Download Document

ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 24: Perfect Competition
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
Characteristics of a Perfectly
Competitive Market Structure

Perfect Competition
A
market structure in which the decisions of
individual buyers and sellers have no effect
on market price

Perfectly Competitive Firm
 A firm
that is such a small part of the total
industry that it cannot affect the price
of the product or service that it sells
2
Characteristics of a Perfectly
Competitive Market Structure

Price Taker
A
competitive firm that must take the price of
its product as given because the firm cannot
influence its price
3
Characteristics of a Perfectly
Competitive Market Structure

Price taker:
A
firm can sell as much as wants at the going
market price.
 There is no incentive to sell for a lower price.
 Attempts to charge a higher price will result in
no sales.
4
Characteristics of a Perfectly
Competitive Market Structure

Characteristics of perfect competition
 Large
number of buyers and sellers
 Homogenous products

When you buy a head of lettuce do you ask what
farm it came from?
 No
barriers to entry or exit
 Buyers and sellers have equal access to
information
5
The Industry Demand Curve
for Recordable DVDs
Neither an individual
buyer nor seller can
influence the price
Price per DVD
S
The interaction of market
supply and demand yields
an equilibrium price of $5
and quantity of 30,000 units
E
5
D
0
Figure 24-1, Panel (a)
10,000 20,000 30,000 40,000 50,000
DVDs per Day
6
The Demand Curve
of the Perfect Competitor

The perfectly competitive firm:




Is a price taker (i.e., must sell for $5)
Will sell all units for $5
Will not be able to sell at a higher price
Will not choose to sell more units at a lower
price
7
The Demand Curve Facing the
Perfectly Competitive Firm
Figure 24-1, Panels (a) and (b)
8
How Much Should
the Perfect Competitor Produce?

The firm will produce the level of output
that will maximize profits given the
market price.
Economic profit = total revenue (TR) - total cost (TC)

Total Revenues
 The
price per unit times the total quantity sold
TR = P x Q
9
How Much Should
the Perfect Competitor Produce?
Economic profit = total revenue (TR) - total cost (TC)
TC  explicit + implicit costs
As well as…
TC  fixed + variable costs
10
Profit Maximization
Figure 24-2, Panel (a)
11
Profit Maximization
Total
Output/
Sales/ Total
day
Costs
Market
Price
Total
Revenue
Total
Profit
0
$10
$5
$0
$10
1
15
5
5
10
2
18
5
10
8
3
20
5
15
5
4
21
5
20
1
5
23
5
25
2
6
26
5
30
4
7
30
5
35
5
8
35
5
40
5
9
41
5
45
4
10
48
5
50
2
11
56
5
55
1
Figure 24-2, Panel (b)
TR = P x Q
12
How Much Should the Perfect
Competitor Produce?

Profit-maximizing rate of production
 The
rate of production that maximizes total
profits, or the difference between total
revenues and total costs
 Also, the rate of production at which marginal
revenue equals marginal cost
13
Profit Maximization
Total
Output/
Sales/ Market
day
Price
0
$5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
9
5
10
5
11
5
Marginal
Cost
Marginal
Revenue
$5
$5
3
5
2
5
1
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
Figure 24-2, Panel (c)
14
Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production
Marginal revenue is the change in total
revenue divided by the change in output
 Marginal cost is the change in total cost
divided by the change in output

15
Using Marginal Analysis to Determine
the Profit-Maximizing Rate of Production

Profit maximization
 Economic
profits = TR  TC
Profit-maximizing
output occurs
when MC = MR
 For
a perfectly competitive firm, this is at
the intersection of the firm’s demand curve
and its marginal cost curve since price
equals marginal revenue.
16
Short-Run Profits

To find out what our competitive individual
DVD producer is making in terms of profits
per unit produced in the short run, we
have to determine the excess of price
above average total cost.
17
Short-Run Profits
14
Price and Cost per Unit ($)
13
12
11
10
• Recall: Profits are
maximized at 7.5 units
where MC = MR.
• How do we measure
profits?
9
8
7
6
5
4
3
2
1
0
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
18
Short-Run Profits
14
Price and Cost per Unit ($)
13
12
11
MC
10
• Profit is maximized where
MR = MC
• ATC = TC/output
• TC = ATC  output
• TR = P  output
• Profit = (P - ATC)  output
9
8
7
ATC
Profits
6
d
5
P = MR = AR
4
3
2
1
0
Figure 24-3
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
19
Minimization of Short-Run Losses
14
• Losses are minimized
where MR = MC
• Loss = ($3 - 4.35)  5.5 or
$7.43
Price and Cost per Unit ($)
13
12
11
MC
10
9
8
7
6
ATC
Losses
d1
5
4
d2
3
P = MR = AR
2
1
0
Figure 24-4
1
2
3
4
5
6
7
8
DVDs per Day
9 10 11 12
20
Short-Run Profits
Short-run average profits or average
losses are determined by comparing
average total costs with price (average
revenue) at the profit-maximizing rate of
output.
 In the short run, the perfectly competitive
firm can make economic profits or
economic losses.

21
The Short-Run Shutdown Price

What do you think?
 Would
you continue to produce if you were
incurring a loss?
In the short run?
 In the long run?

22
Short-Run Shutdown
and Break-Even Price
Figure 24-5
23
The Short-Run Shutdown Price

As long as the price per unit sold exceeds
the average variable cost per unit
produced, the firm will be covering at least
part of the opportunity cost of the
investment in the business—that is, part of
its fixed costs.
24
The Short-Run Shutdown Price

Short-Run Break-Even Price
 The
price at which a firm’s total revenues equal its
costs
 At the break-even price, the firm is just making a
normal rate of return on its capital investment

Short-Run Shutdown Price
 The
price that just covers average variable costs
 It occurs just below the intersection of the marginal
cost curve and the average variable cost curve
25
The Meaning
of Zero Economic Profits
Why produce if you are not making a
profit?
 Hint:

 Distinguish
between economic profits and
accounting profits
 When economic profits are zero, accounting
profits are positive
26
The Perfect Competitor’s
Short-Run Supply Curve

Question
 What
does the supply curve for the individual firm
look like?

Answer
 The
firm’s supply curve is the marginal cost curve
above the short-run shutdown point.
 Thus, the competitive firm’s short-run supply curve is
its marginal costs curve equal to and above the point
of intersection with the average variable cost curve.
27
The Individual Firm’s
Short-Run Supply Curve
• Given the price, the quantity is
determined where MC = MR
• Short-run supply = MC above
minimum AVC
Figure 24-6
28
The Perfect Competitor’s
Short-Run Supply Curve

The Industry Supply Curve
 The
locus of points showing the minimum
prices at which given quantities will be
forthcoming
29
Deriving the Industry Supply Curve
P2
P1
q A1 q A2
Quantity per Time Period
Panel (c)
MCB
P2
P1
q B1
q B2
Quantity per Time Period
Figure 24-7, Panels (a), (b), and (c)
Price and Marginal Cost per Unit
MCA
Panel (b)
Price and Marginal Cost per Unit
Price and Marginal Cost per Unit
Panel (a)
S = ΣMC
G
P2
P1
F
(q A1 + q B1) (q A2 + q B2)
Quantity per Time Period
30
The Perfect Competitor’s
Short-Run Supply Curve

Factors that influence the industry supply
curve (determinants of supply)
 Firm’s
productivity
 Factor costs
 Taxes and subsidies
 Number of firms
31
Competitive Price Determination

Question
 How
is the market, or “going,” price
established in a competitive market?

Answer
 This
price is established by the interaction of
all the suppliers (firms) and all the
demanders.
32
Competitive Price Determination

The competitive price is determined by the
intersection of the market demand curve
and the market supply curve
 The
market supply curve is equal to the
horizontal summation of the supply curves of
the individual firms
33
Competitive Price Determination
Pe is the price
the firm must take
Pe and Qe determined
by the interaction of
the industry S and
market D
Figure 24-8, Panel (a)
34
Competitive Price Determination
Given Pe, firm produces qe where MC = MR
-If AC = AC1, break-even
-If AC = AC2, losses
-If AC = AC3, economic profit
Figure 24-8, Panel (b)
35
The Long-Run Industry Situation:
Exit and Entry

Profits and losses act as signals for
resources to enter an industry or to leave
an industry.
36
The Long-Run Industry Situation:
Exit and Entry

Signals
 Compact
ways of conveying to economic
decision makers information needed to make
decisions
 A true signal not only conveys information but
also provides the incentive to react
appropriately
37
The Long-Run Industry Situation:
Exit and Entry

Summary
 Economic

Signal resources to enter the market and the
price falls to the break-even price
 Economic

profits
losses
Signal resources to exit the market and the price
increases to the break-even level
38
The Long-Run Industry Situation:
Exit and Entry

Summary
 At

break-even
Resources will not enter or exit because the
market is yielding a normal rate of return
 In
the long run, the perfectly competitive
firm will make zero economic profits (a
normal rate of return)
39
The Long-Run Industry Situation:
Exit and Entry

Long-Run Industry Supply Curve
A
market supply curve showing the
relationship between price and quantities
forthcoming after firms have been allowed
time to enter or exit from an industry
40
The Long-Run Industry Situation:
Exit and Entry

Constant-Cost Industry
 An
industry whose total output can be
increased without an increase in long-run perunit costs
41
Constant-Cost Industry
Panel (a)
Constant Cost
Price per Unit
S1
S2
E2
P2
P1
SL
E1
E3
D1
D2
Quantity per Time Period
Figure 24-9, Panel (a)
42
The Long-Run Industry Situation:
Exit and Entry

Increasing-Cost Industry
 An
industry in which an increase in industry
output is accompanied by an increase in longrun per unit costs
43
Increasing-Cost Industry
Panel (b)
Increasing Cost
S1
Price per Unit
S2
SL'
P2
P1
D2
D1
Quantity per Time Period
Figure 24-9, Panel (b)
44
The Long-Run Industry Situation:
Exit and Entry

Decreasing-Cost Industry
 An
industry in which an increase in industry
output leads to a reduction in long-run per-unit
costs
45
Decreasing-Cost Industry
Price per Unit
Panel (c)
Decreasing Cost
S1
S2
P1
P2
SL''
D1
D2
Quantity per Time Period
Figure 24-9, Panel (c)
46
Long-Run Equilibrium


Firms will adjust plant size until there is no
further incentive to change.
In the long run, a competitive firm produces
where price, marginal revenue, marginal cost,
short-run minimum average cost, and long-run
minimum average cost are equal.
47
Long-Run Firm
Competitive Equilibrium
LAC
Price per Unit
MC
P
SAC
E
d = MR = P = AR
Qe
Units per Year
Figure 24-11
48
Competitive Pricing:
Marginal Cost Pricing

Marginal Cost Pricing
A
system of pricing in which the price charged
is equal to the opportunity cost to society of
producing one more unit of the good or
service in question
49
Competitive Pricing:
Marginal Cost Pricing

Market Failure
A
situation in which an unrestrained market
operation leads to either too few
or too many resources going to a specific
economic activity
50
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 24: Perfect Competition
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.