Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Chapter 9: Competitive Markets Copyright © 2014 Pearson Canada Inc. Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 9.1 Market Structure and Firm Behaviour 1. state the difference between competitive behaviour and a competitive market. 9.2 The Theory of Perfect Competition 2. list the four key assumptions of the theory of perfect competition. 9.3 Short-Run Decisions 3. derive a competitive firm's supply curve. 4. determine whether competitive firms are making profits or losses in the short run. 5. explain the role played by profits, entry, and exit in determining a competitive industry's long-run equilibrium. 9.4 Long-Run Decisions Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 2 LO1 Industry • a group of producers Market • the interaction of both producers and consumers Perfect Competition • a market in which all buyers and sellers are price takers © 2012 McGraw-Hill Ryerson Limited 8-3 LO1 © 2012 McGraw-Hill Ryerson Limited 8-4 9.1 Market Structure and Firm Behaviour Competitive Market Structure The competitiveness of the market—the influence that individual firms have on market prices. The less power an individual firm has to influence the market price, the more competitive is that market's structure. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 5 Competitive Behaviour The term competitive behaviour refers to the degree to which individual firms actively vie with one another for business. Examples: 1. MasterCard and Visa engage in competitive behaviour but their market is not competitive. 2. Two wheat farmers do not engage in competitive behaviour but they both exist in a very competitive market. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 6 The Significance of Market Structure The demand curve faced by an individual firm may be different from the demand curve for the industry as a whole. Market structure plays a central role in determining the efficiency of the market. In this chapter we focus on competitive market structures. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 7 9.2 The Theory of Perfect Competition The Assumptions of Perfect Competition 1. All firms sell a homogeneous product. 2. Customers know the product and each firm's price. 3. Each firm reaches its minimum LRAC at a level of output that is small relative to the industry's total output 4. Firms are free to exit and enter the industry. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 8 The Demand Curve for a Perfectly Competitive Firm Fig. 9-1 The Demand Curve for a Competitive Industry and for One Firm in the Industry Each firm in a perfectly competitive market faces a horizontal demand curve—even though the industry demand curve is downward sloping. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 9 This does not mean the firm could actually sell an infinite amount at the market price. "Normal" variations in the firm's level of output have a negligible effect on total industry output. APPLYING ECONOMIC CONCEPTS 9-1 Why Small Firms Are Price Takers Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide10 Total, Average, and Marginal Revenue Total revenue (TR): TR = p x q Average revenue (AR): AR = (p x q)/q = p Marginal revenue (MR): MR = TR/ q = p Note: For a perfectly competitive firm, AR = MR = p Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide11 LO3 Total Revenue • total quantity sold (Q) times price (P) Average Revenue • the amount of revenue received per unit sold Total Revenue (TR) Q P Average Revenue (AR) or P Output (Q) Q Marginal Revenue • the extra revenue derived from one more unit Marginal Revenue © 2012 McGraw-Hill Ryerson Limited Total Revenue (TR) Q P or P Output (Q) Q 8-12 Fig. 9-2 Revenues for a Price-Taking Firm Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 13 9.3 Short-Run Decisions The firm's objective is to maximize profits: Profits = TR – TC As the firm changes its level of output: • Firm's costs vary • Firm's total, average, and marginal revenue vary Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 14 Should the Firm Produce at All? If the firm produces nothing must pay its fixed costs (TFC) If the firm decides to produce must also pay the variable cost of production (TVC) receives revenue from sales (TR) A firm should produce only if at some level of output, TR exceeds TVC. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 15 Should the Firm Produce at All? A firm should produce only if at some level of output, price exceeds AVC. At the shut-down price the firm can just cover its average variable cost, and so is indifferent between producing and not producing. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 16 Fig. 9-3 Shut-Down Price for a Competitive Firm Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 17 How Much Should the Firm Produce? Suppose p > AVC firm does not shut down. To maximize profits, the firm chooses the output where MR = MC. But for a competitive firm, MR = p: The rule: choose output where p = MC. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 18 Fig. 9-4(i) Profit Maximization for a Competitive Firm The market determines the equilibrium price. The firm then picks the quantity of the output that maximizes its own profits. When the firm has reached q*, it has no incentive to change its output. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 19 Fig. 9-4(ii) Profit Maximization for a Competitive Firm The profit maximizing level of output is the point at which price (marginal revenue) equals marginal cost. When the firm has reached q*, it has no incentive to change its output. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 20 Self-Test LO3 Given the data for Marshall’s Meat Ltd., calculate total profits at each output. What are break-even and profit-maximizing outputs? Q 0 1 2 3 4 5 6 7 8 © 2012 McGraw-Hill Ryerson Limited P 50 50 50 50 50 50 50 50 50 TR TC 40 135 180 220 230 250 280 350 450 Tп 8-21 Self-Test LO4 The accompanying graph shows the costs for a perfectly competitive firm. a) What is the break-even price? b) What is the shutdown price? © 2012 McGraw-Hill Ryerson Limited 8-22 Short-Run Supply Curves Fig. 9-5 The Derivation of the Supply Curve for a Competitive Firm A competitive firm's supply curve is given by its marginal cost curve (at prices above AVC). Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 23 Fig. 9-6 The Derivation of a Competitive Industry's Supply Curve A competitive industry's supply curve is the horizontal summation of the individual MC curves (above minimum of AVC curves). Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 24 Self-Test LO5 Given the data for a competitive firm, what quantities will the firm produce at prices of $25, $35, $45, $55, $65, and $75? Output 0 1 2 3 4 5 6 7 8 © 2012 McGraw-Hill Ryerson Limited MC — $40 20 30 40 50 60 70 80 AVC — $40 30 30 32.5 36 40 44.3 48 8-25 Short-Run Equilibrium in a Competitive Market When an industry is in short-run equilibrium, two things are true: • market price is such that the market clears • each firm is maximizing its profits at this price But how large are each firm's profits in this SR equilibrium? There are three possibilities: Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 26 Case 1: Zero Economic Profits Fig. 9-8(ii) Alternative Short-Run Profits of a Competitive Firm The typical firm is just covering its costs, p = ATC. There is zero economic profit. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 27 Case 2: Positive Economic Profits Fig. 9-8(iii) Alternative Short-Run Profits of a Competitive Firm Typical firm maximizes profit at q*. Since p > ATC, the firm makes positive economic profits equal to the blue area. Positive profits means that this firm is earning more than it could in its next best alternative venture. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 28 Case 3: Negative Economic Profits (Losses) Fig. 9-8(i) Alternative Short-Run Profits of a Competitive Firm The typical firm maximizes its profits by producing at q*. But if p < ATC, the firm suffers losses equal to the red shaded area. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 29 MyEconLab www.myeconlab.com A firm that is maximizing its profit but still making losses is actually minimizing its losses. To see a detailed numerical example of a firm in such a situation, look for An Example of Loss Minimization as Profit Maximization in the Additional Topics section of this book's MyEconLab. APPLYING ECONOMIC CONCEPTS 9-2 The Parable of the Seaside Inn Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 30 9.4 Long-Run Decisions Entry and Exit If existing firms have positive economic profits, new firms have an incentive to enter the industry. If existing firms have zero profits, there are no incentives for new firms to enter, and no incentives for existing firms to exit. If existing firms have economic losses, there is an incentive for existing firms to exit the industry. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 31 Fig. 9-9(i) The Effect of New Entrants Attracted by Positive Profits Example: suppose there are positive profits at initial SR equilibrium: 1. Positive profits attract new firms. 2. Entry leads to an increase in supply and a decline in price. 3. Positive profits are eroded. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 32 How about negative profits, and exit? Fig. 9-10 The Effect of Exit Caused by Losses Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 33 Long-Run Equilibrium The LR industry equilibrium occurs when there is no longer any incentive for entry or exit (or expansion). In long-run equilibrium, all existing firms • must be maximizing their profits. • are earning zero economic profits. • are not able to increase their profits by changing the size of their production facilities. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 34 Fig. 9-11 Short-Run Versus Long-Run Profit Maximization for a Competitive Firm In LR equilibrium, competitive firms produce at the minimum point on their LRAC curves. At q0, the firm is maximizing short-run profits but not its long-run profits. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 35 Fig. 9-12 A Typical Competitive Firm When the Industry is in Long-Run Equilibrium Minimum Efficient Scale (MES) In LR competitive equilibrium, each firm's average cost of production is the lowest attainable, given the limits of known technology and factor prices. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 36 Consider a competitive industry that is in long-run equilibrium. Now suppose that the market demand for the industry's product increases. The price will rise, and profits will rise. Entry will then occur, and price will eventually fall. But what will the new long-run equilibrium look like? Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 37 MyEconLab www.myeconlab.com Copyright © 2014 Pearson Canada Inc. Demand shocks in competitive industries naturally lead to price changes. As prices change, firms' profits rise or fall, and these adjustments cause entry to or exit from the industry. After a new long-run equilibrium is reached, will the market price be at its initial level? The answer depends on the nature of costs within the industry. For more details, look for The Long-Run Industry Supply Curve in the Additional Topics section of this book's MyEconLab. 38 Changes in Technology Suppose technological development reduces the costs for newly built plants. New plants will earn economic profits, expand industry output and drive down price. The price will fall until it is equal to the SRATC of the new plants. Old plants may continue, but will earn losses. They will eventually exit. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 39 Fig. 9-13 Plants of Different Vintages in an Industry with Competitive Technological Progress Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 40 Declining Industries What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand? The efficient response is to continue operating with existing equipment as long as variable costs of production can be covered. As demand shrinks, so will capacity. Antiquated equipment in a declining industry is often the effect rather than the cause of the industry's decline. Copyright © 2014 Pearson Canada Inc. Chapter 9, Slide 41