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Chapter 7 slide 1 PERFECT COMPETITION Market Structure is Important for Two Reasons It influences firm Behavior & Profitability It Influences Economic Performance Which Markets Perform Well Which should be Regulated We divide markets according to: Number of Competitors Barriers to Entry Types of Products Barriers to Entry Firms High Medium None 1 Monopoly Few Oligopoly Many Perfect Competition BASICS OF SUPPLY & DEMAND 7.2 The competitive equilibrium occurs at P = $25 and Q = 8 thousand shoes. The increase (shift) in demand results in a higher price and a greater output. Price Supply Demand $25 0 4 8 12 Pairs of Shoes 16 SUPPLY & DEMAND 7.3 The fall in the marginal cost of production causes a favorable shift in supply and a lower price accompanied by greater output. Price Supply Demand $25 0 4 8 12 Pairs of Shoes 16 PERFECT COMPETITION 7.4 Firm Behavior Each firm is a price taker (MR = P). Each firm sets its QF such that P = MC. In long-run equilibrium, price is bid down until: P = MR = MC = ACMIN Revenue & Cost per unit MC AC P = $8 P = $6 QF QF Output Perfect Competition: Industry Outcome 7.5 Initial Equilibrium: P = $6 & Q = 200. After an increase in demand, the short-run result (before entry) is: P = $8 & Q = 240. The long-run result (after entry) is: P = $6 & Q = 280. D’ Supply Curve before Entry D $8 Supply Curve after Entry $6 $4 0 | 200 240 | 280 300 PRIVATE MARKET EFFICIENCY 7.6 Competitive Markets Provide the “Right” Amounts of Goods and Services that People Want and at Least Cost. The Argument goes back to Adam Smith’s “Invisible Hand” Metaphor. We’ll Sketch the Argument Starting with: Individual Transactions and Building up to Competitive Markets. A DAY-CARE EXAMPLE 7.7 Parents of a Two-Year Old are Willing to Pay $8 per hour for up to 10 hours of Day Care per Week. The Granny Down the Street will provide Care for $4 per Hour. Can the Parties bargain to a mutually beneficial agreement? Yes What if a second couple is willing to pay $10 per hour? $10 - Consumer Surplus $20 per Week 8 - Couple’s Maximum Value Consumer Surplus $20 per Week Producer Profit $40 perProfit Week Producer P = $6 - $20 per Week 4 - Granny’s Cost 2 0 0 | | | | | | 2 4 6 8 10 12 7.8 A COMPETITIVE DAY-CARE MARKET All Buyers Pay Same Price. 12 10 - Regional Day-Care Demand MB High Valuers Obtain Day Care. Low-Cost Firms Supply Day Care. The Competitive Quantity is Efficient. 8 6 - Grandmothers 4 - Day-Care Supply MC $2.50 2 - “Store-Bought” Day Care 0 | | | | | | | 2 4 6 8 10 12 14 QC = 9.5 TRADE BARRIERS & DEADWEIGHT LOSS 7.9 US Demand US Supply $15 DWL World Price under Free Trade $12.50 US Imports 15 20 25 Deadweight loss under trade prohibition is greater than w/ a $1.50 tariff. US Demand US Supply $15 $14 $12.50 DWL DWL Imports 18 22 World Price under Free Trade