Download in perfectly competitive markets

CHAPTER
6
Competition
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
1
2
3
4
5
Identify the unique characteristics of perfectly competitive firms and markets.
Illustrate how total profits change as output expands.
Describe how the profit-maximizing rate of output is found.
Recite the determinants of competitive market supply.
Explain why profits get eliminated in competitive markets.
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6-1
MARKET STRUCTURE
The goal of this chapter is to examine
how supply decisions are made
in competitive markets.
Market structure is the number and
relative size of firms in an industry.
• Market structure varies.
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6-2
MARKET STRUCTURE
Firms fall along a spectrum of competition.
Imperfect competition
Perfect
competition
Monopolistic
competition
Oligopoly
Duopoly
Monopoly
• Number of firms, relative size of firms, type of product,
and market power are important determinants in this
spectrum.
• Spectrum shows the range of power a firm might have.
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6-3
MARKET STRUCTURE
A perfectly competitive firm competes with
many other firms in a perfectly competitive
market.
No market power:
• No one producer or consumer is able to
alter the market price or quantity.
• Everyone is a price taker.
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6-4
MARKET STRUCTURE
Imperfect competition are market structures that
lie between monopoly and perfect competition.
Duopoly
• Two firms supply a particular product.
Oligopoly
• A few large firms supply all or most of a similar
product.
Monopolistic competition
• Many firms supply essentially the same product
but each enjoys significant brand loyalty.
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6-5
PERFECT COMPETITION
A competitive market is one in which
producers have no market power.
• All firms sell a homogenous product.
• Output of a single firm is so small
compared to market supply that it has no
significant effect on total quantity or
price in the market.
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6-6
PERFECT COMPETITION
Market Demand versus Firm Demand
In perfect competition, the market demand
curve and the firm demand curve are distinct.
• The market demand curve is always
downward-sloping.
• The firm demand curve is always horizontal.
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6-7
PERFECT COMPETITION
Demand for an
individual firm’s output
Market Demand
PRICE ($ per unit)
Market
Supply
pe
Demand
facing a
single firm
pe
Market
Demand
QUANTITY (per day)
QUANTITY (per day)
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6-8
THE FIRM’S PRODUCTION DECISION
Since a perfectly competitive firm cannot
influence price, the only decision it makes is its
firm’s production decision.
• Chooses a rate of output during a certain
time period with its fixed capital.
• Best rate of output is the one that
maximizes profits.
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6-9
THE FIRM’S PRODUCTION DECISION
Output, Revenues, and Profit
Total revenue is the value of a firm’s sales.
TR = P x Q
where TR = total revenue, P = price, Q = quantity.
Total profit is the difference between total
revenue and total cost
Total profit = TR – TC
where TC = total cost.
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6-10
THE FIRM’S PRODUCTION DECISION
Total profit varies with the rate of output
PRICE ($ per unit)
Total Cost
Total Revenue = p x q
profits
Fixed Cost
0
q1
q2
QUANTITY (per day)
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6-11
PROFIT MAXIMIZATION
To maximize profits, a firm should produce an
additional unit of output only if it brings in revenue
that is greater than the cost of producing it.
MARGINAL REVENUE
MARGINAL COST
= extra revenue from
selling one more unit.
= price (in perfectly
competitive markets)
= extra cost from selling
one more unit.
= (change in cost)
(change in quantity)
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6-12
PROFIT MAXIMIZATION
Profit maximizing rate of output
Price > MC
Increase output rate
Price = MC
Maintain output rate
(profits are maximized)
Price < MC
Decrease output rate
Produce
additional
output if
:
MARGINAL
REVENUE
>_
MARGINAL
COST
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6-13
PROFIT MAXIMIZATION
Quantity
(per day)
Price
Total
Total
Revenue Cost
(=Q*P)
Total
Profit
(=TR-TC)
Price Marginal
Cost
0
---
0
$10
-$10
---
---
1
$13
$13
$15
-$2
$13
$5
2
$13
$26
$22
$4
$13
$7
3
$13
$39
$31
$8
$13
$9
4
$13
$52
$44
$8
$13
$13
5
$13
$65
$61
$4
$13
$17
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6-14
PROFIT MAXIMIZATION
Profit can be computed in one of two ways.
Total profit = TR – TC
or
Total profit = (p – ATC) x q
where ATC is the average total cost.
Notice that:
• (p – ATC) is profit per unit.
• Firms maximize total profits, not profit per unit.
• Profit-maximizing may not minimize ATC.
• Total profits are maximized where p = MC.
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6-15
PROFIT MAXIMIZATION
Total profit = $8
MC
PRICE ($ per unit)
16
ATC
P = $13
Profit per unit = $2
12
8
Cost per unit = $11
4
1
2
3
4
5
6
7
QUANTITY (per day)
Quantity maximizing profit
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6-16
SUPPLY BEHAVIOR
As the market price changes in a
competitive market:
• Firms take the new price as given.
• Firms adjust quantity until MC = price.
• Profit-maximizing quantity moves along
marginal cost curve.
• Firm’s short-run supply curve is it’s
marginal cost curve.
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6-17
SUPPLY BEHAVIOR
Anything that alters marginal cost will
change the supply behavior of a firm.
• The price of factor inputs.
• Technology.
• Expectations.
For example, if wages increase, marginal
cost rises as well. This shifts the MC curve
inward.
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6-18
ENTRY AND EXIT
Positive economic profits influence firms
entry/exit into the market.
• New firms enter the industry.
• Market supply curve shifts outward.
• Market price decreases and output
expands.
Firms enter a competitive industry so long
as positive economic profits exist.
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6-19
ENTRY AND EXIT
S1
S2
E1
P1
p2
p3
S3
E2
E3
Market
demand
(b) Reduces profits of
competitive firms.
PRICE (per pound)
PRICE (per pound)
(a) Market entry pushes
price down and . . .
MC
ATC
p1
p2
p3
QUANTITY (thousands of pounds per day)
q3 q2 q1
QUANTITY (pounds per day)
Long-run competitive market equilibrium occurs when:
• P = min(ATC)
• Economic profits are zero.
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6-20
ENTRY AND EXIT
There are no significant barriers to entry
in competitive markets.
• Barriers to entry are obstacles that
make it difficult or impossible for
would-be producers to enter a market.
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6-21
COMPETITIVE MARKET CHARACTERISTICS
Market Characteristics
• Many firms.
• Downward sloping
demand.
• Identical products.
• Low entry barriers.
• Perfect information.
Firm Characteristics
• Price taker.
• Set output where
MC = p.
• Zero economic
profit in long run.
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6-22
SUMMARY
• We identified the unique characteristics of perfectly
competitive firms and markets.
• We illustrated how total profits change as output
expands
• We described how the profit-maximizing rate of
output is found.
• We discussed the determinants of competitive
market supply.
• We explained why profits get eliminated in
competitive markets.
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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