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Perfect Competition 1 FOUR MARKET MODELS Characteristics of Pure Competition: • Many small firms • Identical products (perfect substitutes) • Firms are “Price Takers” • Easy for firms to enter and exit the industry • No control over price. • No need to advertise Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Market Structure Continuum 2 Review 1. Why is a perfectly competitive firm a price taker? 2. How do firms determine what output to produce? 3. Draw and label a perfectly competitive firm producing 10 units making a profit of $30 4. Draw and label a perfectly competitive firm producing 10 units making a loss of $30 5. On your graph, identify the firms supply curve 6. On your graph, identify the shut down point 7. What happens in the industry if there is a profit? 8. What happens in the industry if there is a loss? 9. Draw a perfectly competitive firm in long run equilibrium 10. List 10 words that rhyme with the word “great” 3 The Competitive Firm is a Price Taker Price is set by the Industry Is the firm making a profit or a loss? Why? P S P MC Loss $10 ATC D=MR $10 D 400 Industry Q 8 Q Firm (price taker) 4 Perfect Competition in the Long-Run You are a wheat farmer. You learn that there is a more profit in making corn. What do you do in the long run? 5 In the Long-run… •Firms will enter if there is profit •Firms will leave if there is loss •So, ALL firms break even, they make NO economic profit (No Economic Profit=Normal Profit) •In long run equilibrium a perfectly competitive firm is EXTREMELY efficient. 6 Side-by-side graph for perfectly completive industry and firm in the LONG RUN Is the firm making a profit or a loss? Why? P S P MC ATC $15 MR=D $15 D 5000 Industry Q 8 Q Firm (price taker) 7 Firm in Long-Run Equilibrium Price = MC = Minimum ATC Firm making a normal profit P MC ATC $15 MR=D There is no incentive to enter or leave the industry TC = TR 8 Q 8 82% Going from Short-Run to Long-Run 12 Firms enter to earn profit so supply increases in the industry Price decreases and quantity increases P S P MC S1 ATC $15 MR=D $15 $10 D 5000 6000 Q Industry 8 Firm Q 14 Price falls for the firm because they are price takers. Price decreases and quantity decreases P S P MC S1 ATC $15 $15 MR=D $10 $10 MR1=D1 D 5000 6000 Q Industry 5 8 Firm Q 15 New Long Run Equilibrium at $10 Price Zero Economic Profit P P MC S1 ATC $10 MR1=D1 $10 D 5000 6000 Q Industry 5 Firm Q 16 1. 2. 3. 4. Is this the short or the long run? Why? What will firms do in the long run? What happens to P and Q in the industry? What happens to P and Q in the firm? P S P $15 MC ATC MR=D $15 D 4000 5000 Industry Q 8 Firm Q 17 Firms leave to avoid losses so supply decreases in the industry Price increases and quantity decreases P S1 S P MC ATC $20 $15 MR=D $15 D 4000 5000 Industry Q 8 Firm Q 18 Price increase for the firm because they are price takers. Price increases and quantity increases P S1 S P $20 MC $20 $15 $15 ATC MR1=D1 MR=D D 4000 5000 Industry Q 89 Firm Q 19 New Long Run Equilibrium at $20 Price Zero Economic Profit S1 P P $20 MC $20 ATC MR1=D1 D 4000 Industry Q 9 Firm Q 20 Going from Long-Run to Long-Run 21 Currently in Long-Run Equilibrium If demand increases, what happens in the short-run and how does it return to the long run? P S P MC ATC MR1=D1 $15 MR=D $15 D 5000 Industry Q 8 Firm Q 22 Demand Increases The price increases and quantity increases Profit is made in the short-run P S P MC ATC $20 $20 $15 $15 MR1=D1 MR=D D1 D 5000 Industry Q 8 9 Firm Q 23 Firms enter to earn profit so supply increases in the industry Price Returns to $15 P S S1 P MC ATC $20 $20 $15 $15 MR1=D1 MR=D D1 D 5000 7000 Q Industry 8 9 Firm Q 24 Back to Long-Run Equilibrium The only thing that changed from long-run to long-run is quantity in the industry S1 P P MC ATC $15 MR=D $15 D1 D 7000 Q Industry 8 Firm Q 25 Efficiency 26 PURE COMPETITION AND EFFICIENCY In general, efficiency is the optimal use of societies scarce resources •Perfect Competition forces producers to use limited resources to their fullest. •Inefficient firms have higher costs and are the first to leave the industry. •Perfectly competitive industries are extremely efficient There are two kinds of efficiency: 1. Productive Efficiency 2. Allocative Efficiency 27 Efficiency Revisited Which points are productively efficient? Which are allocatively efficient? 14 A B Bikes 12 G 10 Productive Efficient combinations are A through D (they are produced at the lowest cost) 8 E 6 Allocative Efficient combinations depend on the wants of society C 4 F 2 D 0 0 2 4 6 8 10 Computers 28 Productive Efficiency The production of a good in a least costly way. (Minimum amount of resources are being used) Graphically it is where… Price = Minimum ATC 29 Short-Run Price MC ATC D=MR Profit P Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity 30 Short-Run MC Price ATC P Loss D=MR Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point). Q Quantity 31 Long-Run Equilibrium MC Price ATC D=MR P Notice that the product is being made at the lowest possible cost (Minimum ATC) Q Quantity 32 Allocative Efficiency Producers are allocating resources to make the products most wanted by society. Graphically it is where… Price = MC Why? Price represents the benefit people get from a product. 33 Long-Run Equilibrium Price MC MR P Optimal amount being produced The marginal benefit to society (as measured by the price) equals the marginal cost. Q Quantity 34 What if the firm makes 15 units? Price MC MR The marginal benefit to society is greater the marginal cost. Not enough produced. Society wants more $5 $3 15 20 Quantity Underallocation of resources 35 What if the firm makes 22 units? MC Price $7 MR $5 The marginal benefit to society is less than the marginal cost. Too much Produced. Society wants less 20 22 Quantity Overallocation of resources 36 Long-Run Equilibrium MC Price ATC D=MR P P = Minimum ATC = MC EXTREMELY EFFICIENT!!!! Q Quantity 37