Transcript O`Sullivan, Sheffrin, Perez: Economics: Principles, Applications, and

Perfect Competition
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,
KYLE THIEL & APARNA SUBRAMANIAN
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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PERFECT COMPETITION
• perfectly competitive market
A market with many sellers and
buyers of a homogeneous product
and no barriers to entry.
• price taker
A buyer or seller that takes the
market price as given.
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PERFECT COMPETITION
Here are the five features of a perfectly competitive
market:
1 There are many sellers.
2 There are many buyers.
3 The product is homogeneous.
4 There are no barriers to market entry.
5 Both buyers and sellers are price takers.
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Extra Application 6
COFFEE WARS
Starbucks, the current heavyweight of the upscale coffee world with 8,600 stores, is being
challenged by Dunkin’ Donuts. The doughnut chain currently maintains 4,400 stores but
plans to open 10,000 more outlets by 2020.
• Many of the upscale coffee houses, and their patrons, do not view Dunkin’ Donuts as
competition.
• Others indicated they prefer Dunkin’ Donuts coffee over Starbucks.
• The new Dunkin’ Donuts outlets have a new image…more urban and upscale.
Can this market accommodate a new entrant?
It is my belief that consumers buy the coffee and the
atmosphere of the coffee house. Starbucks will view Dunkin’
Donuts as a competitive threat if the company believes they
appeal to the same market. New entrants will push the
supply curve to the right and result in a lower price.
However, I believe Starbucks will attempt to reinforce its
image as the upscale coffee house where higher income
individuals should be seen. If this is the case, then the
market is actually for coffee houses, and not coffee.
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6.1
PREVIEW OF THE FOUR MARKET STRUCTURES
• firm-specific demand curve
A curve showing the relationship
between the price charged by a
specific firm and the quantity the
firm can sell.
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6.1
PREVIEW OF THE FOUR MARKET STRUCTURES
 FIGURE 6.1
Monopoly Versus Perfect Competition
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6.1
PREVIEW OF THE FOUR MARKET STRUCTURES
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6.2
THE FIRM’S SHORT-RUN OUTPUT DECISION
The Total Approach: Computing Total Revenue and Total
Cost
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6.2
THE FIRM’S SHORT-RUN OUTPUT DECISION
The Total Approach: Computing Total Revenue and Total
Cost
► FIGURE 6.2
Using the Total Approach to
Choose an Output Level
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6.2
THE FIRM’S SHORT-RUN OUTPUT DECISION
The Marginal Approach
• marginal revenue
The change in total revenue from
selling one more unit of output.
marginal revenue = price
To maximize profit, produce the quantity where price = marginal cost
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6.2
THE FIRM’S SHORT-RUN OUTPUT DECISION
The Marginal Approach
 FIGURE 6.3
The Marginal Approach to Picking an Output Level
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6.2
THE FIRM’S SHORT-RUN OUTPUT DECISION
Economic Profit and the Break-Even Price
economic profit = (price − average cost) × quantity produced
• break-even price
The price at which economic profit is
zero; price equals average total cost.
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6.3
THE FIRM’S SHUT-DOWN DECISION
Total Revenue, Variable Cost, and the Shut-Down
Decision
operate if total revenue > variable cost
shut down if total revenue < variable cost
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6.3
THE FIRM’S SHUT-DOWN DECISION
Total Revenue, Variable Cost, and the Shut-Down
Decision
► FIGURE 6.4
The Shut-Down Decision and
the Shut-Down Price
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6.3
THE FIRM’S SHUT-DOWN DECISION
The Shut-Down Price
operate if price > average variable cost
shut down if price < average variable cost
• shut-down price
The price at which the firm is
indifferent between operating and
shutting down; equal to the minimum
average variable cost.
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6.3
THE FIRM’S SHUT-DOWN DECISION
Fixed Costs and Sunk Costs
• sunk cost
A cost that a firm has already paid or
committed to pay, so it cannot be
recovered.
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THE BREAK-EVEN PRICE FOR A CORN FARMER
APPLYING THE CONCEPTS #1: What is the break-even price?
To illustrate the notions of break-even and shut-down
prices, let’s look at these prices for the typical corn farmer.
• The break-even, or zero-profit, price is $0.72 per bushel.
• At this price, the farmer will produce at the minimum point of the average total-cost
curve, with the average cost equal to the market price of $0.72.
• At a higher price, the farmer will make a positive economic profit.
• The corn farmer’s shut-down price is $0.44.
• At a price between the shut-down price ($0.44) and the break-even price ($0.72),
the farmer will lose money but will continue to operate at a loss because total
revenue will exceed the variable cost of growing corn.
In the long run, farmers will exit the market if the price stays below the break-even
price of $0.72.
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6.4
SHORT-RUN SUPPLY CURVES
The Firm’s Short-Run Supply Curve
• short-run supply curve
A curve showing the relationship
between the market price of a
product and the quantity of output
supplied by a firm in the short run.
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6.4
SHORT-RUN SUPPLY CURVES
The Firm’s Short-Run Supply Curve
 FIGURE 6.5
Short-Run Supply Curves
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6.4
SHORT-RUN SUPPLY CURVES
The Short-Run Market Supply Curve
• short-run market supply curve
A curve showing the relationship
between market price and the
quantity supplied in the short run.
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6.4
SHORT-RUN SUPPLY CURVES
Market Equilibrium
 FIGURE 6.6
Market Equilibrium
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6.4
SHORT-RUN SUPPLY CURVES
Market Equilibrium
For a short-run equilibrium, two conditions are satisfied:
1 At the market level, the quantity of the product supplied equals the
quantity demanded. The demand curve intersects the short-run market
supply curve at a price of $7 and a quantity of 600 shirts per minute
(Panel A).
2 The typical firm in the market maximizes its profit, given the market
price. Given the market price of $7, each of the 100 firms maximizes
profit by producing 6 shirts per minute (Panel B).
The market reaches a long-run equilibrium when the two conditions for
short-run equilibrium are met, and a third long-run condition holds as well.
3 Each firm in the market earns zero economic profit, so there is no
incentive for existing firms to leave the market and no incentive for other
firms to enter the market.
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WIRELESS WOMEN IN PAKISTAN
APPLYING THE CONCEPTS #2: How do entry costs affect the number
of firms in a market?
In Pakistan, many poor villagers cannot afford their own
phones, and phone service is provided by thousands of
“wireless women,” entrepreneurs who invest $310 in wireless
phone equipment (transceiver, battery, charger), a signboard,
a calculator, and a stopwatch.
• They sell phone service to their neighbors, charging by the minute and second.
• On average, their net income is about $2 per day, about three times the average
per capita income in Pakistan.
The market for phone service has the features of a perfectly competitive market, with
easy entry, a standardized good, and a large enough number of suppliers that each
takes the market price as given.
In contrast, to enter the phone business in the United States, your initial investment
would be millions, or perhaps billions, of dollars, so the market for phone service is
not perfectly competitive.
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6.5
THE LONG-RUN SUPPLY CURVE FOR AN
INCREASING-COST INDUSTRY
• long-run market supply curve
A curve showing the relationship
between the market price and
quantity supplied in the long run.
• increasing-cost industry
An industry in which the average
cost of production increases as the
total output of the industry increases;
the long-run supply curve is
positively sloped.
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Extra Application 7
ORACLE’S QUEST FOR GREATER EFFICIENCY
Oracle Corporation’s recent takeover of rival Siebel Systems Inc. has spurred substantial
job cuts. Oracle is expected to cut between 1,000 and 2,000 jobs that are primarily in
functional areas that represent duplication of efforts. Oracle currently employs 51,000
original Oracle employees and the additional 4,700 Siebel employees.
• The reduction in work force could cost some Oracle employees their jobs as the
company attempts to boost profits via the downsizing.
• The company’s cost-cutting moves are an attempt to compete with rival SAP in
business application software.
• Shareholders are not overly impressed with Oracle stock closing only 20 cents a
share higher after the announcement.
Oracle Corporation’s acquisition of Siebel has allowed the
software firm to reduce average total costs via reduction in
labor force. Many jobs in the now-merged company had
substantial overlap and Oracle can reduce costs by
eliminating duplicate positions. Oracle’s total output will be
higher but the long-run average cost per unit should
decline. Oracle will benefit from additional economies of
scale as production and costs move from point a to point b.
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6.5
THE LONG-RUN SUPPLY CURVE FOR AN
INCREASING-COST INDUSTRY
The average cost increases as the industry grows for two reasons:
1
Increasing input price. As an industry grows, it competes with
other industries for limited amounts of various inputs, and this
competition drives up the prices of these inputs.
2
Less productive inputs. A small industry will use only the most
productive inputs, but as the industry grows, firms may be forced to
use less productive inputs.
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6.5
THE LONG-RUN SUPPLY CURVE FOR AN
INCREASING-COST INDUSTRY
Production Cost and Industry Size
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6.5
THE LONG-RUN SUPPLY CURVE FOR AN
INCREASING-COST INDUSTRY
Drawing the Long-Run Market Supply Curve
 FIGURE 6.7
Long-Run Market Supply Curve
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6.6
SHORT-RUN AND LONG-RUN EFFECTS
OF CHANGES IN DEMAND
The Short-Run Response to an Increase in Demand
 FIGURE 6.8
Short-Run Effects of an Increase in Demand
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6.6
SHORT-RUN AND LONG-RUN EFFECTS
OF CHANGES IN DEMAND
The Long-Run Response to an Increase in Demand
 FIGURE 6.9
Short-Run and Long-Run Effects
of an Increase in Demand
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ZONING, LAND PRICES, AND THE SUPPLY CURVE FOR
APARTMENTS
APPLYING THE CONCEPTS #5: When input prices increase with
the total output of the industry, what are the implications for the
market supply curve?
In many communities, the rental-apartment industry is an
increasing-cost industry. As the industry expands by building
more apartments, competition is fierce among firms for the small
amount of land zoned for apartments.
What are the implications of zoning for a market that experiences an increase in
demand?
In the short run, the stock of housing is fixed. An increase in demand for
apartments will increase the price of apartments (the monthly rent), and firms will
convert some owner-occupied houses to rental apartments.
In the long run, firms will enter the market by building more apartments. The
increase in demand leads to a net increase in price because zoning restricts the
supply of apartment land, leading to higher land prices and a higher cost of
producing apartments.
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6.7
LONG-RUN SUPPLY FOR A
CONSTANT-COST INDUSTRY
• constant-cost industry
An industry in which the average cost
of production is constant; the longrun supply curve is horizontal.
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6.7
LONG-RUN SUPPLY FOR A
CONSTANT-COST INDUSTRY
Long-Run Supply Curve for a Constant-Cost Industry
 FIGURE 6.10
Long-Run Supply Curve for a
Constant-Cost Industry
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6.7
LONG-RUN SUPPLY FOR A
CONSTANT-COST INDUSTRY
Hurricane Andrew and the Price of Ice
► FIGURE 6.11
Hurricane Andrew and the
Price of Ice
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