Download Chapter 11

Microeconomics
ECON 2302
May 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 11
Reviewing Learning Objectives from
Chapter 10. You should be able to:
 Define technology and give examples of positive and
negative technological change.
 Distinguish between the economic short run and the
economic long run.
 Understand the relationship between the marginal
product of labor and the average product of labor.
 Explain and illustrate the relationship between
marginal cost and average total cost.
 Graph average total cost, average variable cost, average
fixed cost, and marginal cost.
 Understand how firms use the long-run average cost
curve to plan.
Any questions on
these topics?
Anything else?
Chapter 11. Firms in
Perfectly Competitive Markets
The process of competition is at the heart of the
market system and is the focus of this chapter.
LEARNING OBJECTIVES
After studying this chapter, you should be able
to:
1
2
3
4
5
6
Define a perfectly competitive market, and explain
why a perfect competitor faces a horizontal
demand curve.
Explain how a perfect competitor decides how
much to produce.
Use graphs to show a firm’s profit or loss.
Explain why firms may shut down temporarily.
Explain how entry and exit ensure that firms earn
zero economic profit in the long run.
Explain how perfect competition leads to
economic efficiency.
Firms in Perfectly Competitive Markets
11 – 1
The Four Market Structures
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
Wheat
Apples
Selling DVDs
Restaurants
Entry
blocked
Manufacturing First-class
computers
mail
Manufacturing delivery
automobiles
Tap water
1 LEARNING OBJECTIVE
Perfectly Competitive Markets
 Perfectly competitive market A market
that meets the conditions of:
1.
2.
3.
4.
many buyers and sellers,
all firms selling identical products,
no barriers to new firms entering the market
perfect information – or at least very low
cost to information access
Perfectly Competitive Markets
A Perfectly Competitive Firm Cannot Affect the Market Price
 Price taker A buyer or seller that is unable
to affect the market price.
11 - 1
A Perfectly Competitive Firm
Faces a Horizontal Demand
Curve
2 LEARNING OBJECTIVE
How a Firm Maximizes Profit in a
Perfectly Competitive Market
 Profit Total revenue minus total cost.
Profit = TR - TC
Don’t Confuse the Demand Curve for Farmer Douglas’s
Wheat with the Market Demand Curve for Wheat
11 - 2
The Market Demand for Wheat versus the Demand for
One Farmer’s Wheat
How a Firm Maximizes Profit in a
Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
Average revenue (AR) Total revenue divided by the
number of units sold.
TR
AR 
Q
TR P  Q
so, AR 

P
Q
Q
Marginal revenue (MR) Change in total revenue
from selling one more unit.
Marginal Revenue 
Change in total revenue
TR
, or MR 
Change in quantity
Q
How a Firm Maximizes Profit in a
Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
11 – 2
Farmer Douglas’s Revenue
from Wheat Farming
NUMBER OF
BUSHELS
(Q)
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL
REVENUE
(TR)
AVERAGE
REVENUE
(AR)
MARGINAL
REVENUE
(MR)
0
1
2
3
4
5
6
7
8
9
10
$4
4
4
4
4
4
4
4
4
4
4
$0
4
8
12
16
20
24
28
32
36
40
$4
4
4
4
4
4
4
4
4
4
$4
4
4
4
4
4
4
4
4
4
How a Firm Maximizes Profit in a
Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
11 –3
Farmer Douglas’s Profits from Wheat Farming
QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(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
$1.00
4.00
6.00
7.50
9.50
12.00
15.00
19.50
25.50
32.50
40.50
-$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
-0.50
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
3.00
4.50
6.00
7.00
8.00
How a Firm
Maximizes Profit
in a
Perfectly
Competitive
Market
11 - 3
The Profit-Maximizing Level
of Output
Can you explain why there’s
a difference between MR &
MC at the profit maximizing
quantity in this graph???
3 LEARNING OBJECTIVE
Illustrating Profit or Loss
on the Cost Curve Graph
Profit = (P x Q)  TC
( P  Q ) TC
Profit


Q
Q
Q
Or
Profit
 P  ATC,
Q
Profit = (P  ATC)Q
Illustrating Profit or Loss
on the Cost Curve Graph
11 - 4
The Area of Maximum Profit
11-1
3 LEARNING OBJECTIVE
Determining Profit-Maximizing Price and Quantity
OUTPUT
PER DAY
TOTAL
COST
MARGINAL
COST
0
1
2
3
4
5
6
7
8
9
$1.00
1.50
1.75
2.25
3.00
4.00
5.25
6.75
8.50
10.50
$0.50
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
Illustrating Profit or Loss
on the Cost Curve Graph
Illustrating When a Firm Is Breaking Even or
Operating at a Loss:
 P > ATC, which means the firm makes a profit
 P = ATC, which means the firm breaks even (its total
cost equals it total revenue)
 P < ATC, which means the firm experiences losses
Illustrating Profit or Loss
on the Cost Curve Graph
11 - 5
A Firm Breaking Even and Experiencing Losses
Illustrating Profit or Loss
on the Cost Curve Graph
Remember that Firms Maximize Total Profit, Not Profit per Unit:
11 - 1
Losing Money in the Medical
Screening Industry
Providing preventive medical scans
turned out not to be a profitable business.
What type of medical announcement might change this?
4 LEARNING OBJECTIVE
Deciding Whether to Produce
or to Shut Down in the
Short Run
In the short run a firm suffering losses has
two choices:
 Continue to produce
 Stop production by shutting down
temporarily
 Sunk cost A cost that has already been
paid and that cannot be recovered.
Deciding Whether to Produce or to Shut Down
in the Short Run: The Supply Curve of the Firm in the
11 - 6
Short Run
The Firm’s Short-Run Supply Curve
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.
11 - 2
When to Close a Laundry
Keeping a business
open even when
suffering losses can
sometimes be the
best decision in the
short run.
5 LEARNING OBJECTIVE
The Entry and Exit of Firms in the Long Run

Remember the conditions of a perfectly
competitive market:
1. many buyers and sellers,
2. all firms selling identical products,
3. no barriers to new firms entering the market
4. perfect information – or at least very low
cost to information access
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
11 - 7
Firm Supply and Market Supply
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
 Economic profit A firm’s revenues minus
all its costs, implicit and explicit.
 Economic loss The situation in which a
firm’s total revenue is less than its total
cost, including all implicit costs.
The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision:
11 – 5
Farmer Appleseed’s Costs per Year
EXPLICIT COSTS
Water
Wages
Organic fertilizer
Electricity
Payment on bank loan
$25,000
$35,000
$14,000
$5,000
$6,000
IMPLICIT COSTS
Foregone salary
Opportunity cost of the $100,000 she has invested in her
farm
Total Cost
$30,000
$10,000
$125,000
The Entry and Exit of Firms in the Long Run
ECONOMIC PROFIT LEADS TO ENTRY OF NEW FIRMS
11 - 8
The Effect of Entry on Economic Profits
The Entry and Exit of Firms in the Long Run
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
11 - 9
The Effect of Exit on Economic Losses
The Entry and Exit of Firms in the Long Run
ECONOMIC LOSSES LEAD TO EXIT OF FIRMS
11 -9
The Effect of Exit on Economic Losses (cont’d.)
The Entry and Exit of Firms in the Long Run
Long-Run Equilibrium in a Perfectly Competitive Market
 Long-run competitive equilibrium The situation
in which the entry and exit of firms have resulted
in the typical firm just breaking even.
11 - 3
The Decline of Apple
Production in New York State
When apple growers
in New York State
stopped breaking
even, many sold their
land to housing
developers.
6 LEARNING OBJECTIVE
Perfect Competition and Efficiency
Productive Efficiency
 Productive efficiency The situation in which a
good or service is produced at the lowest
possible cost.
11-2
6 LEARNING OBJECTIVE
How Productive Efficiency Benefits Consumers
Perfect Competition and Efficiency
Allocative Efficiency
 Allocative efficiency A state of the economy in
which production reflects 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.
Perfect Competition and Efficiency
Allocative Efficiency means in the market:
Firms will supply all those goods that provide consumers
with a marginal benefit at least as great as the marginal cost
of producing them:
 The price of a good represents the marginal benefit
consumers receive from consuming the last unit sold.
 Perfectly competitive firms produce up to the point where the
price equals the marginal cost of producing the last unit.
 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. MB = MC
Organic Food Trend Chips Out a Niche in Snack Food Isle
 Allocative efficiency
 Average revenue (AR)
 Perfectly competitive
market
 Economic loss
 Price taker
 Economic profit
 Productive efficiency
 Long-run supply
 Profit
curve
 Marginal revenue
 Shutdown point
 Sunk cost
Assignments for May 22:
Study Ch. 12 and be able to answer:
Review Questions: p. 432, 1.1 – 1.3; p. 436,
4.1 & 4.2; p. 438, 6.1 & 6.2 (1st edition: 1, 2,
3, 7 8 & 10 on pp. 406-407); and
Problems and Applications: p. 432, 1.4; p.
433, 2.5; p. 435, 3.3; & p. 4.34, 2.11 (1st
edition: 1, 3, 5 & 17 on pp. 407-410).