Transcript Document

Chapter 8
Perfect Competition
© 2009 South-Western/ Cengage Learning
An Introduction to Perfect
Competition
• Market structure determinants
– Number of buyers/sellers
– Product’s degree of uniformity
– Ease of entry into the market
– Forms of competition among firms
• Industry
– All firms supplying output to a market
2
•2
Perfectly Competitive Market
Structure
• Theoretical construct, difficult to find in the real
world
• Many buyers and sellers
• Commodity; standardized product
• Fully informed buyers and sellers
• No barriers to entry
• Individual buyer or seller
– No control over price
– Price takers
•3
Demand Under Perfect Competition
• Market price
– Determined by market supply and and demand
• Demand curve facing one supplier
– Horizontal line at the market price
– Perfectly elastic
• The individual firm is a price taker
•4
Exhibit 1
Market equilibrium and a firm’s demand curve in
perfect competition
(b) Firm’s demand
(a) Market equilibrium
$5
D
Price per bushel
Price per bushel
S
$5
d
0
5
10 15 Bushels of
1,200,000 Bushels of
wheat per day
wheat per day
Market price ($5)- determined by the intersection of the market demand and
market supply curves. A perfectly competitive firm can sell any amount at that
price. The demand curve facing the perfectly competitive firm - horizontal at 5
the market price.
0
Short Run Profit Maximization
• Maximize economic profit
– Quantity at which total revenue (TR) exceeds total
cost (TC) by the greatest amount
• Profit = TR – TC
– If TR > TC: economic profit
– If TC > TR: economic loss
– If TC = TR: zero economic profit, normal profit
•6
Short Run Profit Maximization
• Marginal revenue (MR) = P = AR (perfect
competition)
• Marginal cost (MC)—upward sloping
• Maximize economic profit:
– Increase production as long as each additional unit
adds more to MR than MC
• Golden rule
– Expand output: MR>MC
– Contract output: MR < MC
– Stop when MC=MR
•7
Exhibit 3
Short-run profit maximization
Total dollars
Total cost
$60
(a)Total revenue minus
total cost
TR: straight line, slope=5=P
TC increases with output
Max Economic profit:
where TR exceeds TC by
the greatest amount
Maximum economic
profit = $12
48
15
0
Dollars per bushel
Total revenue
(=$5 × q)
5
7
10 12 15
e
$5
4
Bushels of wheat per day
Marginal cost
Average total cost
(b) Marginal cost equals
marginal revenue
d = Marginal revenue
MR: horizontal line at P=$5
= Average revenue
Profit
Max Economic profit:
at 12 bushels,
where MR=MC
a
0
5
7
10 12 15
Bushels of wheat per day
8
SHORT RUN PROFIT
MC = MR
MC
Cost
Market sales price = marginal revenue (MR)
P1
ATC
Total Economic Profit = (P1 – C1) x Q1
C1
AVC
Q1
QUANTITY
9
Minimizing Short-Run Losses
• Total Cost (TC) = Fixed cost (FC) + Variable cost
(VC)
• Shut down in short run: pay fixed cost
• If TC<TR: economic loss
– Produce if TR>VC (P>AVC)
• Revenue covers variable costs and a portion of fixed
cost
• Loss < fixed cost
– Shut down if TR<VC (P<AVC)
• Loss = FC
•10
Exhibit 5
Short-run loss minimization
Total revenue
(=$3 × q)
Total dollars
Total cost
$40
30
TC>TR; loss
Minimize loss: 10 bushels
Minimum economic
loss = $10
15
0
5
10
15
Marginal cost
Dollars per bushel
(a)Total revenue minus
total cost
$4.00
3.00
2.50
0
Bushels of wheat per day
Average total cost
(b) Marginal cost equals
marginal revenue
Average variable cost
Loss
5
e
10
d = Marginal revenue
= Average revenue
15
Bushels of wheat per day
MR=MC=$3; ATC=$4
P=$3; P>AVC
Continue to produce
in short run
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SHORT RUN LOSS--PRODUCE
MC
Cost
ATC
ATC1
Economic Loss – C1 > P1
P1
MC=MR
Market price –Marginal Revenue (MR)
AVC
AVC1
Q1
Quantity
SHORT RUN LOSS—SHUT DOWN
MC
Cost
ATC
Loss on fixed
cost
AVC
Loss on average variable cost
P1
Market price – marginal revenue
MC = MR
QUANTITY
Firm and Industry Short-Run S curves
• Short-run firm supply curve
– Upward sloping portion of MC curve
– Above minimum AVC curve
• Short-run industry supply curve
– Horizontal sum of all firms’ short-run supply curves
•14
Exhibit 6
Summary of short-run output decisions
Break-even
Firm’s short run S curve
Marginal cost
point
5
p5>ATC, q5, economic profit
d5
Average total cost
4
p4=ATC, q4, normal profit
d4
Average variable cost
3
ATC>p3>AVC, q3, loss <FC
d3
2
p2=AVC, q2 or 0, loss=FC
d2
1
d1
p1<AVC, shut down,
Shutdown
q1=0,loss=FC
point
Dollars per unit
p5
p4
p3
p2
p1
0
q1
q2 q3 q4 q5
Quantity per period
15
Exhibit 7
Aggregating individual supply to form market supply
Price per unit
(a) Firm A
(b) Firm B
SA
(c) Firm C
SB
(d) Industry, or market, supply
SC
SA + SB + SC = S
p’
p’
p’
p’
p
p
p
p
0
10 20
0
Quantity
per period
10 20
0
Quantity
per period
10 20
Quantity
per period
0
30
60
Quantity per period
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Firm Supply and Market Equilibrium
• Short run, perfect competition
– Market converges to equilibrium P and Q based on
market supply and demand
– Options available to the firm
• Max profit
• Min loss
• Shuts down temporarily
•17
Exhibit 8
(a) Firm
MC = s
ATC
$5
4
d
AVC
Profit
(b) Industry, or market
Price per unit
Dollars per unit
Short-run profit maximization and market equilibrium
∑ MC = S
$5
D
0
5
10 12
Bushels of
wheat per day
Market price $5 determines the perfectly
elastic demand curve (and MR) facing
the individual firm.
0
Bushels of
1,200,000
wheat per day
S = horizontal sum of the supply curves
of all firms in the industry
Intersection of S and D: market price $5
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Perfect Competition in the Long Run
• Long run
– Firms enter/exit the market
– Firms adjust scale of operations
• Until average cost is minimized
– All resources are variable
•19
Perfect Competition in the Long Run
• Economic profit in short run
– New firms enter market in long run
– Existing firms expand in long run
– Market supply increases—supply curve shifts to
the right
• P decreases
• Economic profit disappears
• Firms break even—price decreases to the minimum of
the ATC curve
•20
Perfect Competition in the Long Run
• Economic loss in short run
– Some firms exit the market in long run
– Some firms reduce scale in long run
– Market supply decreases—supply curve shifts to
the left
• P increases
• Economic loss disappears
• Firms break even--price increases to the minimum of
the ATC curve
•21
Zero Economic Profit in the Long Run
• Firms enter, leave, change scale
• Market:
– supply shifts; price changes
• Firm
– d(P=MR=AR) shifts
– Long run equilibrium
• MR=MC =ATC=LRAC
• Normal profit
• Zero economic profit
•22
Exhibit 9
Long-run equilibrium for a firm and the industry
(a) Firm
(b) Industry, or market
S
ATC
LRAC
e
p
d
Price per unit
Dollars per unit
MC
p
D
0
q
Quantity
per period
0
Q
Quantity
per period
Long run equilibrium: P=MC=MR=ATC=LRAC. No reason for new firms to
enter the market or for existing firms to leave. As long as the market
demand and supply curves remain unchanged, the industry will continue to
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produce a total of Q units of output at price p.
Long-Run Adjustment to a Change in D
• Effects of an Increase in Demand
– Short run
• market demand increases, P increases
• Firms increase quantity supplied
• Economic profit
– Long run
•
•
•
•
New firms enter the market
Market supply increases, P decreases
Firm’s horizontal demand curve decreases
Normal profit
•24
Exhibit 10
Long-run adjustment to an increase in demand
(a) Firm
(b) Industry, or market
S
d’
ATC
LRAC
p’
Profit
p
d
Price per unit
Dollars per unit
MC
S’
b
p’
a
c
p
S*
D’
D
0
q
q’
Quantity
per period
0
Qa Qb
Qc
Quantity
per period
Increase in D to D’ moves the market equilibrium point from a to b; firm’s
demand increases to d’; economic profit in short run.
Long run: new firms enter the industry; supply increases to S’; price
drops back to p; firm’s demand drops back to d
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Long-Run Adjustment to a Change in D
• Effects of a Decrease in Demand
– Short run
• Market demand decreases, P decreases
• Firms decrease quantity supplied
• Economic loss
– Long run
•
•
•
•
Firms exit the market
Market supply decreases, P increases
Firm’s demand curve increases
Normal profit
•26
Exhibit 11
Long-run adjustment to a decrease in demand
(a) Firm
(b) Industry, or market
S’’
ATC
LRAC
d
p
p’’
0
Loss
q’’
d’’
q
Quantity
per period
Price per unit
Dollars per unit
MC
g
a
S*
p
p’’
0
S
f
Qg
Qf
D’’
Qa
D
Quantity
per period
Decrease in D to D’’ moves the market equilibrium point from a to f; firm’s
demand decreases to d’’; economic loss in short run.
Long run: firms exit the industry; supply decreases to S’’; price
increases back to p; firm’s demand rises back to d
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The Long-Run Industry Supply Curve
• Short run
– Change quantity supplied along MC curve
• Long run industry supply curve S*
– Perfectly horizontal at the minimum of the ATC
curve (break even price)
• Constant-cost industries
– LRAC doesn’t shift with output
– Long run S* curve for industry: straight horizontal
line
•28
Increasing Cost Industries
– Average costs increase as output expands
• Effects of an increase in demand
– Short run
• Market demand increases; P increases;
• Firms increase output; Economic profit
– Long run
• New firms enter the market;
• Market: supply increases; price decreases
• Firm: MC and ATC increase (shift upward), higher
minimum of ATC curve
•29
Exhibit 12
An increasing-cost industry
(a) Firm
(b) Industry, or market
MC
S
pc
b ATC’
db
ATC
dc
pa
da
pb
c
a
Price per unit
Dollars per unit
MC’
S*
b
pb
pc
S’
a
c
pa
D’
D
0
q
qb
Quantity
per period
0
Qa Qb Qc
Quantity
per period
D increases to D’, new short-run equilibrium: point b. Higher price pb; firm’s
demand curve shifts up (db); economic profit, which attracts new firms.
Input prices go up, MC and ATC curves shift up.
Market S increases to S’; new price pc, firm’s demand curve shifts
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down to dc; normal profit.
Perfect Competition and Efficiency
• Productive efficiency: Making Stuff Right
– Produce output at the least possible cost
• Min point on LRAC curve
• P = min average total cost in long run
• Allocative efficiency: Making the Right Stuff
– Produce output that consumers value most
• Marginal benefit = P = Marginal cost
• Allocative efficient market
•31
What’s So Perfect About Perfect
Competition?
• Consumer surplus
• Consumers pay less (P) than they are willing to pay
(along D curve)
• Producer surplus
• Producers are willing to accept less (along S curve; MC)
than what they are receiving (P)
• Gains from voluntary exchange
• Consumer and producer surplus
• Productive and allocative efficiency
• Maximum social welfare
•32
Exhibit 13
Dollars per unit
Consumer surplus and producer surplus for a
competitive market
$10
6
5
Consumer surplus: area above the
market-clearing price ($10) and
S below the demand.
Consumer
surplus
e
Producer
surplus
m
0
Producer surplus: area above the
short-run market supply curve and
below the market-clearing price
100,000
200,000
120,000
D
At p=$5: no producer surplus; the
price just covers each firms AVC.
At p=$6: producer surplus is the area
between $5, $6, and S curve.
Quantity
per period
33