Download Chapter 8 - Perfect Competition

Spring 2015 MICROECONOMICS – Coverage and Study Guide - Chapter 8
95% of the Exam questions will come from the following areas:
Chapter 8 - Perfect Competition
The chart below will give you an overview of the 4 market structures we will cover in chapters 8, 9, and 10.
Mkt. Structure
Example
# of Firms
Similarity of
Products
Ease of Entry
And or Exit
Perfect
Competition
Monopolistic
Competition
Oligopoly
Farming
Very Many
Very Easy
Retail Stores
Many
Identical
(Homogeneous)
Similar
Steel/Auto
Few
Similar or Identical
Difficult
Monopoly
Utilities
One
Unique
Impossible
Easy
Comparing all four structures, we say that Perfect Competition and Monopoly are very far apart from each
other. We will find out that Monopolistic Competition and Oligopoly are somewhere between the two
extremes. We will also see that Monopolistic Competition is closer to Perfect Competition and Oligopoly is
closer to Monopoly.
The “# of firms” has to do with how much market power (power in setting the selling price) the firm has.
The more competition, the less market power the firm has.
“Similarity of Products” has to do with are there any exact or close substitutes for a company’s product.
“Ease of Entry and Exit” has to do with how easy is it for others to get into the same business and compete.
Keep in mind that even though we can classify all businesses into one of these four categories, many times
the distinction between them is not clear. For instance, a place that sells hot dogs and beer would be
generally categorized as a Monopolistic Competitor. If this hot dog and beer place were located inside the
“Q” (Cav’s arena) it would be acting like a Monopoly. In fact all business would like to act like a Monopoly.
If they can get people to believe that there is no other product like theirs they will be able to get more.
We will talk quite a bit about the level of production. This could mean the amount that a manufacturer
is producing where they are the most efficient and making the most money. Level of production also
means how many stores should Wal-Mart open in Stark County or how many hours should a pizza shop
stay open to maximize profits. This is an important point to remember.
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Characteristics of Perfect Competition (Price Taker)
The Perfectly Competitive Firm as a Price Take
Exhibit 1 – page 215
(refer back to pg 134 to review Perfectly Elastic Demand)
Short-Run Profit Maximization
Exhibits 2 and 3 – pages 216 and 217
Total Revenue/Total Cost Method (cost figures come from Exhibit #3 pg 189)
Total Revenue – Total Cost = Profit (Loss)
Marginal Revenue equals Marginal Cost method (MR=MC)
We will find that for all four Market Structures, to make the most profit or minimize their loss,
they will operate where MR=MC.
Exhibit #4 – page 219
The company is making a profit.
At 9 units of output (where MR=MC) the selling price ($70)
is above the ATC (Average Fixed + Average Variable).
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Short-Run Loss Minimization
A Perfectly Competitive Firm Facing a Short-Run Loss
Exhibit #5 – page 221
The firm is not making a profit because at 6 units of output, the selling price ($35) is below the ATC of about
$45. The firm will not shut down because even though the selling price is not enough to cover both fixed
and variable costs it is enough to cover the AVC (Average Variable Cost). The firm will stay in business
because for each item that is sold the difference between the selling price and average variable cost will be
used to pay down the fixed costs. If the firm stopped operating, it would no longer have this money to pay
down fixed expenses and losses would be higher.
A Perfectly Competitive Firm Shutting Down
Exhibit #6 – page 222
The firm will shut down because even at the point where MR=MC the selling price is lower than the
AVC. If the firm does not shut down they will lose even more money on each one sold and losses
will be higher.
You should know that in the short-run, a perfectly competitive firm can make a positive economic profit,
make a normal economic profit, or make a loss. In the long run (when others have a chance to enter the
market and become a competitor), the best a perfect competitor can do is to earn a normal economic
profit (remember this isn’t a bad place to be – a normal economic profit means you are taking in enough
revenue to cover both explicit and implicit costs).
Note: I don’t cover anything past page 222 on the test.
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