Download Competitive Equilibrium

Review
Perfect
Competition
Market
© 2008 Pearson Addison Wesley. All rights reserved
Competition
• Competition is a common market
structure that has very desirable
properties, so it is useful to
compare other market structures
to competition.
© 2008 Pearson Addison Wesley. All rights reserved.
8-2
Price Taking
• Economists say that a market is
competitive if each firm in the
market is a price taker: a firm that
cannot significantly affect the
market price for its output or the
prices at which it buys its inputs.
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8-3
Figure 8-3
How a
Competitive Firm
Maximizes Profit
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8-4
Figure 8.4
The Short-Run Shutdown Decision
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8-5
Short-Run Firm Supply
Curve
• Tracing Out the Short-Run Supply
Curve
–The competitive firm’s short-run
supply curve is its marginal cost
curve above its minimum
average variable cost.
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8-6
Figure 8.5
How the Profit-Maximizing Quantity Varies
with Price
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8-7
Short-Run Competitive
Equilibrium
• By combining the short-run market
supply curve and the market
demand curve, we can determine
the short-run competitive
equilibrium.
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8-8
Figure 8.9
Short-Run Competitive Equilibrium in
the Lime Market
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8-9
Long-Run Firm Supply
Curve
• A firm’s long-run supply curve is
its long-run marginal cost curve
above the minimum of its long-run
average cost curve (because all
costs are variable in the long run).
© 2008 Pearson Addison Wesley. All rights reserved.
8-10
Figure 8.10
The Short-Run and Long-Run Supply Curves
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8-11
Role of Entry and Exit
• The number of firms in a market in
the long run is determined by the
entry and exit of forms.
–A firm enters the market if it can
make a long-run profit, p > 0.
–A firm exits the market to avoid a
long-run loss, p < 0.
© 2008 Pearson Addison Wesley. All rights reserved.
8-12
Figure 8.12
Long-Run Market Supply in an IncreasingCost Market
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8-13
Long-Run Competition
Equilibrium
• The intersection of the long-run
market supply and demand curves
determines the long-run
competitive equilibrium.
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8-14
Figure 8.14
The Short-Run and Long-Run Equilibria for
Vegetable Oil
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8-15
Properties of the Competitive
Model
• Properties of the Competitive Model
– Zero Profit for Competitive Firms in the
Long Run
– Competition Maximizes Welfare
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9-2
Zero Profit for Competitive
Firms in the Long Run
• Competitive firms earn zero profit
in the long run whether or not
entry is completely free.
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9-3
How Competition
Maximizes Welfare
• How should we measure society’s
welfare?
• One commonly used measure of the
welfare of society, W, is the sum of
consumer surplus plus producer
surplus:
W = CS + PS
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9-4
Figure 9.3
Why Reducing Output from the
Competitive Level Lowers Welfare
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9-5
Figure 9.4
Why Increasing Output from the
Competitive Level Lowers Welfare
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9-6
Review
General
Equilibrium of the
Perfectly
Competitive Model
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Figure 10.3
Contract Curve
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10-2
Mutually Beneficial Trades
• Indifference curves are also tangent at
Bundles b , c , and d , so these
allocations, like f , are Pareto efficient.
• By connecting all such bundles, we
draw the contract curve: the set of all
Pareto-efficient bundles.
© 2008 Pearson Addison Wesley. All rights reserved.
10-3
Competitive Exchange
• The First Theorem of Welfare
Economics
– The competitive equilibrium is efficient:
Competition results in a Paretoefficient allocation—no one can be
made better off without making
someone worse off—in all markets.
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10-4
Competitive Exchange
• The Second Theorem of Welfare
Economics
– Any efficient allocations can be
achieved by competition: All possible
efficient allocations can be obtained
by competitive exchange, given an
appropriate initial allocation of goods.
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10-5
Figure 10.4(a)
Competitive Equilibrium
© 2008 Pearson Addison Wesley. All rights reserved.
10-6
The Efficiency of
Competition
• The first welfare theorem tells us that
society can achieve efficiency by
allowing competition.
• The second welfare theorem adds that
society can obtain the particular
efficient allocation it prefers based on
its value judgments about equity by
appropriately redistributing
endowments (income).
© 2008 Pearson Addison Wesley. All rights reserved.
10-7
Efficient Product Mix
• Optimal Product Mix.
– The optimal product mix, a , could be
determined by maximizing an individual’s
utility by picking the allocation for which
an indifference curve is tangent to the
production possibility frontier.
– It could also be determined by picking the
allocation where the relative competitive
price, pc / p f , equals the slope of the PPF.
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10-8
Figure 10.6
Optimal Product Mix
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10-9
Efficient Product Mix
• The marginal rate of transformation
along this smooth PPF tells us about
the marginal cost of producing one
good relative to the marginal cost of
producing the other good.
MCc
MRT  
MCw
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10-10
Competition
• Each price-taking consumer picks a
bundle of goods so that the
consumer’s marginal rate of
substitution equals the slope of the
consumer’s price line (the negative of
the relative prices):
pc
MRS  
pw
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10-11
Competition
• If candy and wood are sold by
competitive firms, pc  MCc and pw  MCw
in the competitive equilibrium, the MRS
equals the relative prices, which equals
the MRT:
pc
MRS  
 MRT
pw
© 2008 Pearson Addison Wesley. All rights reserved.
10-12
Competition
• Because competition ensures that the
MRS equals the MRT, a competitive
equilibrium achieves an efficient product
mix: The rate at which firms can transform
one good into another equals the rate at
which consumers are willing to substitute
between the goods, as reflected by their
willingness to pay for the two goods.
• In this competitive equilibrium, supply
equals demand in all markets.
• The consumers buy the mix of goods at f .
© 2008 Pearson Addison Wesley. All rights reserved.
10-13
Figure 10.7
Competitive Equilibrium
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10-14
Efficiency and Equity
• Role of the Government
– By altering the efficiency with which goods
are produced and distributed and the
endowment of resources, governments
help determine how much is produced and
how goods are allocated.
– By redistributing endowments or by
refusing to do so, governments, at least
implicitly, are making value judgments
about which members of society should
get relatively more of society’s goodies.
© 2008 Pearson Addison Wesley. All rights reserved.
10-15