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Chapter 11: Firms in Perfectly Competitive Markets
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Chapter 11: Firms in Perfectly Competitive Markets
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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CHAPTER
11
Chapter 11: Firms in Perfectly Competitive Markets
Firms in Perfectly
Competitive Markets
The market for
organically grown
food has expanded
rapidly in the
United States.
Prepared by:
Fernando Quijano
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CHAPTER
11
Chapter Outline and
Learning Objectives
Chapter 11: Firms in Perfectly Competitive Markets
Firms in Perfectly
Competitive Markets
11.1
Perfectly Competitive Market
Explain what a perfectly competitive market is and
why a perfect competitor faces a horizontal demand
curve.
11.2
How a Firm Maximizes Profit in a Perfectly
Competitive Market.
Explain how a firm maximizes profit in a perfectly
competitive market.
11.3
Illustrating Profit or Loss on the Cost Curve Graph
Use graphs to show a firm’s profit or loss.
11.4
Deciding Whether to Produce or to Shut Down in
the Short Run
Explain why firms may shut down temporarily.
11.5
“If Everyone Can Do It, You Can’t Make Money at
It”: The Entry and Exit of Firms in the Long Run
Explain how entry and exit ensure that perfectly
competitive firms earn zero economic profit in the long
run.
11.6
Perfect Competition and Efficiency
Explain how perfect competition leads to economic
efficiency.
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Firms in Perfectly Competitive Markets
Table 11-1
The Four Market Structures
Chapter 11: Firms in Perfectly Competitive Markets
MARKET STRUCTURE
CHARACTERISTIC
PERFECT
COMPETITION
MONOPOLISTIC
COMPETITION
OLIGOPOLY
MONOPOLY
Number of firms
Many
Many
Few
One
Type of product
Identical
Differentiated
Unique
Ease of entry
High
High
Identical or
differentiated
Low
Examples of
industries
• Growing Wheat
• Apples
• Clothing Stores
• Restaurants
• Manufacturing
computers
• Manufacturing
automobiles
• First-class
mail delivery
• Tap water
Entry blocked
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11.1 LEARNING OBJECTIVE
Perfectly Competitive Markets
Explain what a perfectly competitive
market is and why a perfect competitor
faces a horizontal demand curve.
Chapter 11: Firms in Perfectly Competitive Markets
Perfectly competitive market A market that
meets the conditions of (1) many buyers and
sellers, (2) all firms selling identical products,
and (3) no barriers to new firms entering the
market.
A Perfectly Competitive Firm Cannot Affect the Market Price
Price taker A buyer or seller that is unable to
affect the market price.
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11.1 LEARNING OBJECTIVE
Perfectly Competitive Markets
Explain what a perfectly competitive
market is and why a perfect competitor
faces a horizontal demand curve.
The Demand Curve for the Output of a Perfectly Competitive Firm
FIGURE 11-1
Chapter 11: Firms in Perfectly Competitive Markets
A Perfectly Competitive Firm
Faces a Horizontal Demand
Curve
A firm in a perfectly competitive market
is selling exactly the same product as
many other firms. Therefore, it can sell
as much as it wants at the current
market price, but it cannot sell anything
at all if it raises the price by even 1
cent. As a result, the demand curve for
a perfectly competitive firm’s output is a
horizontal line.
In the figure, whether the wheat farmer
sells 6,000 bushels per year or 15,000
bushels has no effect on the market
price of $4.
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11.1 LEARNING OBJECTIVE
Perfectly Competitive Markets
Explain what a perfectly competitive
market is and why a perfect competitor
faces a horizontal demand curve.
The Demand Curve for the Output of a Perfectly Competitive Firm
FIGURE 11-2
Chapter 11: Firms in Perfectly Competitive Markets
The Market Demand for
Wheat versus the Demand
for One Farmer’s Wheat
In a perfectly competitive market,
price is determined by the
intersection of market demand
and market supply.
In panel (a), the demand and
supply curves for wheat intersect
at a price of $4 per bushel.
An individual wheat farmer like
Farmer Parker cannot affect the
market price for wheat.
Therefore, as panel (b) shows,
the demand curve for Farmer
Parker’s wheat is a horizontal
line.
Don’t Let This Happen to YOU!
Don’t Confuse the Demand Curve for Farmer Parker’s Wheat with the Market Demand Curve for Wheat
YOUR TURN: Test your understanding by doing related problem 1.6 at the end of
this chapter.
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How a Firm Maximizes Profit
in a Perfectly Competitive Market
11.2 LEARNING OBJECTIVE
Explain how a firm maximizes profit
in a perfectly competitive market.
Profit Total revenue minus total cost.
Profit = TR – TC
Chapter 11: Firms in Perfectly Competitive Markets
Revenue for a Firm in a Perfectly Competitive Market
Average revenue (AR) Total revenue
divided by the quantity of the product sold.
Marginal revenue (MR) The change in
total revenue from selling one more unit of
a product.
Marginal Revenue 
Change in total revenue
TR
, or MR 
Change in quantity
Q
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How a Firm Maximizes Profit
in a Perfectly Competitive Market
11.2 LEARNING OBJECTIVE
Explain how a firm maximizes profit
in a perfectly competitive market.
Revenue for a Firm in a Perfectly Competitive Market
Table 11-2
Farmer Parker’s Revenue from Wheat Farming
Chapter 11: Firms in Perfectly Competitive Markets
NUMBER OF
BUSHELS
(Q)
0
1
2
3
4
5
6
7
8
9
10
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL
REVENUE
(TR)
$4
4
4
4
4
4
4
4
4
4
4
$0
4
8
12
16
20
24
28
32
36
40
AVERAGE
REVENUE
(AR)
MARGINAL
REVENUE
(MR)
$4
4
4
4
4
4
4
4
4
4
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
$4
4
4
4
4
4
4
4
4
4
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How a Firm Maximizes Profit
in a Perfectly Competitive Market
11.2 LEARNING OBJECTIVE
Explain how a firm maximizes profit
in a perfectly competitive market.
Determining the Profit-Maximizing Level of Output
Table 11-3
Chapter 11: Firms in Perfectly Competitive Markets
Farmer Parker’s Profits from Wheat Farming
QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COST
(TC)
PROFIT
(TR-TC)
0
1
2
3
4
5
6
7
8
9
10
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
40.00
$2.00
5.00
7.00
8.50
10.50
13.00
16.50
21.50
28.50
38.00
50.50
-$2.00
-1.00
1.00
3.50
5.50
7.00
7.50
6.50
3.50
-2.00
-10.50
MARGINAL
REVENUE
(MR)
MARGINAL
COST
(MC)
—
$4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
—
$3.00
2.00
1.50
2.00
2.50
3.50
5.00
7.00
9.50
12.50
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How a Firm Maximizes Profit
in a Perfectly Competitive Market
11.2 LEARNING OBJECTIVE
Explain how a firm maximizes profit
in a perfectly competitive market.
Determining the Profit-Maximizing Level of Output
FIGURE 11-3
Chapter 11: Firms in Perfectly Competitive Markets
The Profit-Maximizing Level of Output
In panel (a), Farmer Parker maximizes his
profit where the vertical distance between
total revenue and total cost is the largest.
Panel (b) shows that Farmer Parker’s marginal revenue
(MR) is equal to a constant $4 per bushel.
Farmer Parker maximizes profits by producing wheat up to
the point where the marginal revenue of the last bushel
produced is equal to its marginal cost, or MR = MC.
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How a Firm Maximizes Profit
in a Perfectly Competitive Market
11.2 LEARNING OBJECTIVE
Explain how a firm maximizes profit
in a perfectly competitive market.
Determining the Profit-Maximizing Level of Output
Chapter 11: Firms in Perfectly Competitive Markets
From the information in Table 11-3 and Figure 11-3, we
can draw the following conclusions:
1. The profit-maximizing level of output is where
the difference between total revenue and total
cost is the greatest.
2. The profit-maximizing level of output is also
where marginal revenue equals marginal cost,
or MR = MC.
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Illustrating Profit or Loss on
the Cost Curve Graph
11.3 LEARNING OBJECTIVE
Use graphs to show a firm’s profit
or loss.
Profit = (P x Q)  TC
Chapter 11: Firms in Perfectly Competitive Markets
( P  Q ) TC
Profit


Q
Q
Q
or
Profit
 P  ATC
Q
Profit = (P  ATC) x Q
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Illustrating Profit or Loss on
the Cost Curve Graph
11.3 LEARNING OBJECTIVE
Use graphs to show a firm’s profit
or loss.
Showing a Profit on the Graph
FIGURE 11-4
Chapter 11: Firms in Perfectly Competitive Markets
The Area of Maximum
Profit
A firm maximizes profit at the
level of output at which
marginal revenue equals
marginal cost.
The difference between price
and average total cost equals
profit per unit of output.
Total profit equals profit per
unit multiplied by the number
of units produced. Total profit
is represented by the area of
the green-shaded rectangle,
which has a height equal to
(P - ATC) and a width equal
to Q.
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11.3 LEARNING OBJECTIVE
Solved Problem
11-3
Use graphs to show a firm’s profit
or loss.
Chapter 11: Firms in Perfectly Competitive Markets
Determining Profit-Maximizing
Price and Quantity
OUTPUT
PER DAY
TOTAL
COST
0
$10.00
1
20.50
2
24.50
3
28.50
4
34.00
5
43.00
6
55.50
7
72.00
8
93.00
9
119.00
YOUR TURN: For more practice, do related problems 3.3 and 3.4 at the end of this chapter.
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Illustrating Profit or Loss
on the Cost Curve Graph
11.3 LEARNING OBJECTIVE
Use graphs to show a firm’s profit
or loss.
Don’t Let This Happen to YOU!
Chapter 11: Firms in Perfectly Competitive Markets
Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit
YOUR TURN: Test your understanding by doing related problem 3.5 at the end of this
chapter.
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Illustrating Profit or Loss
on the Cost Curve Graph
11.3 LEARNING OBJECTIVE
Use graphs to show a firm’s profit
or loss.
Chapter 11: Firms in Perfectly Competitive Markets
Illustrating When a Firm Is Breaking Even or Operating at a Loss
1.
P > ATC, which means the firm makes a profit.
2.
P = ATC, which means the firm breaks even (its
total cost equals its total revenue).
3.
P < ATC, which means the firm experiences
losses.
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11.3 LEARNING OBJECTIVE
Illustrating Profit or Loss
on the Cost Curve Graph
Use graphs to show a firm’s profit
or loss.
Illustrating When a Firm Is Breaking Even or Operating at a Loss
FIGURE 11-5
Chapter 11: Firms in Perfectly Competitive Markets
A Firm Breaking Even and a Firm Experiencing Losses
In panel (a), price equals average total cost, and
the firm breaks even because its total revenue will
be equal to its total cost. In this situation, the firm
makes zero economic profit.
In panel (b), price is below average total cost, and the firm
experiences a loss. The loss is represented by the area of
the red-shaded rectangle, which has a height equal to
(ATC - P) and a width equal to Q.
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11.3 LEARNING OBJECTIVE
Chapter 11: Firms in Perfectly Competitive Markets
Making
Losing Money in the
the Medical Screening Industry
Connection
Use graphs to show a firm’s profit
or loss.
YOUR TURN: Test your understanding by doing related problem 3.8 at the end of
this chapter.
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Deciding Whether to Produce
or to Shut Down in the Short Run
11.4 LEARNING OBJECTIVE
Explain why firms may shut down
temporarily.
In the short run, a firm experiencing losses
has two choices:
Chapter 11: Firms in Perfectly Competitive Markets
1. Continue to produce
2. Stop production by shutting
down temporarily
Sunk cost A cost that has already been
paid and that cannot be recovered.
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11.4 LEARNING OBJECTIVE
Explain why firms may shut down
temporarily.
Making
the
When to Close a Laundry
Chapter 11: Firms in Perfectly Competitive Markets
Connection
Keeping a business open
even when suffering
losses can sometimes be
the best decision for an
entrepreneur in the short
run.
YOUR TURN: Test your understanding by doing related problems 4.5 and 4.6 at
the end of this chapter.
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Deciding Whether to Produce
or to Shut Down in the Short Run
11.4 LEARNING OBJECTIVE
Explain why firms may shut down
temporarily.
The Supply Curve of a Firm in the Short Run
Total revenue < Variable cost,
or, in symbols:
Chapter 11: Firms in Perfectly Competitive Markets
(P × Q) < VC
If we divide both sides by Q, we have the result that
the firm will shut down if:
P < AVC
Shutdown point The minimum point on a firm’s
average variable cost curve; if the price falls below this
point, the firm shuts down production in the short run.
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Deciding Whether to Produce
or to Shut Down in the Short Run
11.4 LEARNING OBJECTIVE
Explain why firms may shut down
temporarily.
The Supply Curve of a Firm in the Short Run
FIGURE 11-6
Chapter 11: Firms in Perfectly Competitive Markets
The Firm’s Short-Run
Supply Curve
For any given price, we can
determine the quantity of output
the firm will supply from the
marginal cost curve. In other
words, the marginal cost curve is
the firm’s supply curve.
The firm will shut down if the price
falls below average variable cost.
The marginal cost curve crosses
the average variable cost at the
firm’s shutdown point. This point
occurs at output level QSD.
For prices below PMIN, the supply
curve is a vertical line along the
price axis, which shows that the
firm will supply zero output at
those prices. The red line in the
figure is the firm’s short-run supply
curve.
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Deciding Whether to Produce
or to Shut Down in the Short Run
11.4 LEARNING OBJECTIVE
Explain why firms may shut down
temporarily.
The Market Supply Curve in a Perfectly Competitive Industry
FIGURE 11-7
Chapter 11: Firms in Perfectly Competitive Markets
Firm Supply and Market Supply
We can derive the market supply curve by adding up the quantity that each firm in the market is
willing to supply at each price. In panel (a), one wheat farmer is willing to supply 15,000 bushels
of wheat at a price of $4 per bushel.
If every wheat farmer supplies the same amount of wheat at this price and if there are 167,000
wheat farmers, the total amount of wheat supplied at a price of $4 will equal 15,000 bushels per
farmer × 167,000 farmers = 2.5 billion bushels of wheat.
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“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
Economic Profit and the Entry or Exit Decision
Table 11- 4
Farmer Moreno’s Costs per Year
Chapter 11: Firms in Perfectly Competitive Markets
EXPLICIT COSTS
Water
Wages
Organic fertilizer
Electricity
Payment on bank loan
$10,000
$15,000
$10,000
$5,000
$45,000
IMPLICIT COSTS
Foregone salary
Opportunity cost of the $100,000 she has invested in her farm
Total cost
$30,000
$10,000
$125,000
Economic profit A firm’s revenues
minus all its costs, implicit and explicit.
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“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
Economic Profit and the Entry or Exit Decision
Economic Profit Leads to Entry of New Firms
FIGURE 11-8
Chapter 11: Firms in Perfectly Competitive Markets
The Effect of Entry on Economic Profits
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“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
Economic Profit and the Entry or Exit Decision
Economic Losses Lead to Exit of Firms
FIGURE 11-9
Chapter 11: Firms in Perfectly Competitive Markets
The Effect of Exit on Economic Losses
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“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
Economic Profit and the Entry or Exit Decision
Economic Losses Lead to Exit of Firms
FIGURE 11-9
Chapter 11: Firms in Perfectly Competitive Markets
The Effect of Exit on Economic Losses (continued)
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“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
Economic Profit and the Entry or Exit Decision
Economic Losses Lead to Exit of Firms
Chapter 11: Firms in Perfectly Competitive Markets
Economic loss The situation in which
a firm’s total revenue is less than its
total cost, including all implicit costs.
Long-Run Equilibrium in a Perfectly Competitive Market
Long-run competitive equilibrium
The situation in which the entry and exit
of firms has resulted in the typical firm
breaking even.
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30 of 39
“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
The Long-Run Supply Curve in a Perfectly Competitive Market
FIGURE 11-10
Chapter 11: Firms in Perfectly Competitive Markets
The Long-Run Supply Curve in a Perfectly Competitive Industry
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31 of 39
“If Everyone Can Do It, You Can’t Make
Money at It”: The Entry and Exit of Firms in
the Long Run
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
The Long-Run Supply Curve in a Perfectly Competitive Market
Chapter 11: Firms in Perfectly Competitive Markets
Long-run supply curve A curve that
shows the relationship in the long run
between market price and the quantity
supplied.
Increasing-Cost and Decreasing-Cost Industries
Industries with upward-sloping longrun supply curves are called
increasing-cost industries.
Industries with downward-sloping longrun supply curves are called
decreasing-cost industries.
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11.5 LEARNING OBJECTIVE
Chapter 11: Firms in Perfectly Competitive Markets
Making Easy Entry Makes the Long Run
the Pretty Short in the Apple iPhone
Connection Apps Store
Explain how entry and exit ensure
that perfectly competitive firms earn
zero economic profit in the long run.
In a competitive market,
earning an economic
profit in the long run is
extremely difficult. And
the ease of entering the
market for iPhone apps
has made the long run
pretty short.
Economic profits are rapidly competed away in
the iPhone apps store.
YOUR TURN: Test your understanding by doing related problem 6.7 at the end of this
chapter.
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11.6 LEARNING OBJECTIVE
Perfect Competition and Efficiency
Explain how perfect competition
leads to economic efficiency.
Chapter 11: Firms in Perfectly Competitive Markets
Productive Efficiency
Productive efficiency The
situation in which a good or service
is produced at the lowest possible
cost.
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11.6 LEARNING OBJECTIVE
Solved Problem
11-6
Explain how perfect competition
leads to economic efficiency.
Chapter 11: Firms in Perfectly Competitive Markets
How Productive Efficiency Benefits Consumers
In the long run, firms only break even on their investment in producing high-technology goods.
That result implies that investors in these firms are also unlikely to earn an economic profit in the long run.
YOUR TURN: For more practice, do related problems 6.4, 6.5, and 6.6 at the end of this
chapter.
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11.6 LEARNING OBJECTIVE
Perfect Competition and Efficiency
Explain how perfect competition
leads to economic efficiency.
Allocative Efficiency
Chapter 11: Firms in Perfectly Competitive Markets
Firms will supply all those goods that provide consumers with
a marginal benefit at least as great as the marginal cost of
producing them.
1. The price of a good represents the marginal benefit
consumers receive from consuming the last unit of
the good sold.
2. Perfectly competitive firms produce up to the point
where the price of the good equals the marginal
cost of producing the last unit.
3. Therefore, firms produce up to the point where the
last unit provides a marginal benefit to consumers
equal to the marginal cost of producing it.
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11.6 LEARNING OBJECTIVE
Perfect Competition and Efficiency
Explain how perfect competition
leads to economic efficiency.
Chapter 11: Firms in Perfectly Competitive Markets
Allocative Efficiency
Allocative efficiency A state of the
economy in which production represents
consumer preferences; in particular,
every good or service is produced up to
the point where the last unit provides a
marginal benefit to consumers equal to
the marginal cost of producing it.
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Chapter 11: Firms in Perfectly Competitive Markets
AN INSIDE
LOOK
>> It Isn’t Easy—or Cheap—to Be Green
Figure 1
The demand for a product increases after it is
“green certified.” The graph assumes that the
firm did not spend money to acquire
certification for its product.
Figure 2
The demand for a product increases after it is
“green certified.” The marginal cost and
average total cost curves shift up due to the
cost of certification.
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Chapter 11: Firms in Perfectly Competitive Markets
KEY TERMS
Allocative efficiency
Perfectly competitive market
Average revenue (AR)
Price taker
Economic loss
Productive efficiency
Economic profit
Profit
Long-run competitive equilibrium
Shutdown point
Long-run supply curve
Sunk cost
Marginal revenue (MR)
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