Download Perfect Competition

Chapter 10:
Perfect
Competition
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-2
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-3
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-4
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-5
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-6
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-7
Demand, Price, and Revenue
in Perfect Competition
Table 10.1
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-8
Demand, Price, and Revenue
in Perfect Competition
Figure 10.1
25
D
0
Total revenue (dollar per day)
Price (dollars per T-shirt)
S
9
TR
225
A
0
Quantity (thousands
of T-shirts per day)
9
Price (dollars per T-shirt)
Sam’s total
revenue
T-shirt market
50
Sam’s demand,
average revenue, and
marginal revenue
50
AR=
MR
25
0
Quantity (T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
Demand for
Sam’s T-shirts
10
20
Quantity (T-shirts
per day)
10-9
The Firm’s Decisions in
Perfect Competition
§ A perfectly competitive firm faces two constraints:
1. A market constraint summarised by the market price and
the firm’s revenue curves.
2. A technology constraint summarised by the firm’s
product curves and cost curves.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-10
The Firm’s Decisions in
Perfect Competition
§ Short-Run Decisions
§ The perfectly competitive firm makes two
decisions in the short run:
1. Whether to produce or to temporarily shut down
2. What quantity to produce
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-11
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-12
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-13
Total Revenue, Total Cost,
and Economic Profit
Table 10.2
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-14
Total revenue & total cost
(dollars per day)
Revenue and Cost
Figure 10.2(a)
TC
TR
300
Economic
loss
225
Economic
profit =
TR - TC
183
100
Economic
loss
0
4
9
12
Quantity (T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-15
Economic Profit and Loss
Figure 10.2(b)
Profit/loss
(dollars per day)
Economic profit and loss
42
20
0
4
-20
-40
Economic
profit
Economic
loss
Profit
maximising
quantity
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
9
12
Profit/
loss
Quantity
(T-shirts
per day)
10-16
The Firm’s Decisions in
Perfect Competition
§ Marginal Analysis
§ The firm can use marginal analysis to determine the profitmaximising output.
§ Profit is maximised by producing the output at which
marginal revenue, MR, equals marginal cost, MC.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-17
Profit-Maximising Output
Table 10.3
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-18
Marginal revenue & marginal cost
(dollars per T-shirt)
Profit-Maximizing Output
Profitmaximization
point
30
25
Figure 10.3
MC
Loss from an extra
10th T-shirt
MR
Profit from
an extra 10th
T-shirt
20
10
0
8 9 10
Quantity (T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-19
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-20
Three Possible Profit
Outcomes in the Short-Run
Normal profit
Price (dollars per T-shirt)
30.00
Break-even
point
25.00
ATC
Figure 10.4(a)
MC
20.00
AR = MR
15.00
0
8
10
Quantity (T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-21
Three Possible Profit
Outcomes in the Short-Run
Economic profit
Price (dollars per T-shirt)
30.00
ATC
Figure 10.4(b)
MC
25.00
Economic
Profit
MR
20.00
15.00
0
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
9 10
Quantity ( T-shirts per day)
10-22
Three Possible Profit
Outcomes in the Short-Run
Economic loss
Price (dollars per T-shirt)
30.00
Figure 10.4(c)
ATC
MC
25.00
20.00
Economic
loss
17.00
15.00
0
MR
7
10
Quantity ( T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-23
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-24
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-25
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-26
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-27
A Firm’s Shutdown Point and
Supply Curve
Figure 10.5(a)
Marginal revenue & marginal cost
(dollars per T-shirt)
MC
31
AVC
MR2
Shutdown
point
25
T
MR1
MR0
17
0
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
7 9 10
Quantity (T-shirts per day)
10-28
A Firm’s Supply Curve
Marginal revenue & marginal cost
(dollars per T-shirt)
Figure 10.5(b)
S
31
25
T
17
0
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
60 70 80
Quantity (T-shirts per day)
10-29
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-30
Industry Supply Curve
Price (dollars per T-shirt)
S1
31
D
25
20
17
0
Figure 10.6
C
B
A
7 8 9 10
Quantity (thousands of T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-31
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-32
Short-run Equilibrium
Price (dollars per T-shirt)
S1
31
D
25
20
17
Figure 10.7(a)
C
B
A
D1
0
7 8 9 10
Quantity (thousands of T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-33
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-34
Price (dollars per T-shirt)
Short-Run Equilibrium
Figure 10.4(b)
Increase in demand:
price rises and firms
increase production
31
S
25
Decrease in demand:
price falls and firms
20
decrease production
D2
17
D3
0
D1
6
7
8
9
10
Quantity (thousands of T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-35
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-36
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-37
Price (dollars per T-shirt)
Entry and Exit
Entry
increases
supply
Figure 10.8
31
S1
S0
S2
23
Exit
decreases
supply
20
17
D1
0
7
8
9
10
Quantity (thousands of T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-38
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-39
Price (dollars per T-shirt)
Plant Size and
Long-Run Equilibrium
Figure 10.9
Short-run profit
maximizing point
MC0
MC1
LRAC
SRAC0
SRAC1
25
MR0
MR1
20
M
6
Long-run
competitive
equilibrium
8
Quantity (T-shirts per day)
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-40
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-41
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-42
A Decrease in Demand
S1
Firm
S0
MC
Price and Cost
Price
Industry
Figure 10.10
P0
P0
P1
P1
ATC
MR0
MR1
D0
D1
0
Q2 Q1
Q0
Quantity
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
q1
q0
Quantity
10-43
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-44
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-45
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
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-46
Long-Run Changes in
Price and Quantity
Figure 10.11
S0
S1
Ps
LSA
P0
S0
Ps
P2
P0
S2
LSB Ps
S3
LSC
D1
D0
Qs Q1
S0
P0
P3
D1
Q0
Decreasing-cost industry
Price
Increasing-cost industry
Price
Price
Constant-cost industry
Q0
Quantity
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
D0
Qs Q2
Quantity
D1
Q0
Qs
D0
Q3
Quantity
10-47
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-48
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-49
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-50
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.
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-51
Efficiency of Competition
A Market
Price
Price and cost
A Single Firm
MC
SRAC
P*
S
LRAC
MR
P*
Consumer
surplus
Efficient
allocation
Producer
surplus
Long-run
Competitive
equilibrium
0
q*
D=MSB
0
q*
Quantity
Quantity
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-52
END
CHAPTER 10
McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia
10-53