Transcript ch08, lecture

Chapter 8
Perfect Competition
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
Who was Adam Smith?
The father of modern
economics who wrote
The Wealth of Nations,
published in 1776
2
What did Adam
Smith say about
competitive forces?
They are like an “invisible
hand” that leads people
who simply pursue their
own interests to serve
the interests of society
3
What is the purpose of
this chapter?
To explain how
competitive markets
determine prices,
output, and profits
4
What is
market structure?
A classification system for
the key traits of a market,
including the number of
firms, the similarity of the
products they sell, and the
ease of entry and exit
5
What is
perfect competition?
1. many small firms
2. homogeneous product
3. very easy entry and exit
4. price taker
6
What does
homogeneous mean?
Goods that cannot be
distinguished from one
another; for example,
one potato cannot be
distinguished from
another potato
7
What is a price taker?
A seller that has no
control over the price
of the product it sells
8
What determines price?
Supply and Demand
9
P Market Supply and Demand
$140
$130
$120
$100
$80
$60
$40
$20
S
DQ
5 10 15 20 25 30 35 40 45
10
What determines the
individual firm’s
demand curve?
A horizontal line at
the market price
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$140
$130
$120 Individual firm demand
$100
$80
$60
$40
$20
5 10 15 20 25 30 35 40 45
D
12
Why is this horizontal
line the firm’s
demand curve?
If the firm charges more
than this price, it will not
sell anything, and it has
no incentive to charge
less than this price
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Why does the firm
have no incentive to
charge less than the
market price?
It can sell everything
it brings to market
at the market price
14
What does the
perfectly competitive
firm control?
The only thing it
controls is how many
units it produces
15
How many units should
this firm produce?
The number of units
whereby it will maximize
its profits, or at least
minimize its losses
16
What are the two
methods to
determine how many
units to produce?
• TR and TC
• MR and MC
17
Using the total
revenue - total cost
method, where should
a firm produce?
Where the distance
between TR and
TC is the greatest
18
P
$500
Maximize Profit
TR
TC
$400
$300
$200
$100
Quantity of Output
1
2
3
4
5
Q
19
P
Maximize Profit Output
$150
$100
TR
$50
0
-$50
Quantity of Output
1
2
3
4
5
Q
20
What is
marginal revenue?
MR = TR / 1 output
21
What is
marginal cost?
MC = TC / 1 output
22
Using the marginal
revenue and marginal
cost method, where
should a firm produce?
MR = MC
23
Why should a firm
continue to produce
as long as MR > MC?
As long as MR is > than
MC, money is being
made on that last unit
24
Why will a firm not
produce that unit
where MR < MC?
At the unit of output where
MR < MC, money is
being lost on that last unit
25
Why does P = AR in
perfect competition?
Each additional unit sold
is adding the market
price to TR and TR
divided by P = AR
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Price & Cost per unit
$80
$70
$60
$50
$40
$30
$20
$10
MR=MC MC
ATC
P = MR = AR
Profit
AVC
1 2 3 4 5 6 7 8 9
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$70
$60
$50
$40
$30
$20
$10
Price & Cost per unit
P
MR=MC MC
Loss
ATC
AVC
P=MR=AR
1 2 3 4 5 6 7 8 9
Q
28
$70
$60
$50
$40
$30
$20
$10
Price & Cost per unit
P
Short-Run Shutdown
MC
ATC
AVC
Loss
P=MR=AR
MR=MC
1 2 3 4 5 6 7 8 9
Q
29
Firm will shut down
Price (MR) is below
minimum average
variable cost
30
What is the perfectly
competitive firm’s shortrun supply curve?
The firm’s marginal cost
curve above the minimum
point on its average
variable cost curve
31
P
$70
$60
$50
$40
$30
$20
$10
Firm’s Short-Run Supply Curve
MR3
MR2
MC ATC
AVC
MR1
1 2 3 4 5 6 7 8 9
Q
32
What is the industry’s
supply curve?
The summation of the
individual firm’s MC
curves that lie above their
minimum AVC points
33
P
$130
$120
$100
$80
$60
$40
$20
Industry Equilibrium
S = MC
5 10 15 20 25 30 35 40 45
Q
34
What is a normal profit?
The minimum profit
necessary to keep
a firm in operation
35
In the long-run,
what happens when
economic profits
are made?
When firms make more
than a normal profit, firms
enter the industry, as
supply increases, a
downward pressure is
put on prices
36
In the long-run, what
happens when
losses are made?
When firms make less than
a normal profit, firms leave
the industry, as supply
decreases, an upward
pressure is put on prices
37
In the long-run, where
is equilibrium?
At the market price
that enables firms to
make a normal profit
38
What exists at long-run
perfectly competitive
equilibrium?
P = MR = SRMC =
SRATC = LRAC
39
P
$70
$60
$50
$40
$30
$20
$10
Long-Run Competitive Equilibrium
Equilibrium SRMC
SATC
LRAC
MR
1 2 3 4 5 6 7 8 9
Q
40
P
$130
$120
$100
$80
$60
$40
$20
Industry Equilibrium
S = MC
D
5 10 15 20 25 30 35 40 45
Q
41
What different types
of industries can
exist in the long-run?
• Constant-cost
• Decreasing-cost
• Increasing-cost
42
What is a
constant-cost industry?
An industry in which the
expansion of industry
output by the entry of
new firms has no effect
on the firm’s cost curves
43
What does the longrun supply curve look
like in a constant-cost
industry?
It is perfectly elastic,
which is horizontal
44
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Initial equilibrium
price is restored
Perfectly elastic long-run
supply curve
45
What is a decreasingcost industry?
An industry in which the
expansion of industry
output by the entry of
new firms decreases
the firm’s cost curves
46
What does the long-run
supply curve look like
in a decreasing-cost
industry?
It is downward sloping
47
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Equilibrium price
and ATC decrease
Downward sloping long-run
supply curve
48
What is an increasingcost industry?
An industry in which the
expansion of industry
output by the entry of
new firms increases the
firm’s cost curves
49
What does the long-run
supply curve look like
in a increasing-cost
industry?
It is upward sloping
50
Increase in demand sets a
higher equilibrium price
Entry of new firms
increases supply
Equilibrium price
and ATC increase
Upward sloping long-run
supply curve
51
Key Concepts
52
Key Concepts
•
•
•
•
What is perfect competition?
What is a price taker?
What determines price?
What determines the individual firm’s demand
curve?
• Why does the firm have no incentive to charge
less than the market price?
• Using the marginal revenue and marginal cost
method, where should a firm produce?
53
Key Concepts cont.
• Why does MR = P in perfect competition?
• What is a normal profit?
• In the long-run, what happens when
economic profits are made?
• In the long-run, what happens when losses
are made?
• In the long-run, where is equilibrium?
• What different types of industries can exist
in the long-run?
54
Summary
55
Market structure consists of three
market characteristics: (1) the
number of sellers, (2) the nature
of the product, (3) the case of
entry into or exit from the market.
56
Perfect competition is a market
structure in which an individual
firm cannot affect the price of the
product it produces. Each firm in
the industry is very small relative
to the market as a whole, all the
firms sell a homogeneous
product, and firms are free to
enter and exit the industry.
57
A price-taker firm in perfect
competition faces a perfectly
elastic demand curve. It can sell
all it wishes at the marketdetermined price, but it will sell
nothing above the given market
price. This is because so many
competitive firms are willing to
sell at the going market price.
58
The total revenue-total cost
method is one way the firm
determines the level of output
that maximizes profit. Profit
reaches a maximum when the
vertical difference between the
total revenue and the total cost
curves is at a maximum.
59
P
$500
Maximize Profit
TR
TC
$400
$300
$200
$100
Quantity of Output
1
2
3
4
5
Q
60
The marginal revenue equals
marginal cost method is a second
approach to finding where a firm
maximizes profits. Marginal
revenue is the change in total
revenue from a one-unit change
in output. Marginal revenue for a
perfectly competitive firm equals
the market price.
61
The MR = MC rule states that the
firm maximizes profit or minimizes
loss by producing the output
where marginal revenue equals
marginal cost. If the price
(average revenue) is below the
minimum point on the average
variable cost curve, the MR = MC
rule does not apply, and the firm
shuts down to minimize its losses.
62
Price & Cost per unit
$80
$70
$60
$50
$40
$30
$20
$10
MR=MC MC
ATC
P = MR = AR
Profit
AVC
1 2 3 4 5 6 7 8 9
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$70
$60
$50
$40
$30
$20
$10
Price & Cost per unit
P
MR=MC MC
Loss
ATC
AVC
P=MR=AR
1 2 3 4 5 6 7 8 9
Q
64
$70
$60
$50
$40
$30
$20
$10
Price & Cost per unit
P
Short-Run Shutdown
MC
ATC
AVC
Loss
P=MR=AR
MR=MC
1 2 3 4 5 6 7 8 9
Q
65
The perfectly competitive firm’s
short-run supply curve is a curve
showing the relationship between
the price of a product and the
quantity supplied in the short run.
66
The individual firm always produces
along its marginal cost curve above
its intersection with the average
variable cost curve. The perfectly
competitive industry’s short-run
supply curve is the horizontal
summation of the short-run supply
curves of all firms in the industry.
67
P
$130
$120
$100
$80
$60
$40
$20
Industry Equilibrium
S = MC
5 10 15 20 25 30 35 40 45
Q
68
Long-run perfectly competitive
equilibrium occurs when the firm
earns a normal profit by
producing where price equals
minimum long-run average cost
equals minimum short-run
average total cost equals shortrun marginal cost.
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Long-Run Competitive Equilibrium
P
$70
$60
$50
$40
$30
$20
$10
Equilibrium
SRMC
SATC
LRAC
MR
1 2 3 4 5 6 7 8 9
Q
70
A constant-cost industry is an
industry whose total output can
be expanded without an increase
in the firm’s average total cost.
Because input prices remain
constant, the long-run supply
curve in a constant-cost industry
is perfectly elastic.
71
A decreasing-cost industry is an
industry in which lower input
prices result in a downwardsloping long-run supply curve. As
industry output expands, the
firm’s average total cost curve
shifts downward, and the long-run
equilibrium market price falls.
72
An increasing-cost industry is an
industry in which input prices rise
as industry output increases. As a
result, the firm’s average total
cost curve rises, and the long-run
supply curve for an increasingcost industry is upward sloping.
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Chapter 8 Quiz
©2002 South-Western College Publishing
74
1. A perfectly competitive market is not
characterized by
a. many small firms.
b. a great variety of different products.
c. free entry into and exit from the
market.
d. none of the above.
B. Perfect competition is characterized
by goods that cannot be
distinguished from one another.
75
2. Which of the following is a
characteristic of perfect competition?
a. Entry barriers.
b. Homogeneous products.
c. Expenditures on advertising.
d. Quality of service.
B. A homogeneous product is one that
cannot be distinguished from the
others, for example, one potato
looks just like another potato.
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3. Which of the following are the same at
all levels of output under perfect
competition?
a. Marginal cost and marginal
revenue.
b. Price and marginal revenue.
c. Price and marginal cost.
d. All of the above.
e. None of the above.
B. Price equals marginal revenue
because each unit is sold at the same
price; therefore, every additional unit
sold adds the price to total revenue.
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4. If a perfectly competitive firm sells 100
units of output at a market price of $100
per unit, its marginal revenue per unit is
a. $1.
b. $100.
c. more than $1, but less than $100.
d. less than $100.
B. Marginal revenue is defined as the
addition to total revenue when selling
one unit.
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5. Short-run profit maximization for a
perfectly competitive firm occurs
when the firm’s marginal cost
equals
a. average total cost.
b. average variable cost.
c. marginal revenue.
d. all of the above.
C. Profits are maximized or losses are
minimized at the unit of output where
MR = MC. If MR were > than MC, an
additional unit would be produced. If MR
were < MC, that last unit would not be
produced.
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6. A perfectly competitive firm sells its
output for $100 per unit, and the minimum
average variable cost is $150 per unit. The
firm should
a. increase output.
b. decrease output, but not shut down.
c. maintain its current rate of output.
d. shut down.
D. At this output a firm’s losses exceed its
fixed costs; it would therefore lose more
money by staying open than by closing
down.
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Price & Cost per unit
$80
$70
$60
$50
$40
$30
$20
$10
Short-Run Shutdown
MR=MC MC
ATC
AVC
P=MR=AR
1 2 3 4 5 6 7 8 9
81
7. A perfectly competitive firm’s supply
curve follows the upward sloping
segment of its marginal cost curve
above the
a. average total cost curve.
b. average variable cost curve.
c. average fixed cost curve.
d. average price curve.
B. The supply curve does not extend
below the AVC curve because
below this price the firm would
close down; there would not be a
supply curve.
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$20
$15
$10
$5
Price & Cost per unit
P
Exhibit 15
MC
D
C
B
ATC
AVC
A
500 1,000 1,500 2,000
Q
83
8. Assume the price of the firm’s
product in Exhibit 15 is $15 per
unit. The firm will produce
a. 500 units per week.
b. 1,000 units per week.
c. 1,500 units per week.
d. 2,000 units per week.
e. 2,500 units per week.
D. This is the number of units in
which MR = MC.
84
9. The lowest price in Exhibit 15 at which
the firm earns zero economic profit in
the short-run is
a. $5 per unit.
b. $10 per unit.
c. $20 per unit.
d. $30 per unit.
B. This is the minimum point of the
ATC curve at which P = ATC.
Exactly a normal profit is being
made, that is, zero economic profit.
85
10. Assume the price of the firm’s product in
Exhibit 15 is $6 per unit. The firm should
a. continue to operate because it is
earning an economic profit.
b. stay in operation for the time being
even though it is making an economic
loss.
c. shut down temporarily.
d. shut down permanently.
B. At this price, the firm’s losses are
less than its fixed costs; it will
therefore lose less money by staying
open than closing.
86
11. Assume the price of the firm’s
product in Exhibit 15 is $10 per unit.
The maximum profit the firm earns is
a. zero.
b. $5,000 per week.
c. $1,500 per week.
d. $10,500 per week.
A. In perfect competition, Price = AR =
MR = the firm’s short-run demand
curve. When P = ATC, the firm’s
revenues equal its costs, so zero
economic profits are made. Normal
profit is included as a part of the firm’s
cost data because it is a necessary
expense of operating the business. 87
12. In Exhibit 15, the firm’s total revenue
at a price of $10 per unit pays for
a. a portion of total variable costs.
b. a portion of total fixed costs.
c. none of the total fixed costs.
d. all of the total fixed costs.
D. At a price of $10, the firm is making an
economic profit - more than enough
money is being made to meet its fixed
costs.
88
13. As shown in Exhibit 15, the short-run
supply curve for this firm corresponds
to which segment of its marginal cost
curve?
a. A to D and all points above.
b. B to D and all points above.
c. C to D and all points above.
d. B to C only.
B. A supply curve shows how many
units will be produced at various
prices. The firm’s supply curve is its
MC curve which lies above its AVC
curve because it will always produce
where MR (AR, P) = MC.
89
14. In long-run equilibrium, the perfectly
competitive firm’s price equals which
of the following?
a. Short-run marginal cost.
b. Minimum short-run average total
cost.
c. Marginal revenue.
d. All of the above.
D. Long-run equilibrium is at the price
in which a normal profit is being
made. Normal profit is when P(AR) =
ATC in long-run equilibrium.
90
15. In a constant-cost industry, input
prices remain constant as?
a. the supply of inputs fluctuates.
b. firms encounter diseconomies of
scale.
c. workers become more
experienced.
d. firms enter and exit the industry.
D. A constant-cost industry is when the
entry or exit of firms has little impact
on a firm’s cost curves.
91
16. Suppose that , in the long run, the
price of feature films rises as the
movie production industry expands.
We can conclude that movie
production is a (an)
a. increasing-cost industry.
b. constant-cost industry.
c. decreasing-cost industry.
d. marginal-cost industry.
A. An industry in which the expansion
of industry output by the entry of new
firms increases the firm’s cost curves
92
17. Which of the following is true of a
perfectly competitive market?
a. If economic profits are earned,
then the price will fall over time.
b. In long-run equilibrium, P = MR =
SRMC = SRATC = LRAC.
c. A constant-cost industry exists
when the entry of new firms has no
effect on their cost curves.
d. All of the above.
D. All of the above statements are true.
93
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END
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