Download Economics for Today 2nd edition Irvin B. Tucker

Chapter 8
Perfect Competition
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
Who was Adam Smith?
The father of modern
economics who wrote
The Wealth of Nations,
published in 1776
2
What did Adam
Smith say about
competitive forces?
They are like an “invisible
hand” that leads people
who simply pursue their
own interests to serve
the interests of society
3
What is the purpose of
this chapter?
To explain how
competitive markets
determine prices,
output, and profits
4
What is
market structure?
A classification system for
the key traits of a market,
including the number of
firms, the similarity of the
products they sell, and the
ease of entry and exit
5
What is
perfect competition?
1. many small firms
2. homogeneous product
3. very easy entry and exit
4. price taker
6
What does
homogeneous mean?
Goods that cannot be
distinguished from one
another; for example,
one potato cannot be
distinguished from
another potato
7
What is a price taker?
A seller that has no
control over the price
of the product it sells
8
What determines price?
Supply and Demand
9
What determines the
individual firm’s
demand curve?
A horizontal line at
the market price
10
Why is this horizontal
line the firm’s
demand curve?
If the firm charges more
than this price, it will not
sell anything, and it has
no incentive to charge
less than this price
11
Why does the firm
have no incentive to
charge less than the
market price?
It can sell everything
it brings to market
at the market price
12
What does the
perfectly competitive
firm control?
The only thing it
controls is how many
units it produces
13
How many units should
this firm produce?
The number of units
whereby it will maximize
its profits, or at least
minimize its losses
14
What are the two
methods to
determine how many
units to produce?
• TR and TC
• MR and MC
15
Using the total
revenue - total cost
method, where should
a firm produce?
Where the distance
between TR and
TC is the greatest
16
What is
marginal revenue?
MR = TR / 1 output
17
What is
marginal cost?
MC = TC / 1 output
18
Using the marginal
revenue and marginal
cost method, where
should a firm produce?
MR = MC
19
Why should a firm
continue to produce
as long as MR > MC?
As long as MR is > than
MC, money is being
made on that last unit
20
Why will a firm not
produce that unit
where MR < MC?
At the unit of output where
MR < MC, money is
being lost on that last unit
21
Why does P = AR in
perfect competition?
Each additional unit sold
is adding the market
price to TR and TR
divided by P = AR
22
Firm will shut down
Price (MR) is below
minimum average
variable cost
23
What is the perfectly
competitive firm’s shortrun supply curve?
The firm’s marginal cost
curve above the minimum
point on its average
variable cost curve
24
What is the industry’s
supply curve?
The summation of the
individual firm’s MC
curves that lie above their
minimum AVC points
25
What is a normal profit?
The minimum profit
necessary to keep
a firm in operation
26
In the long-run,
what happens when
economic profits
are made?
When firms make more
than a normal profit, firms
enter the industry, as
supply increases, a
downward pressure is
put on prices
27
In the long-run, what
happens when
losses are made?
When firms make less than
a normal profit, firms leave
the industry, as supply
decreases, an upward
pressure is put on prices
28
In the long-run, where
is equilibrium?
At the market price
that enables firms to
make a normal profit
29
What exists at long-run
perfectly competitive
equilibrium?
P = MR = SRMC =
SRATC = LRAC
30
What different types
of industries can
exist in the long-run?
• Constant-cost
• Decreasing-cost
• Increasing-cost
31
What is a
constant-cost industry?
An industry in which the
expansion of industry
output by the entry of
new firms has no effect
on the firm’s cost curves
32
What does the longrun supply curve look
like in a constant-cost
industry?
It is perfectly elastic,
which is horizontal
33
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Initial equilibrium
price is restored
Perfectly elastic long-run
supply curve
34
What is a decreasingcost industry?
An industry in which the
expansion of industry
output by the entry of
new firms decreases
the firm’s cost curves
35
What does the long-run
supply curve look like
in a decreasing-cost
industry?
It is downward sloping
36
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Equilibrium price
and ATC decrease
Downward sloping long-run
supply curve
37
What is an increasingcost industry?
An industry in which the
expansion of industry
output by the entry of
new firms increases the
firm’s cost curves
38
What does the long-run
supply curve look like
in a increasing-cost
industry?
It is upward sloping
39
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Equilibrium price
and ATC increase
Upward sloping long-run
supply curve
40
Key Concepts
41
Key Concepts
•
•
•
•
What is perfect competition?
What is a price taker?
What determines price?
What determines the individual firm’s demand
curve?
• Why does the firm have no incentive to charge
less than the market price?
• Using the marginal revenue and marginal cost
method, where should a firm produce?
42
Key Concepts cont.
• Why does MR = P in perfect competition?
• What is a normal profit?
• In the long-run, what happens when
economic profits are made?
• In the long-run, what happens when losses
are made?
• In the long-run, where is equilibrium?
• What different types of industries can exist
in the long-run?
43
Summary
44
Market structure consists of three
market characteristics: (1) the
number of sellers, (2) the nature
of the product, (3) the case of
entry into or exit from the market.
45
Perfect competition is a market
structure in which an individual
firm cannot affect the price of the
product it produces. Each firm in
the industry is very small relative
to the market as a whole, all the
firms sell a homogeneous
product, and firms are free to
enter and exit the industry.
46
A price-taker firm in perfect
competition faces a perfectly
elastic demand curve. It can sell
all it wishes at the marketdetermined price, but it will sell
nothing above the given market
price. This is because so many
competitive firms are willing to
sell at the going market price.
47
The total revenue-total cost
method is one way the firm
determines the level of output
that maximizes profit. Profit
reaches a maximum when the
vertical difference between the
total revenue and the total cost
curves is at a maximum.
48
The marginal revenue equals
marginal cost method is a second
approach to finding where a firm
maximizes profits. Marginal
revenue is the change in total
revenue from a one-unit change
in output. Marginal revenue for a
perfectly competitive firm equals
the market price.
49
The MR = MC rule states that the
firm maximizes profit or minimizes
loss by producing the output
where marginal revenue equals
marginal cost. If the price
(average revenue) is below the
minimum point on the average
variable cost curve, the MR = MC
rule does not apply, and the firm
shuts down to minimize its losses.
50
The perfectly competitive firm’s
short-run supply curve is a curve
showing the relationship between
the price of a product and the
quantity supplied in the short run.
51
The individual firm always produces
along its marginal cost curve above
its intersection with the average
variable cost curve. The perfectly
competitive industry’s short-run
supply curve is the horizontal
summation of the short-run supply
curves of all firms in the industry.
52
Long-run perfectly competitive
equilibrium occurs when the firm
earns a normal profit by
producing where price equals
minimum long-run average cost
equals minimum short-run
average total cost equals shortrun marginal cost.
53
A constant-cost industry is an
industry whose total output can
be expanded without an increase
in the firm’s average total cost.
Because input prices remain
constant, the long-run supply
curve in a constant-cost industry
is perfectly elastic.
54
A decreasing-cost industry is an
industry in which lower input
prices result in a downwardsloping long-run supply curve. As
industry output expands, the
firm’s average total cost curve
shifts downward, and the long-run
equilibrium market price falls.
55
An increasing-cost industry is an
industry in which input prices rise
as industry output increases. As a
result, the firm’s average total
cost curve rises, and the long-run
supply curve for an increasingcost industry is upward sloping.
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END
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