Download Chpt9 - Iona

Chapter 9
Supply Under
Perfect
Competition
Introduction to Economics (Combined
Version) 5th Edition
Market Structure
 Market structure is the characteristics of the market
environment; such as the nature of the product, number and size
of competitors, and conditions of entry and exit, that shape the
ways in which a firm interacts with its customers and
competitors.
 Market structure matters because it helps determine the
constraints a firm faces in making decisions related to pricing and
profit maximization.
Introduction to Economics (Combined
Version) 5th Edition
Perfect Competition
 Many small firms
 Each has small market share
 Product is homogeneous
 Entry is unrestricted
 Equal access to information
 Example: Some kinds of
farming
Introduction to Economics (Combined
Version) 5th Edition
Monopoly
 One firm
 100% market share
 Unique product
 Restricted entry
 Possible restrictions on
information
 Example: Post office
monopoly on first-class mail
Introduction to Economics (Combined
Version) 5th Edition
ww.pdclipart.org
Oligopoly
 A few firms
 At least some have large
market shares
 Homogeneous or
differentiated products
 Entry may be restricted
 Possible restrictions on
information
 Example: Airlines
Introduction to Economics (Combined
Version) 5th Edition
Monopolistic Competition
 Many firms
 Each has small market
share
 Product differentiated by
quality, location, style,
etc.
 Unrestricted entry
 Possible restrictions on
information
 Example: Hotels in a
resort community
Introduction to Economics (Combined
Version) 5th Edition
Demand for a Perfect Competitor
 The perfectly competitive firm is a price taker
 It is so small relative to the market as a whole that its decisions do
not significantly affect the market price, so the demand curve it
faces is perfectly elastic.
Introduction to Economics (Combined
Version) 5th Edition
Profit Maximization for Perfect Competitor
 Assume a perfectly competitive
firm and a market price P=50
 The maximum profit will be
earned at a quantity Q* where
P = MC and MC is increasing
At a lower Q, P>MC so
revenue from one more
unit will exceed the cost
of that unit
At a higher Q, P<MC so
revenue from one more
unit will be less than the
cost of that unit
Introduction to Economics (Combined
Version) 5th Edition
Profit Maximization vs. Loss Minimization
 If P>ATC where P=MC, then the
firm will earn a positive profit
at that point (point a)
 If ATC>P>AVC where P=MC,
then “profit maximization” will
really mean loss minimization,
for example, point b
Introduction to Economics (Combined
Version) 5th Edition
Profit Maximization vs. Loss Minimization
 At point b, price is enough to
pay variable costs in full.
 After variable costs are paid,
there is enough revenue left
to pay part, but not all of
fixed costs.
 If market conditions are
expected to return to
profitability in the future,
short-run losses are minimized
by operating at point b
Introduction to Economics (Combined
Version) 5th Edition
Example: Housing Construction
 During a downturn in the
housing market, a building
contractor may continue to
operate even though prices
for contractor services are
low.
 Revenue is enough to cover
variable costs (workers’
wages) with enough left over
to pay part, but not all, of
fixed costs (tools and heavy
equipment).
 When the housing market
recovers, prices will rise and
profits will return.
Introduction to Economics (Combined
Version) 5th Edition
Short-Run Shutdown
 Suppose that the firm is
expected to be profitable in the
long run but, in the short run,
P<AVC
 The firm should consider
shutting down in the short-run
to minimize operating losses
 Possible exceptions:
 Continue operating to avoid losing
your regular customers
 Continue operating to retain
loyalty of key employees
Introduction to Economics (Combined
Version) 5th Edition
Example: Seasonal Resorts
 Some ski resorts do not have
enough demand to even cover
their variable costs of
operation in the summer.
 They shut down in the
summer to minimize losses.
 Other mountain resorts have
enough demand from hikers
and sightseers to remain open
all year.
 Exercise: Draw diagrams to
illustrate each possibility.
Introduction to Economics (Combined
Version) 5th Edition
MC Curve and the Supply Curve
 As the price increases, the
profit-maximizing quantity will
increase
 The positively-sloped segment
of the marginal cost curve
above minimum average
variable cost can be considered
the firm’s supply curve
 Points where price intersects
the negatively-sloped segment
of the MC curve are not part of
the supply curve
Introduction to Economics (Combined
Version) 5th Edition
Industry Supply Curve
 A short-run industry supply curve can be obtained by summing
the supply curves of individual firms. Here this method is shown
for the first three firms in an industry. The supply curves of
additional firms would be added in the same way.
Introduction to Economics (Combined
Version) 5th Edition
Long-Run Equilibrium
Long-run equilibrium in a perfectly
competitive industry requires
that the firm
1. have no short-run incentive to
change the level of its output
2. have no long-run incentive to
change the size of the plant
used to produce its output
3. have no long-run incentive to
enter or leave the industry
This requires that price, short-run
marginal cost, short-run
average total cost, and longrun average cost all have the
same value in equilibrium
Introduction to Economics (Combined
Version) 5th Edition
Entry in Perfect Competition
 An increase in demand temporarily increases price. With positive
economic profit, new firms will enter. Supply shifts to right and
price returns to AVC.
Introduction to Economics (Combined
Version) 5th Edition
Exit from Perfect Competition
 A decrease in demand temporarily lowers price. With negative
economic profit (assuming no sunk costs), some firms leave the
market. As they do, supply shifts to left and price returns to AVC
Introduction to Economics (Combined
Version) 5th Edition
Industry Supply with Rising Input Prices
 This pair of diagrams show what happens if industry expansion causes input
prices to rise. As output expands, rising input prices push up the firm’s
marginal cost curve from MC1 to MC2, and its average total cost from ATC1 to
ATC2. The result is a new long-run equilibrium price that is higher than the
initial price. The long-run industry supply curve thus has a positive slope.
Introduction to Economics (Combined
Version) 5th Edition