Download Chapter 7 Perfect Competition

Econ 1900 Laura Lamb
1
1.
Perfect competition
2.
Monopolistic competition
3.
Oligopoly
4.
Pure Monopoly
2

What are the major characteristics of each
market model?
3

Large number of firms

Standardized products

Price takers

Easy entry & exit of firms
4

Then why do we study it?
◦ helps analyze industries with characteristics similar
to perfect competition.
◦ provides a context in which to apply revenue and
cost concepts developed in previous chapters.
◦ provides a norm or standard against which to
compare and evaluate the efficiency of the real
world.
5

Demand is perfectly elastic for each firm
◦ Not for the industry
◦ Individual firms can sell as much as they want at the
market price
6
Product price
Quantity
Demanded
8
8
8
8
8
8
8
0
1
2
3
4
5
6
Total Revenue
Marginal
Revenue
7

Average Revenue

Total Revenue

Marginal Revenue
8
1.
Compare total revenue & total cost
2.
Compare marginal revenue & marginal cost
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Total Revenue & Total Cost Schedule
Quantity
(cans/day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Total Revenue
($/day)
0
8
16
24
32
40
48
56
64
72
80
88
96
104
112
Total cost
($/day)
15
22
27
30
32
33
34
36
39
44
51
60
76
104
144
Economic profit
($/day)
-15
-14
-11
-6
0
7
14
20
25
28
29
28
20
0
-32
10

Where is the break-even point for the firm?
◦ This is where a normal profit is made
◦ No economic profit at this point
11
MR = MC rule: in the short run, a firm will
maximize profit by producing at the output
level where MR = MC.
12
Quantity
Total
(cans/day) Revenue
($/day)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
0
8
16
24
32
40
48
56
64
72
80
88
96
104
112
Marginal
Revenue
8
8
8
8
8
8
8
8
8
8
8
8
8
8
Total Cost
($/day)
15
22
27
30
32
33
34
36
39
44
51
60
76
104
144
Marginal
Cost
7
5
3
2
1
1
2
3
5
7
9
16
28
40
Economic
profit
($/day)
-15
-14
-11
-6
0
7
14
20
25
28
29
28
20
0
-32
13
***The MR=MC rule is applicable to all market
models***
14
For perfectly competitive firms: MR = MC is
equivalent to P= MC
Why?
15
1. Suppose the price dropped from $8/can to
$6/can, how would the profit maximizing
level of output change?
3. Now suppose, the price drops to $4/can.
How much should be produced?
16
Quantity
(cans/day)
7
8
9
10
11
12
Total revenue MR ($/day)
Total cost
($/day)
($/day)
28
32
35
40
44
48
4
4
4
4
4
4
36
39
44
51
60
76
MC ($/day)
2
3
5
7
9
16
Economic
profit
(TR-TC)
-8
-7
-8
-11
-16
-28
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

If a loss is incurred, the firm should continue
to produce as long as the price is greater
than average variable cost (AVC).
Modified rule: MR = MC if P>minimum AVC
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

In the example of Dave’s Maple Syrup:
when P=$8, quantity supplied = 10
when P=$4, quantity supplied = 8
◦ appears rational in light of the law of supply!
◦ The short-run supply curve is the section of the MC
curve starting at minimum AVC (and above).
19
In what situations would the supply curve for
the firm shift?
20
Quantity
supplied by 1
firm
10
8
6
5
Total quantity
supplied by
1000 firms
10,000
8,000
6,000
5,000
Product price
8
4
2
1
Total quantity
demanded
3,000
5,000
6,000
10,000
21

Is the industry profitable at the equilibrium?
22
1.
2.
The firm should produce is P≥minimum
AVC
The firm should produce the quantity at
MR=MC
23

Individual firms must take price as given, but
the supply plans of all competitive producers
as a group are a major determinant of
product price.
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Assumptions:
1. Entry and exit of firms are the only long-run
adjustments
2. Firms in the industry have identical cost
curves.
3. The industry is a constant-cost industry

the entry and exit of firms will not affect resource
prices or location of unit-cost schedules for
individual firms.
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**In the long run, product price = minimum
ATC
26


If P>minimum ATC →economic profits will
attract new firms to the industry →increased
supply of the product →price is driven down
to minimum ATC.
If P<minimum ATC →economic losses will
cause some firms to leave the industry
→decreased supply of the product →price is
driven up to minimum ATC.
27
A change in consumer tastes increases the
demand for product


trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm
and one for the industry.
28
Household income decreases causing a fall in
demand for the product.


trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm
and one for the industry.
29
**In the long run, equilibrium price & quantity
always occur where ATC is at a minimum for
a perfectly competitive firm.
30

The product price will be exactly equal to
each firm’s point of minimum average total
cost.
31

Perfectly elastic
◦ Level of output does not affect price in the longrun.
32

Upward sloping as industry expands output.
33

Downward sloping as the industry expands
output.
34
In the long run:
◦ Productive efficiency occurs where P = minimum
ATC
◦ Allocative efficiency occurs where P = MC
 allocative efficiency implies maximum consumer and
producer surplus.
35



When a pharmaceutical company introduces a
new drug, it typically owns the patent and can
price and produce as a monopolist, earning
economic profits.
When patent rights expire, firms pursuing
economic profits enter the market for that drug.
Prices of these drugs typically drop 30-40
percent.
◦ Those lower prices increase efficiency and consumer
surplus.
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