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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. 1 of 39 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. 2 of 39 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 3 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 4 of 39 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 5 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 6 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 7 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 8 of 39 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 9 of 39 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 10 of 39 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 11 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 12 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 13 of 39 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 14 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 15 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 16 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 17 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 18 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 19 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 20 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 21 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 22 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 23 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 24 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 25 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. 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 26 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. 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 27 of 39 “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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 28 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. 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) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 29 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. 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 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 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 32 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 33 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 34 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 35 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 36 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 37 of 39 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. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 38 of 39 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) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 39 of 39