Download CHAPTER 7 PERFECT COMPETITION

Part Two: Microeconomics
of Product Markets
CHAPTER 7
PERFECT COMPETITION
Slides prepared by Dr. Amy Peng, Ryerson University
In this chapter you will learn:
7.1
7.2
7.3
7.4
7.5
7.6
The four basic market structures
The conditions required for perfectly
competitive markets
How firms in perfect competition maximize
profits or minimize losses
Why the marginal cost curve and supply
curve of competitive firms are the same
About the firm’s profit maximization in the
long run
About the efficiency of competitive markets
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7
2
Four Market Structures
•
•
•
•
Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.1
3
Characteristics of Perfect Competition
•
•
•
•
Very Large Numbers
Standardized Product
Price-Takers
Easy Entry and Exit
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2
4
Demand for a Firm in Perfect Competition
• Perfectly Elastic Demand
• Average, Total, and Marginal Revenue
– average revenue = price
– marginal revenue = price
– total revenue = price x quantity
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2
5
Product price,
Quantity
Total
Marginal
P (average
demanded, Q Revenue, TR Revenue, MR
revenue)
131
0
131
1
131
2
131
3
131
4
131
5
131
6
131
7
131
8
131
9
131
10
©2007 McGraw-Hill Ryerson Ltd.
0
]
]
262
]
393
]
524
]
655
]
786
]
917
]
1048
]
1179
]
131
1310
Chapter 7.2
131
131
131
131
131
131
131
131
131
131
6
Figure 7-1 The Demand and Revenue Curves
for a Firm in Perfect Competition
1179
1048
TR
917
Demand is perfectly
elastic since the firm
can sell as much
output as it wants
at the market price
Price and revenue
786
655
524
393
262
D = MR = AR
131
0
2
4
6
8
10
12
Quantity Demanded
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.2
7
Profit Maximization in the Short Run
•
Purely competitive firm can maximize its
profit (minimize its loss) only by
adjusting output
Two Approaches:
• total revenue-total cost approach
• marginal revenue-marginal cost
approach
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
8
Q
TFC
TVC
0
$100
$
1
TC
0
$ 100
100
90
190
2
100
170
3
100
240
4
100
5
Profit or
Loss
TR
0
$-100
131
- 59
262
-
340
393
+ 53
300
400
524
+124
100
370
470
655
+185
6
100
450
550
786
+236
7
100
540
640
917
+277
8
100
650
750
1048
+298
9
100
780
880
1179
+299
10
100
930
1030
1310
+280
©2007 McGraw-Hill Ryerson Ltd.
p=$131
270
Chapter 7.3
$
8
9
Figure 7-2
Profit Maximization, Pure Competition
Break-even point
2,000
1,800
Maximum
economic profit
$299
1,600
1,400
$
1,200
TR
TC
1,000
800
600
400
Break-even point (normal
profit)
200
0
0
2
4
6
8
10
12
14
Quantity
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
10
Total Revenue-Total Cost Approach
• Profit = TR - TC
• Profit is maximized where the vertical
distance between TR and TC is
maximized
• Break-even points are where TR=TC
• Now, the marginal revenue-marginal cost
approach…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
11
MC
MR
]
$ 90
2
270
]
80
3
340
]
70
4
100
300
400
]
60
9
units
will
maximize
profits
5
100
370
470
]
80
the
same
profit-maximizing
result
6
100
450
550
as with the TR-TC approach!]
90
7
100
540
640
]
110
about 750
8
100What 650
]
130
th
9
100the 9 780
unit? 880
]
150
$131
Q
0
1
10
TFC
TVC
$100
$
TC
0
$ 100
Should the
100
90
firm
produce
100What 170
about
st
the 1nd240
unit?
100
the 2 unit?
100
930
190
1030
131
131
131
131
131
131
131
131
Figure 7-3
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
12
Marginal Revenue-Marginal Cost Approach
Short run profit maximization occurs where
MR=MC:
1. Rule applies only if producing is
preferable to shutting down
2. Rule is an accurate guide to profit
maximization for ALL firms
3. Rule can be restated as P=MC for
purely competitive firms, since MR=P
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
13
Figure 7 - 3
200
MC
Cost & Revenue
160
131
120
Profit = 9 X (131 - 97.78) = 299
ATC
97.78
Find ATC
80
AVC
Find the quantity
where MR=MC
40
AFC
0
0
2
4
6
8
9
10
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
14
Loss-Minimizing Case
• Suppose price falls from $131 to $81…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
15
Q
TFC
TVC
0
$100
$
1
100
2
3
4
5
6
7
8
9
10
TC
0
$ 100
90
190
]
100
170
270
]
100
240
340
]
100
300
400
]
Firm should
100
370
470
]
produce the
100
450
550
]
first
6
units
100
540
640
]
100
650
750
]
100
780
880
]
100
930
1030
MC
MR
$ 90
$81
80
81
70
81
60
81
80
81
90
81
110
81
130
81
150
81
Figure 7-4
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
16
Figure 7 - 4
200
Cost & Revenue
160
MC
Loss = 6 X (81 - 91.67) = -64.02 < TFC
ATC
120
91.67
81
80
AVC
40
AFC
0
0
2
4
6
8
10
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7
17
Shutdown Case
• Suppose the price falls even further, to
$71…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
18
Figure 7- 5
Cost & Revenue
200
160
MC
120
ATC
94
80
Loss = 5 X (71 - 94) = -115>TFC
71
AVC
40
0
0
2
When price is below
minimum4 AVC,
5 the6 firm
should shut
Outputdown
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.3
AFC
8
10
19
Costs and revenues (dollars)
Figure 7-6
Marginal Cost and Short-Run Supply
P
©2007 McGraw-Hill Ryerson Ltd.
ATC
MC
AVC
At every price, the
MR = MC point
indicates the quantity
being produced...
Chapter 7.4
Q
20
Costs and revenues (dollars)
Marginal Cost and Short-Run Supply
P
ATC
MC
AVC
P3
MR3
Record the
quantity being
supplied for
each price
Q3
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4
Q
21
Costs and revenues (dollars)
Marginal Cost and Short-Run Supply
P
ATC
MC
AVC
P3
P2
MR3
MR2
At a lower price
a lower quantity
will be supplied
Q2 Q3
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4
Q
22
Costs and revenues (dollars)
Marginal Cost and Short-Run Supply
P
ATC
MC
P4
P3
P2
AVC
MR4
MR3
MR2
At a higher price
a higher quantity
will be supplied
Q2 Q3Q4
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4
Q
23
Costs and revenues (dollars)
Marginal Cost and Short-Run Supply
P
P5
P4
P3
P2
P1
©2007 McGraw-Hill Ryerson Ltd.
ATC
MC
MR5
AVC
MR4
MR3
MR2
MR1
Firm should not
produce
below P2
Q
Q2 Q3Q4Q5
Chapter 7.4
24
Costs and revenues (dollars)
Marginal Cost and Short-Run Supply
P
ATC
Short-run
supply curve
(Above AVC)
MR5
P5
P4
P3
P2
P1
AVC
Q2 Q3Q4Q5
©2007 McGraw-Hill Ryerson Ltd.
MC
Chapter 7.4
MR4
MR3
MR2
MR1
Q
25
Marginal Cost and Short-run Supply
• Firm’s short-run supply curve is the portion of
its MC curve above minimum AVC
• Diminishing Returns, Production Costs, and
Product Supply
• Supply curve shifts:
– A wage increase shifts the supply curve upward and
to the left (decreasing in supply)
– Technological progress would shift the supply curve
downward to the right (increasing in supply)
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4
26
Figure 7-7
Competitive Equilibrium for a Firm and the Industry
P
Economic
ATC Profit
P
MC
$111
D
$111
S=MCs
AVC
D
8
Firm
(price taker)
©2007 McGraw-Hill Ryerson Ltd.
Q
8000
Q
Industry
1000 firms
Chapter 7.4
27
Table 7-4 Output Determination in Perfect
Competition in the Short Run
Question
Answer
Should this firm
produce?
Yes, if P ≥ minimum ATC; this means
that the firm is profitable or that its
losses are less than its fixed cost
Produce where MR (=P) = MC; there,
profit is maximized or loss is
minimized
What quantity
should the firm
produce?
Will production
Yes, if P > ATC (TR > TC)
result in economic
profits?
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.4
28
Profit Maximization in the Long Run
• Assumptions:
– Entry and Exit Only
– Identical Costs
– Constant-Cost Industry
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
29
The Goal of Our Analysis
•
•
In the long run, p = minimum ATC
Because:
1. Firms seek profit and avoid losses
2. Firms are free to enter and exit the industry
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
30
Figure 7-8
Entry Eliminates Economic Profits
S1
P
MC
ATC
$60
$50
$40
Economic Profits
P
$60
MR $50
$40
D2
D1
100
Q
Firm
(price taker)
©2007 McGraw-Hill Ryerson Ltd.
100,000
Q
Industry
1000 firms
Chapter 7.5
31
Entry Eliminates Economic Profits
S1
P
MC
P
ATC
S2
$60
$50
$40
$60
MR $50
$40
D2
New Equilibrium with more firms
D1
100
Firm
(price taker)
©2007 McGraw-Hill Ryerson Ltd.
Q
100,000
110,000
Q
Industry
110,000 firms
Chapter 7.5
32
Figure 7-9 Exit Eliminates Losses
S1
P
$60
$50
$40
MC
P
ATC
$60
MR $50
$40
Economic Loss
D1
D2
100
Q
Firm
(price taker)
©2007 McGraw-Hill Ryerson Ltd.
100,000
Q
Industry
1000 firms
Chapter 7.5
33
Exit Eliminates Losses
S3 S
1
P
MC
P
ATC
$60
$50
$40
$60
MR $50
$40
New equilibrium with fewer firms
D1
D2
100
Q
Firm
(price taker)
©2007 McGraw-Hill Ryerson Ltd.
90,000 100,000
Q
Industry
90,000 firms
Chapter 7.5
34
Long-Run Equilibrium
• If price > min ATC
– profits attract new firms
– as S increases, price drops to min ATC
• If price < min ATC
– losses cause firms to exit
– as S decreases, price rises to min ATC
• So, in the long run, p = min ATC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
35
Long-run Supply
• Crucial factor is whether the number of
firms in the industry affects the costs of
individual firms
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
36
Figure 7-10 Long-run Supply for a ConstantCost Industry Is Horizontal
Demand
Profits
increases
attract new
firms
P
S1
P>$50
P=$50
D2
D1
Price remainsQthe same
in
the
long
run
Q
Q
1
©2007 McGraw-Hill Ryerson Ltd.
2
Chapter 7.5
37
Figure 7-11 Long-run Supply for an IncreasingCost Industry Is Upsloping
Demand
Profits
increases
attract
new
firms
S1
P
P>>$50
P=$50
D2
D1
In the long run, greater supply is offered at a
higher price
Q
Q2
Q1
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
38
Long-run Supply for a Decreasing-Cost
Industry Is Downsloping
S1
P
P>$50
Demand
Profits
increases
attract
new
firms
P=$50
P<$50
D1
long-run S
D2
In the long run, greater supply is offered at a
lower price
Q2 Q
Q1
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.5
39
Figure 7-12
Pure Competition and Efficiency
P
MC
ATC
MR
P
Price = MC = Minimum ATC
(normal profit)
Q
Q
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6
40
Pure Competition and Efficiency
• Productive Efficiency
– P = Minimum ATC
• Allocative Efficiency
– P = MC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6
41
Allocative Efficiency and
Consumer and Producer Surplus
• Consumer Surplus is the difference
between what the consumer is willing to
pay and the market price
• Producer Surplus is the difference
between the marginal cost of production
and the market price
• At equilibrium, consumer and producer
surplus is maximized
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6
42
Figure 7-12 Long-Run Equilibrium:
A Competitive Firm and Market
P
The sum of
consumer and
producer surplus
is maximized
Consumer
Surplus
Pe
Producer
Surplus
©2007 McGraw-Hill Ryerson Ltd.
Qe
Chapter 7.6
Q
43
Pure Competition and Efficiency
• Productive Efficiency
– P = Minimum ATC
• Allocative Efficiency
– P = MC
• Dynamic Adjustments
– purely competitive markets adjust to restore
efficiency when disrupted by changes in the
economy
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6
44
The “Invisible Hand” Revisited
• The efficient allocation of resources in
perfect competition comes about
because businesses and resource
suppliers seek to further their self-interest
• Both business profits and consumer
satisfaction are maximized
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7.6
45
Chapter Summary
 7.1 Four Market Structures
 7.2 Characteristics of Pure Competition and
the Firm’s Demand Curve
 7.3 Profit Maximization in the Short Run
–
MR ( = P) = MC ; TR – TC is the highest
 7.4 Marginal Cost and Short-Run Supply
–
Firm’s short-run MC that Lies above its AVC
 7.5 Profit Maximization in the Long Run
 7.6 Pure Competition and Efficiency
–
P = ATC = MC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 7
46