Download Chapter 11

Microeconomics
ECON 2302
Spring 2011
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 11
CHAPTER
11
Firms in Perfectly Competitive Markets
The market for organically
grown food has expanded
rapidly in the United States.
CHAPTER
11
Firms in Perfectly Competitive Markets
Chapter Outline and Learning Objectives
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.
Firms in Perfectly Competitive Markets
Chapter Outline and Learning Objectives, cont.
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.
Firms in Perfectly Competitive Markets
Table 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
• Growing Wheat
• Apples
• Clothing Stores
• Restaurants
• Manufacturing
computers
• Manufacturing
automobiles
• First-class
mail delivery
• Tap water
Entry blocked
11.1 LEARNING OBJECTIVE
Explain what a perfectly competitive market is and why
a perfect competitor faces a horizontal demand curve.
Perfectly Competitive Markets
Perfectly competitive market A market that meets these
conditions:
1. Many buyers and sellers
2. Identical products
3. No barriers to new firms entering the market and no
barriers to firms choosing to leave the market
4. Very low cost information
A Perfectly Competitive Firm Cannot Affect the Market Price!
Price taker A buyer or seller that is unable to affect the
market price.
Perfectly Competitive Markets
The Demand Curve for the Output of a Perfectly Competitive Firm
FIGURE 11-1 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. Thus, 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.
Perfectly Competitive Markets:
The Demand Curve for the Output of a Perfectly Competitive Firm
FIGURE 11-2 The Market Demand for Wheat versus the Demand for One Farmer’s Wheat
In a perfectly
competitive market, P
is determined by the
intersection of market
D and market S.
In panel (a), the D and
S curves for wheat
intersect at a P of $4
per bushel.
An individual wheat
farmer like Farmer
Parker cannot affect
the market P for
wheat. Therefore, as
panel (b) shows, the D
curve for Farmer
Parker’s wheat is a
horizontal line.
Don’t Let This Happen to YOU!
Don’t Confuse the D Curve for Farmer Parker’s
Wheat with the Market D Curve for Wheat!
Explain how a firm maximizes profit in a perfectly competitive market.
11.2 LEARNING OBJECTIVE
How a Firm Maximizes Profit
in a Perfectly Competitive Market
Profit Total revenue minus total cost.
Profit = TR – TC
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
How a Firm Maximizes Profit
in a Perfectly Competitive Market
Revenue for a Firm in a Perfectly Competitive Market
Table 11-2
NUMBER OF
BUSHELS
(Q)
0
1
2
3
4
5
6
7
8
9
10
Farmer Parker’s Revenue from Wheat Farming
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)
$4
4
4
4
4
4
4
4
4
4
MARGINAL
REVENUE
(MR)
$4
4
4
4
4
4
4
4
4
4
How a Firm Maximizes Profit
in a Perfectly Competitive Market
Determining the Profit-Maximizing Level of Output
Table 11-3
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
How a Firm Max’es p in a Perfectly Competitive Market:
Determining the Profit-Maximizing Level of Output
In panel (a), Farmer Parker maximizes
his profit where the vertical distance
between TR and TC is the largest.
FIGURE 11-3
The Profit-Maximizing Level of Output
Panel (b) shows that Farmer Parker’s MR is equal to a constant $4/bushel.
Farmer Parker maximizes profits by producing wheat up to the point
where MR of the last bushel produced is equal to its MC.
How a Firm Max’es p in a Perfectly Competitive Market:
Determining the Profit-Maximizing Level of Output
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.
11.3 LEARNING OBJECTIVE
Use graphs to show a firm’s profit or loss.
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) x Q
Illustrating Profit or Loss on the Cost Curve Graph
Showing a Profit on the Graph
A firm
maximizes p at
the level of Q at
which MR = MC.
The difference
between P and
ATC equals
p/unit of Q.
FIGURE 11-4
Total p equals
p/unit multiplied
by the number of
units produced.
Total p is represented by the area of the greenshaded rectangle, which has a height equal to
(P - ATC) and a width equal to Q.
The Area of Maximum Profit
Solved Problem
11-3
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
Illustrating Profit or Loss on
the Cost Curve Graph
Don’t Let This Happen to YOU!
Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit
Illustrating Profit or Loss on
the Cost Curve Graph
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.
Illustrating When a Firm Is Breaking Even
or Operating at a Loss
In panel (a), P equals ATC, and the firm breaks
even because its TR will be equal to its TC. In this
situation, the firm makes zero economic profit.
FIGURE 11-5
A Firm Breaking Even and
a Firm Experiencing Losses
In panel (b), P is below ATC, 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.
Making
the Losing Money in the
Medical Screening Industry
Connection
11.4 LEARNING OBJECTIVE
Explain why firms may shut down temporarily.
Deciding Whether to Produce
or to Shut Down in the Short Run
In the short run, a firm experiencing losses has two choices:
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.
Making
the
When to Close a Laundry
Connection
Keeping a business
open even when
suffering losses can
sometimes be the
best decision for an
entrepreneur in the
short run.
11.4 LEARNING OBJECTIVE
Explain why firms may shut down temporarily.
Deciding Whether to Produce
or to Shut Down in the Short Run
The Supply Curve of a Firm in the Short Run
Total revenue < Variable cost,
or, in symbols:
(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.
Deciding Whether to Produce
or to Shut Down in the Short Run
The Supply Curve of a Firm in the Short Run
For any given P, we can
determine the Q of
output the firm will
supply from the MC
curve. In other words,
the MC 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.
FIGURE 11-6
The Firm’s Short-Run Supply Curve
For prices below PMIN, the S curve is a vertical line along the P
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 S curve.
The Market Supply Curve in a Perfectly Competitive Industry
We can derive the market S curve by adding up the Q that
each firm in the market is willing to supply at each P.
FIGURE 11-7 Firm Supply and Market Supply
In panel (a), one wheat farmer is willing to supply 15,000 bushels of wheat at a P of $4/bu.
Panel (b): If every wheat farmer supplies the same amount of wheat at this P and if there are
167,000 wheat farmers, the total amount of wheat supplied at a price of $4 will equal
15,000 bushels/farmer × 167,000 farmers = 2.5 billion bushels of wheat.
11.5 LEARNING OBJECTIVE
Explain how entry and exit ensure that perfectly competitive
firms earn zero economic profit in the long run.
“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
EXPLICIT COSTS
Table 11- 4
Farmer Moreno’s Costs per Year
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
“If Everyone Can Do It, You Can’t Make Money at
It”: The Entry and Exit of Firms in the Long Run
Economic profit A firm’s revenues minus all its costs,
implicit and explicit.
Economic Losses Lead to Exit of Firms
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 – in terms of economic costs.
“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 Profit Leads to Entry of New Firms
FIGURE 11-8
The Effect of Entry on Economic Profits
“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
The Effect of Exit on Economic Losses
“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 The Effect of Exit on Economic Losses, cont.
Making
the Easy Entry Makes the Long Run Pretty Short in
Connection the Apple iPhone Apps Store
Economic profits are rapidly competed
away in the iPhone apps store.
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.
11.6 LEARNING OBJECTIVE
Explain how perfect competition leads to economic efficiency.
Perfect Competition and Efficiency
Productive Efficiency
Productive efficiency The situation in which a good or
service is produced at the lowest possible cost.
Solved Problem
11-6
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.
Perfect Competition and Efficiency
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.
Perfect Competition and Efficiency:
Allocative Efficiency
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.
AN INSIDE
LOOK
>> It Isn’t Easy - or Cheap - to Be Green
Figure 1
The D 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 D 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.
KEY TERMS
Allocative efficiency
Perfectly competitive market
Average revenue (AR)
Price taker
Economic loss
Economic profit
Productive efficiency
Profit
Long-run competitive
equilibrium
Shutdown point
Sunk cost
Long-run supply curve
Marginal revenue (MR)
Pre-read Ch. 12 before we start
going over it in class, including:
 Review Questions: 3rd ed. p. 422, 1.1—1.3; p. 426, 4.1,
4.2; p. 6.1, 6.2 (2nd ed., 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: 3rd ed. p 422 1.4; p 423,
2.5; p424, 2.11; p 425, 3.3 (2nd ed., 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).