shirts) (dollars) T-shirts)
7 25 200
8 25 225
9 25 250
Demand, Price, and Revenue
in Perfect Competition
The Firm’s Decisions in Perfect Competition
A perfectly competitive firm faces two constraints:
A market constraint summarised by the market price and the firm’s revenue curves.
A technology constraint summarised by the firm’s product curves and cost curves.
The Firm’s Decisions in Perfect Competition
Short-Run Decisions
The perfectly competitive firm makes two
decisions in the short run:
Whether to produce or to temporarily shut down
What quantity to produce
The Firm’s Decisions in Perfect Competition
Long-Run Decisions
A firm’s long-run decisions are:
Whether to increase or decrease its plant size
Whether to remain in, enter, or leave an industry
The Firm’s Decisions in Perfect Competition
Profit-Maximising Output
A perfectly competitive firm chooses the output that maximises its economic profit.
One way to find the profit maximising output is to look at the firm’s the total revenue and total cost curves.
Revenue and Cost
Economic Profit and Loss
The Firm’s Decisions in Perfect Competition
Marginal Analysis
The firm can use marginal analysis to determine the profit-maximising output.
Profit is maximised by producing the output at which marginal revenue, MR, equals marginal cost, MC.
Profit-Maximizing Output
The Firm’s Decisions in Perfect Competition
Profits and Losses in the Short-run
Maximum profit is not always a positive economic profit.
To determine whether a firm is earning an economic profit or incurring an economic loss, we compare the firm’s average total cost, ATC, at the profit maximising output with the market price.
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
The Firm’s Decisions in Perfect Competition
Temporary Plant Shutdown
If price is less than the minimum average variable cost, the firm shuts down temporarily and incurs a loss equal to total fixed cost.
This loss is the largest that the firm must bear.
If the firm were to produce just 1 unit of output at price below average variable cost, it would incur an additional (and avoidable) loss.
The Firm’s Decisions in Perfect Competition
The Firm’s Short-run Supply Curve
A perfectly competitive firm’s short-run supply curve shows how the firm’s profit-maximising output varies as the market price varies, other things remaining the same.
Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve.
But there is a price below which the firm produces nothing and shuts down temporarily.
The Firm’s Decisions in Perfect Competition
The shutdown point is the output and price at which the firm just covers its total variable cost.
This point is where average variable cost is at its minimum.
It is also the point at which the marginal cost curve crosses the average variable cost curve.
At the shutdown point, the firm is indifferent between producing and shutting down temporarily.
It incurs a loss equal to total fixed cost from either action.
The Firm’s Decisions in Perfect Competition
If the price exceeds minimum average variable cost, the firm produces the quantity at which marginal cost equals price.
Price exceeds average variable cost, and the firm covers all its variable cost and at least part of its fixed cost.
A Firm’s Shutdown Point and Supply Curve
A Firm’s Supply Curve
The Firm’s Decisions in Perfect Competition
Short-run Industry Supply Curve
The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant.
The quantity supplied by the industry at any given price is the sum of the quantities supplied by all the firms in the industry at that price.
Industry Supply Curve
Output, Price, and Profit in Perfect Competition
Short-Run Equilibrium
Short-run industry supply and industry demand determine the market price and output.
A short-run equilibrium occurs at the intersection of the demand and supply curves.
Short-run Equilibrium
Output, Price, and Profit in Perfect Competition
A Change in Demand
An increase in demand brings a rightward shift of the industry demand curve: the price rises and the quantity increases.
A decrease in demand brings a leftward shift of the industry demand curve: the price falls and the quantity decreases.
Short-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Adjustments
In short-run equilibrium, a firm may earn an economic profit, earn normal profit, or incur an economic loss and which of these states exists determines the further decisions the firm makes in the long run.
In the long run, the firm may:
Enter or exit an industry
Change its plant size
Output, Price, and Profit in Perfect Competition
Entry and Exit
New firms enter an industry in which existing firms earn an economic profit.
Firms exit an industry in which they incur an economic loss.
Entry and exit of new firms shifts the industry supply curve.
Entry and Exit
Output, Price, and Profit in Perfect Competition
Changes in Plant Size
Firms change their plant size whenever doing so is profitable.
If average total cost exceeds the minimum long-run average cost, firms change their plant size to lower costs and increase profits.
Figure 10.9 on the next slide shows the effects of changes in plant size.
Plant Size and
Long-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Equilibrium
Long-run equilibrium occurs in a competitive industry when:
Economic profit is zero, so firms neither enter nor exit the industry.
Long-run average cost is at its minimum, so firms don’t change their plant size.
Changing Tastes and Advancing Technology
A Permanent Change in Demand
A decrease in demand shifts the demand curve leftward. The price falls and the quantity decreases.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
A Decrease in Demand
Changing Tastes and Advancing Technology
Increase in Demand
An increase in demand shifts the demand curve rightward. The price rises and the quantity increases.
Economic profit induces entry, which increases short-run supply and shifts the short-run industry supply curve rightward.
As industry supply increases, the price falls and the market quantity continues to increase.
Changing Tastes and Advancing Technology
External Economics and Diseconomies
The change in the long-run equilibrium price following a permanent change in demand depends on external economies and external diseconomies.
External economies are factors beyond the control of an individual firm that lower the firm’s costs as the industry output increases.
External diseconomies are factors beyond the control of a firm that raise the firm’s costs as industry output increases.
Changing Tastes and Advancing Technology
A long-run industry supply curve shows how the quantity supplied by an industry varies as the market price varies, after all the possible adjustments have been made, including changes in plant size and changes in the number of firms in the industry
Long-Run Changes in
Price and Quantity
Changing Tastes and Advancing Technology
Technological Change
New technologies are constantly discovered that lower costs.
A new technology enables firms to produce at a lower average cost and lower marginal cost—firms’ cost curves shift downward.
Firms that adopt the new technology earn an economic profit.
Competition and Efficiency
Efficient Use of Resources
Resource use is efficient when we produce the goods and services that people value most highly
If someone can become better off without anyone else becoming worse off, resources are not being used efficiently.
In other words, resource use is efficient when marginal benefit equals marginal cost.
Competition and Efficiency
Choices, Equilibrium, and Efficiency
We can describe an efficient use of resources in terms of the choices of consumers and firms coordinated in market equilibrium.
Consumers allocate their resources to get the most value possible out of them
Consumers get the most value possible out of their resources at all points along their demand curves, which are also their marginal benefit curves.
Competition and Efficiency
In competitive equilibrium, the quantity demanded equals the quantity supplied. This means that the consumer’s marginal benefit equals the producer’s marginal cost.
The gains from trade — consumer surplus plus producer surplus — are maximised.
Efficiency of Competition
Objectives
After studying this chapter, you will be able to:
Define perfect competition
Explain how firms make their supply decisions and why they sometimes shut down temporarily and lay off workers
Explain how price and output are determined and why firms enter and leave an industry
Predict the effects of a change in demand and of a technological advance
Explain why perfect competition is efficient
Rivalry in Personal Computers
The personal computer business is a highly competitive business made of such firms as Apple, Dell, Gateway etc competing with hundreds of smaller firms.
How do firms operate when they face the fiercest competition from other firms. What determines their production decisions? Why do firms enter or leave the industry?
These and other questions about competitive markets will be answered in this chapter
What is Perfect Competition?
Perfect competition is an industry in which:
Many firms sell identical products to many buyers.
There are no restrictions to entry into the industry.
Existing firms have no advantages over new ones.
Sellers and buyers are well informed about prices.
What is Perfect Competition?
How Perfect Competition Arises
Perfect competition arises when two conditions are present:
A firm’s minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level.
When each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm they buy from.
What is Perfect Competition?
Price Takers
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the market price of a good or service.
Each firm produces a tiny fraction of the total output and buyers are well informed about the prices of other firms.
The firm faces a perfectly elastic demand for its output
What is Perfect Competition?
Economic Profit and Revenue
The goal of each firm is to maximise economic profit, which equals total revenue minus total cost.
Total cost is the opportunity cost of production, which includes normal profit.
A firm’s total revenue equals price times quantity sold
A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.
Demand, Price, and Revenue
in Perfect Competition
Demand, Price, and Revenue
in Perfect Competition
The Firm’s Decisions in Perfect Competition
A perfectly competitive firm faces two constraints:
A market constraint summarised by the market price and the firm’s revenue curves.
A technology constraint summarised by the firm’s product curves and cost curves.
The Firm’s Decisions in Perfect Competition
Short-Run Decisions
The perfectly competitive firm makes two
decisions in the short run:
Whether to produce or to temporarily shut down
What quantity to produce
The Firm’s Decisions in Perfect Competition
Long-Run Decisions
A firm’s long-run decisions are:
Whether to increase or decrease its plant size
Whether to remain in, enter, or leave an industry
The Firm’s Decisions in Perfect Competition
Profit-Maximising Output
A perfectly competitive firm chooses the output that maximises its economic profit.
One way to find the profit maximising output is to look at the firm’s the total revenue and total cost curves.
Revenue and Cost
Economic Profit and Loss
The Firm’s Decisions in Perfect Competition
Marginal Analysis
The firm can use marginal analysis to determine the profit-maximising output.
Profit is maximised by producing the output at which marginal revenue, MR, equals marginal cost, MC.
Profit-Maximizing Output
The Firm’s Decisions in Perfect Competition
Profits and Losses in the Short-run
Maximum profit is not always a positive economic profit.
To determine whether a firm is earning an economic profit or incurring an economic loss, we compare the firm’s average total cost, ATC, at the profit maximising output with the market price.
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
Three Possible Profit Outcomes in the Short-Run
The Firm’s Decisions in Perfect Competition
Temporary Plant Shutdown
If price is less than the minimum average variable cost, the firm shuts down temporarily and incurs a loss equal to total fixed cost.
This loss is the largest that the firm must bear.
If the firm were to produce just 1 unit of output at price below average variable cost, it would incur an additional (and avoidable) loss.
The Firm’s Decisions in Perfect Competition
The Firm’s Short-run Supply Curve
A perfectly competitive firm’s short-run supply curve shows how the firm’s profit-maximising output varies as the market price varies, other things remaining the same.
Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve.
But there is a price below which the firm produces nothing and shuts down temporarily.
The Firm’s Decisions in Perfect Competition
The shutdown point is the output and price at which the firm just covers its total variable cost.
This point is where average variable cost is at its minimum.
It is also the point at which the marginal cost curve crosses the average variable cost curve.
At the shutdown point, the firm is indifferent between producing and shutting down temporarily.
It incurs a loss equal to total fixed cost from either action.
The Firm’s Decisions in Perfect Competition
If the price exceeds minimum average variable cost, the firm produces the quantity at which marginal cost equals price.
Price exceeds average variable cost, and the firm covers all its variable cost and at least part of its fixed cost.
A Firm’s Shutdown Point and Supply Curve
A Firm’s Supply Curve
The Firm’s Decisions in Perfect Competition
Short-run Industry Supply Curve
The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant.
The quantity supplied by the industry at any given price is the sum of the quantities supplied by all the firms in the industry at that price.
Industry Supply Curve
Output, Price, and Profit in Perfect Competition
Short-Run Equilibrium
Short-run industry supply and industry demand determine the market price and output.
A short-run equilibrium occurs at the intersection of the demand and supply curves.
Short-run Equilibrium
Output, Price, and Profit in Perfect Competition
A Change in Demand
An increase in demand brings a rightward shift of the industry demand curve: the price rises and the quantity increases.
A decrease in demand brings a leftward shift of the industry demand curve: the price falls and the quantity decreases.
Short-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Adjustments
In short-run equilibrium, a firm may earn an economic profit, earn normal profit, or incur an economic loss and which of these states exists determines the further decisions the firm makes in the long run.
In the long run, the firm may:
Enter or exit an industry
Change its plant size
Output, Price, and Profit in Perfect Competition
Entry and Exit
New firms enter an industry in which existing firms earn an economic profit.
Firms exit an industry in which they incur an economic loss.
Entry and exit of new firms shifts the industry supply curve.
Entry and Exit
Output, Price, and Profit in Perfect Competition
Changes in Plant Size
Firms change their plant size whenever doing so is profitable.
If average total cost exceeds the minimum long-run average cost, firms change their plant size to lower costs and increase profits.
Figure 10.9 on the next slide shows the effects of changes in plant size.
Plant Size and
Long-Run Equilibrium
Output, Price, and Profit in Perfect Competition
Long-Run Equilibrium
Long-run equilibrium occurs in a competitive industry when:
Economic profit is zero, so firms neither enter nor exit the industry.
Long-run average cost is at its minimum, so firms don’t change their plant size.
Changing Tastes and Advancing Technology
A Permanent Change in Demand
A decrease in demand shifts the demand curve leftward. The price falls and the quantity decreases.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
Economic losses induce exit, which decreases short-run supply and shifts the short-run industry supply curve leftward.
A Decrease in Demand
Changing Tastes and Advancing Technology
Increase in Demand
An increase in demand shifts the demand curve rightward. The price rises and the quantity increases.
Economic profit induces entry, which increases short-run supply and shifts the short-run industry supply curve rightward.
As industry supply increases, the price falls and the market quantity continues to increase.
Changing Tastes and Advancing Technology
External Economics and Diseconomies
The change in the long-run equilibrium price following a permanent change in demand depends on external economies and external diseconomies.
External economies are factors beyond the control of an individual firm that lower the firm’s costs as the industry output increases.
External diseconomies are factors beyond the control of a firm that raise the firm’s costs as industry output increases.
Changing Tastes and Advancing Technology
A long-run industry supply curve shows how the quantity supplied by an industry varies as the market price varies, after all the possible adjustments have been made, including changes in plant size and changes in the number of firms in the industry
Long-Run Changes in
Price and Quantity
Changing Tastes and Advancing Technology
Technological Change
New technologies are constantly discovered that lower costs.
A new technology enables firms to produce at a lower average cost and lower marginal cost—firms’ cost curves shift downward.
Firms that adopt the new technology earn an economic profit.
Competition and Efficiency
Efficient Use of Resources
Resource use is efficient when we produce the goods and services that people value most highly
If someone can become better off without anyone else becoming worse off, resources are not being used efficiently.
In other words, resource use is efficient when marginal benefit equals marginal cost.
Competition and Efficiency
Choices, Equilibrium, and Efficiency
We can describe an efficient use of resources in terms of the choices of consumers and firms coordinated in market equilibrium.
Consumers allocate their resources to get the most value possible out of them
Consumers get the most value possible out of their resources at all points along their demand curves, which are also their marginal benefit curves.
Competition and Efficiency
In competitive equilibrium, the quantity demanded equals the quantity supplied. This means that the consumer’s marginal benefit equals the producer’s marginal cost.
The gains from trade — consumer surplus plus producer surplus — are maximised.
Efficiency of Competition
Table 10.1
Total Revenue, Total Cost,
and Economic Profit
Table 10.2
Profit-Maximising Output
Table 10.3
