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
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
Average Revenue

Total Revenue

Marginal Revenue
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Product price
Quantity
Demanded
8
8
8
8
8
8
8
0
1
2
3
4
5
6
Total Revenue
Marginal
Revenue
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1.
Compare total revenue & total cost
2.
Compare marginal revenue & marginal cost
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Consider the Maple Syrup Market:
 The North American maple syrup market
produces nearly 30 million litres/year. More than
80% is produced in Canada. The number of firms
can only be estimate because some are very
small and sell their output in a small local
market. There are about 9,500 producers in
Canada & about 2,000 in the US.

Maple syrup is not quite a standardized good,
but is close. At the wholesale level, the market is
highly competitive and a good example for
perfect competition.
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Total Revenue & Total Cost Schedule for Dave’s Maple Syrup
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
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Where is the break-even point?
How do we describe the profit at this point?
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MR = MC rule: in the short run, a firm will
maximize profit by producing at the output
level where MR = MC.
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Quantity
Total
(cans/day) Revenue
$/day
8
64
9
72
10
80
11
88
12
96
MR
$/day
8
8
8
8
Total Cost
$/day
39
44
51
60
76
MC
$/day
5
7
9
16
Economic
Profit
25
28
29
28
20
14
***The MR=MC rule is applicable to all market
models***
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Note: for perfectly competitive firms: MR =
MC is equivalent to P= MC
Why?
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1. If average cost is $8/can, what is the
economic profit?
2. 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 $4/can.
How much should Dave produce?
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Quantity
(cans/day)
Total revenue MR ($/day)
Total cost
($/day)
($/day)
7
28
8
32
9
35
10
40
11
44
12
48
4
4
4
4
4
36
39
44
51
60
76
MC ($/day)
Economic
profit
(TR-TC)
3
5
7
9
16
-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).
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In what situations would the supply curve for
the firm shift?
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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
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
Is the industry profitable at the equilibrium?
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1.
2.
The firm should produce is P≥minimum
AVC
The firm should produce the quantity at
MR=MC
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
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
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

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.
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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.
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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.
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**In the long run, equilibrium price & quantity
always occur where ATC is at a minimum for
a perfectly competitive firm.
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
The product price will be exactly equal to
each firm’s point of minimum average total
cost.
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
Perfectly elastic
◦ Level of output does not affect price in the longrun.
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
Upward sloping as industry expands output.
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
Downward sloping as the industry expands
output.
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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.
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


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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