Transcript Definition of a Perfectly Competitive Market

PERFECTLY COMPETITIVE
MARKETS
Definition of a Perfectly
Competitive Market
• Very Large Number of Sellers and Buyers
• Identical (Homogeneous) Product
• Easy Entry/Easy Exit
• Perfect Information
Definition of a Perfectly
Competitive Market
A. Very Large Number of Sellers
–
Each firm produces an extremely small percent
of total market supply.
B. Identical Product
–
The product sold by one firm is identical to that
sold by another firm.
Definition of a Perfectly
Competitive Market Cont’
C. Easy Entry and Easy Exit
- Easy to enter this industry because costs are low.
- Also easy to quit this industry because of the low
costs.
D. Buyers and Sellers Have Perfect
Information
- All the buyers and sellers know all of the relevant
information.
Consequences of a Competitive
Market for the Firm
A. The Competitive Firm Is A Price Taker
- The firm must take the market price as given.
B. The Competitive Firm Has No Market
Power
- The firm is so small that it has no power to shape
the market in any way.
Consequences of a
Competitive Market for the
Firm Cont’
C. The Competitive Firm Has A Horizontal
Demand Curve
–
–
–
The firm must take the market price as given, and
then decide how much it can produce.
It can sell any level of output, but only at the market
price.
Whatever levels of output it sells at, the price will stay
the same.
The Profit Maximizing Rate
of Output
• We wish to answer the question:
– At what rate of output will a competitive firm
maximize its profits?
There Are Two Approaches
to Answer This Question
A. Total Revenue/Total Cost
B. Marginal Revenue/Marginal Cost
Total Revenue
• Total Revenue =
- Price times Sales or
- Price times Output
Average Revenue
• Average Revenue =
– Same as price for the competitive firm.
Marginal Revenue
• Marginal Revenue=
- The change in total revenue that comes
from selling one more unit of output.
Total Revenue/Total Cost
Approach
• Total Profits = Total Revenue Total Costs
• Total Revenue = Price * Output
= Price * Sales
• Total Costs
= Fixed Costs +
Variable Costs
Total Revenue/Total Cost
Approach
• Firms maximize profits where total
revenues are larger than total costs
by the largest amount.
The Marginal Cost/
Marginal Revenue Approach
• More important than the total cost total revenue
approach
• This is because firms use the approach to
determine exactly what level to produce at.
Recall That:
• Marginal Revenue =
- Change
sale.
in total revenue from one more
Marginal Cost
• Marginal cost will be defined as:
- Change
sale.
in total cost from one more
The Marginal Cost-Marginal
Revenue Approach Cont’
• The approach is to examine each sale to determine
whether the costs of production is less than, equal
to, or greater than, the revenues generated from
the sale of that unit.
Profit Maximization, Marginal
Cost/Marginal Revenue
Approach
• If a new sale from a new level of production
generates more revenues than costs, the firm
should produce at the new level.
• In this case marginal revenue is greater than
marginal cost.
Profit Maximization, Marginal
Cost/Marginal Revenue
Approach
• If a new sale from a new level of production
generates more costs than revenues, the firm
should not produce at the new level.
• In this case marginal cost is greater than marginal
revenue.
Profit Maximization for the
Competitive Firm Cont’
• Firms will expand output as long as:
MR>MC
• Firms will cut back output as long as:
MC>MR
• Firms will maximize profits at the output:
Where MC=MR
SHORT RUN
PROFITS AND LOSSES
Short Run Profits and Losses
A. As long as price is greater than the
minimum average total cost, the firm has
profits.
P > MIN ATC
Short Run Profits and Losses
B. The break-even price is the price that is
equal to the minimum ATC curve.
P = MIN ATC
Short Run Profits and Losses
Cont’
C. If price falls below minimum ATC, it will
suffer losses.
P < MIN ATC
THE SHUT DOWN
DECISION
Short Run Profits and Losses:
The Shut Down Price
A. If a firm shuts down, it will suffer a loss
equal to its fixed costs. Investors lose all
of their money.
B. As long as the firm can pay for some of its
fixed costs, it should continue to produce.
Short Run Profits and Losses:
The Shut Down Price
C. The shut down price is the price that is
just equal to the minimum average
variable cost.
P = MIN AVC
Short Run Profits and Losses:
The Shut Down Price Cont’
D. At any price above the minimum average
variable cost, the firm will lose money, but
less money than if it shuts down.
•
At any price below the minimum average
variable cost, the firm should shut down.
Summary of Price Decisions
• If P > MIN ATC, there will be profits.
• Produce where MR=MC
• If P = MIN ATC, the firm will break even.
• Produce where MR=MC
Summary of Price Decisions
Cont’
• If P < MIN ATC, but P > MIN AVC there will be
losses.
• Produce where MR = MC
• If P < MIN ATC, and P < MIN AVC then shut
down.
LONG RUN SUPPLY
Constant-Cost Industries
• An industry in which expansion or
contraction will not affect resource prices.
Therefore production costs will stay the
same.
Increasing-Cost Industry
• An industry in which expansion will lead to
a rise in resource prices and production
costs; and contraction leads to a fall in
resource prices and production costs
Decreasing-Cost Industry
• An industry in which expansion will lead to
a fall in resource prices and production
costs; and contraction leads to a rise in
resource prices and production costs.
TOTAL
FIXED VARIABLE
PRODUCT COSTS
COSTS
TOTAL
COSTS
0
150
1
350
2
510
3
630
4
710
5
750
6
930
7
1130
8
1350
9
1590
10
1850
MARGINAL
COSTS
AVG.
AVG.
FIXED VARIABLE
COSTS
COSTS
1)
Compute all costs
2)
If price is $186, compute revenues and profit max. level of output.
2)
If price is $136, compute revenues and profit max. level of output.
2)
If price is $106, compute revenues and profit max. level of output.
AVG.
TOTAL
COSTS